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Bank regulator exit a pivotal moment for Wall St

They don’t go in for pomp and ceremony at the US Federal Reserve.

The retirement of Daniel Tarullo next Wednesday will be marked by coffee and doughnuts, according to a person familiar with the send-off.

That’s a pity, in a way, as the departure of the 64-year-old member of the board of governors — and the world’s most fearsome bank regulator — marks a seminal moment on Wall Street.

When Mr Tarullo arrived at the Fed in February 2009, appointed by president Barack Obama to overhaul the central bank’s approach to regulation, the big US banks were in a pretty terrible state: lacking capital and liquid assets, too reliant on short-term funding and with risk-management systems mostly unfit for purpose.

By the time the governor penned his resignation letter in February 2017, the same set of banks were among the most robust in the world, with well over twice the level of common equity as a proportion of risk-weighted assets. 

Years of rigorous annual stress tests, combined with a host of other measures to strengthen balance-sheets, mean that — on paper, at least — the likes of Citigroup and Bank of America could sail through a shock many times worse than Lehman.

“It was very strong medicine, but it worked,” says Ruth Porat, who spent five years as Morgan Stanley’s finance chief before joining Alphabet in 2015 as chief financial officer. 

“If you look at the health of the US banks, and the speed with which they raised capital and liquidity post-financial crisis, the regulatory system was clearly doing its job,” she says.

For Sherrod Brown, the top Democrat on the Senate banking committee, Mr Tarullo was simply “an exemplary public servant who has made our financial system safer”.

In a nod to President Donald Trump’s plans to “do a number” on Dodd-Frank, the landmark piece of post-crisis rulemaking, he adds: “We cannot afford to weaken the reforms [Mr Tarullo] championed that protect taxpayers and families from being on the hook for another bailout.”

Not many bankers will be sad to see Mr Tarullo go. Some say they locked horns with the ex-professor and found him aloof and autocratic.

One CEO at a top 10 bank accuses the governor of “reckless conservatism,” repeatedly ratcheting up capital and liquidity requirements for the biggest and most complex banks without ever considering possible ill-effects. 

Not all the criticisms are unfair. You could argue, for example, that Mr Tarullo clung too stubbornly to some of questionable elements of the stress test. One is the assumption that banks would continue to increase assets and pay dividends during a catastrophic economic meltdown — a notion many bankers have dismissed as ridiculous.

The tests assume, too, that banks take no actions to try to limit the damage. In a letter to shareholders about a year ago, Jamie Dimon pointed out that the most recent set of stress-test estimates from the Fed had JPMorgan losing $55bn over the nine-quarter planning horizon.

“It bears repeating,” wrote the bank’s chairman and chief executive, “that in the actual Great Recession [we] never lost money in any quarter.”

It’s also possible to argue that the qualitative part of the test — a judgment by the board on how well a bank plans its capital needs — is opaque and unscientific. 

Citi, BofA, Morgan Stanley, Goldman Sachs and JPMorgan were all rapped for failings in this area during the Tarullo years. Other banks spent billions of dollars on upgrading systems, but still fretted that the governor and his team would find fault in their plans to return capital.

“He’s been the most impactful person in my life over the past seven years,” says another CEO at a top 10 bank, with a grimace.

Mr Tarullo certainly did not go out of his way to make friends on Wall Street, or in the big banking towns such as Charlotte or Minneapolis. 

“He can be impatient, as we all can, and doesn’t suffer fools gladly,” says Sheila Bair, president of Washington College in Maryland, who chaired the Federal Deposit Insurance Corporation for five years to 2011. 

“But any criticism you might hear from the industry is a reflection of the regulatory changes that were necessary after the crisis.”

One thing’s for sure: with Mr Tarullo out of the picture, the prospect of regulatory relief for the banks seems brighter.

Within minutes of the resignation announcement, one analyst in New York rushed out a note to clients.

“Buy banks,” wrote Neil Dutta at Renaissance Macro Research. “The dog is running without its leash on.”

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