Tarullo May Be Key to Economic Team

He's probably the least-noted member of Barack Obama's new financial regulatory police, but Dan Tarullo may end up having the most impact. Think of Tarullo as the anti-Greenspan, or perhaps as a pro-regulation virus planted in the heart of a Federal Reserve System that for two decades has been predisposed to letting markets self-correct. Certainly Tarullo—who was named Thursday to fill one of two open spots on the seven-member Board of Governors—is far from you run-of-the-mill Fed official. Most governors have been academic economists, bankers or businessmen. Tarullo, a Georgetown law professor who specializes in bank regulation and international monitoring, is basically a high-toned cop. "Our regulatory system has let us down," he said on PBS's Lehrer show last April, before the worst of the subprime fallout hit. "We've had multiple opportunities in the last 10 or 15 years to take account of the new forms of financial activity. We haven't done so."

Most media attention is focused on Obama's nomination of Mary Schapiro, a tough-minded former futures regulator, to head the Securities and Exchange Commission, and Gary Gensler, a Treasury undersecretary in the Clinton administration, to chair the Commodities Futures Trading Commission. But those two may end up waiting on direction from the new super-empowered Fed. Many experts agree that one reason the subprime securitization disaster occurred is because it cut across so many once-segregated sectors; mortgage lending and securitization were once entirely separate practices. The SEC, for example, is only supposed to oversee publicly issued securities, and can't do anything about lending practices. Only the Federal Reserve Board can monitor the entire financial landscape. As a result, Tarullo could potentially play a bigger role than either Schapiro or Gensler in the future financial system, some experts say. "It just depends on what deal was made" with Federal Reserve Chairman Ben Bernanke, "or whether there was a deal," says Ted Truman, a former senior Fed official. "It's not automatic that someone with that kind of expertise would immediately have a role in banking policy. Board members are assigned in terms of seniority."

Bernanke, a conservative, has already expanded regulation. Under the Home Ownership and Equity Protection Act passed by Congress in 1994, the Fed was given the authority to oversee mortgage loans. But then-Chairman Alan Greenspan, an Ayn Rand libertarian who by his own admission believed that markets could mostly self-correct, kept putting off writing any rules and stoutly resisted other efforts to regulate derivatives on Wall Street. Bernanke, by contrast, earlier this year instituted "Regulation Z," which created common-sense rules such as forbidding loans without sufficient documentation. Bernanke has also vastly expanded the Fed's lending powers to deal with the crisis. He believes the Fed should at some point return to its old modest role as a regulator of the money supply and inflation. But since he is also known to want re-appointment as chairman next year—and incoming Obama economic advisor Larry Summers is said to covet the post—it's likely that Bernanke will go out of his way to satisfy Tarullo.

And that may mean a whole new regulatory structure that will dwarf anything Schapiro does at the SEC or Gensler can accomplish at the CFTC. Those who who've worked with the soft-spoken Tarullo says he brings the right blend of save-the-world zeal and balanced judgment. "I think it's a great choice," says a former senior member of the Clinton administration. "It's the right person with the right skill set and the right judgment at right time."

The question is whether Tarullo will push for too much regulation. In his 2008 book on international banking regulation, "Banking on Basel," Tarullo repeatedly argues that the subprime crisis is a once-in-a-lifetime opportunity to regulate. "The crisis has—at least for a time—altered the political environment for financial reform by placing banks on the defensive," he wrote. "Domestic reformers may have the upper hand if they move quickly." The debates at the Fed should tell us a lot in the coming months.