No Matter What Tarullo Says, More Regulation Will Not Make Us Safer

Federal Reserve Governor Daniel Tarullo has announced that the Fed is about to propose new capital requirements for large banks.

The New York Times reports that these new “special” requirements will be more stringent than the international regulations being promulgated, something that is not entirely unexpected given previous announcements.

However, Tarullo also made this statement to the Senate Banking Committee: “We intend to improve the resiliency of these firms. This measure might also create incentives for them to reduce their systemic footprint and risk profile.”

This statement highlights two persistent myths regarding the recent financial crisis: deregulation caused the crisis, and new regulations can fix it.

First, Fed officials have no particular advantage over anyone else when it comes to figuring out what a bank should invest in or which loans—or how many—it should make.

Second, financial firms were not deregulated leading up to the crisis. In fact, the Fed’s regulatory power—along with that of all federal financial regulators—has been steadily increasing for nearly a century.

To be sure, the precise nature of these regulations has certainly evolved over the years. But financial regulators did not take a vacation starting in the Reagan years.

In the 1980s, interest rate ceilings on deposits were phased out, and “thrifts” were allowed to make commercial loans and offer new products. But these changes did not constitute deregulation.

In the 1990s, interstate branch banking was phased in, and bank holding companies were allowed to affiliate with companies engaged in investment banking. But these activities were still regulated.

In the 2000s, the Securities and Exchange Commission (SEC) amended its net capital rule, and Congress passed the Commodity Futures Modernization Act (CFMA). But the SEC still required brokered dealers to follow a rule, and the CFMA was passed to clarify (among other things) which regulator—the SEC or the Commodity Futures Trading Commission—would regulate single stock futures contracts.

In other words, financial firms were not deregulated.

This deregulation notion is particularly silly with regard to the Fed, an agency that has been regulating banks since it was created. The Fed even had a hand in crafting the very capital requirements that contributed to the 2008 meltdown because regulators thought mortgage-backed securities were so safe.

All the Dodd–Frank Act has really done is increase the scope of the Fed’s regulatory power, so there’s really no reason to expect a different outcome in the next crisis.