The Most Powerful Man in Banking

Fed governor Daniel Tarullo is known for his behind-the-scenes influence over everything from corporate strategy to capital rules

By Ryan Tracy and Emily Glazer

Daniel Tarullo is called the ‘Wizard of Oz’ by Wall Street financiers for his powerful sway over banks. Photo: Brooks Kraft for The Wall Street Journal

The most important person in the banking business isn’t a banker.

To most Wall Street executives, that title goes to Federal Reserve governor Daniel Tarullo, a brusque, white-haired former law professor who has come to personify Washington’s postcrisis influence over how banks do business.

Mr. Tarullo heads the Fed’s Committee on Bank Supervision. On paper—and in practice for most of the previous decades—the post isn’t a hugely powerful one. But the 63-year-old took office at the Fed in 2009 at a moment of broad public support for a more aggressive tack and has pressed that advantage ever since.

Financiers privately call Mr. Tarullo “the Wizard of Oz” for his behind-the-scenes sway over everything from corporate strategy to how many billions of dollars banks must maintain in capital.

Through the stress tests he championed to evaluate how banks might fare in another market shock, the Fed wields control over whether banks can raise the dividends they pay to shareholders.

For a big bank in 2016, getting a stamp of approval from Mr. Tarullo is an effort consuming thousands of employees. The industry’s lawyers pore over transcripts of Mr. Tarullo’s dense speeches to grasp the meaning of every word. When Citigroup Inc. C -0.02 % and Bank of America Corp. BAC -0.60 % stumbled on the stress tests in recent years, each bank said it spent at least $100 million to correct the problems the Fed had called out.

Peter Conti-Brown, a historian and author of “The Power and Independence of the Federal Reserve,” called Mr. Tarullo’s influence extraordinary. One former bank executive put a finer point on it: “He’s judge and jury and everything else,” he said.

Mr. Tarullo in an interview attributed his power to his longevity at the Fed and consensus with other regulators. And, he said, the full impact of the regulatory changes made on his watch have yet to be felt.

“I think it likely that firms are going to have to change in some cases their size, in some cases their business model, and in some cases their organization,” he said.

Mr. Tarullo’s influence illustrates the outsize role that government regulation now plays for banks.

For most of the modern era, regulators took a more hands-off approach, monitoring the industry for abuses but stopping short of injecting themselves into bank operations. But the near collapse of the financial system in 2008 brought widespread criticism of regulators for not being more vigilant and changed the equation.

Many in the industry said the pendulum has now swung too far, creating large banks that are ultrasafe but which shy away from healthy risk-taking. Banks change their behavior “even if it doesn’t make sense to do it because of the fear of the retribution,” said Richard Kovacevich, former chairman and CEO of Wells Fargo WFC -0.26 % & Co.

Mr. Tarullo’s defenders said the heightened regulatory environment is justified given the severity of the financial crisis. They said banks are safer and regulators more capable of curbing problems than they were before.

Mr. Tarullo, a liberal policy wonk who loves the TV show “Seinfeld,” the Boston Red Sox and writer William Faulkner, has spent most of his career in government and academia. He worked on and studied economic policy for decades, including at Harvard Law School, where he became embroiled in an ideological dispute over a legal theory that contended the law was biased toward powerful interests. Mr. Tarullo was denied tenure when some conservative professors pushed back against the theory’s adherents, though he said he was collateral damage rather than a central player in the debate.

He homed in on banking regulation while teaching at Georgetown University in the last decade, concluding regulators needed to create tougher rules and more powerful means of imposing them. As the financial crisis intensified in September 2008, he published a book called “Banking on Basel,” which argued capital requirements agreed to by the Basel committee of global regulators weren’t doing enough to limit banks’ borrowing and trading.

Federal Deposit Insurance Corp. Chairman Martin Gruenberg said Mr. Tarullo has a creative mind that both grasps esoteric financial concepts and “is very effective on how to make things happen.” He recalled a conversation with Mr. Tarullo in the early part of his tenure after the winter holidays, in which Mr. Tarullo said he had spent the previous weeks reading academic papers about banks’ use of short-term wholesale funding, a volatile type of loan central to the 2008 financial crisis.

The Fed has since tried to curb what it views as excessive reliance on those loans, including capital rules adopted in 2015 that have forced J.P. Morgan Chase JPM -0.24 % & Co., the nation’s largest bank by assets, to shrink both its size and its short-term borrowing.

Few bank executives knew him when he was appointed by President Barack Obama to the Fed’s Board of Governors. But he made an early impression. At one of his first meetings with financial CEOs, in March 2009, Mr. Tarullo said the administration was planning to allow their banks to continue to exist, according to people who were present or briefed.

“We have a problem,” one of those people said, describing the reaction by the bank executives, who read the remarks as a heavy-handed expression of authority.

Soon after taking office, Mr. Tarullo led the Fed’s negotiation with global regulators on capital rules. Previous Fed governors had left the job to staff, and his hawkish voice helped secure a series of global agreements on stricter rules for the largest banks.

Mr. Tarullo “understood the need to inject some social consciousness into the market in a way that doesn’t dent its efficiency,” said former Rep. Barney Frank (D., Mass.), who worked with him on financial policy and was one of the authors of the 2010 Dodd-Frank financial-overhaul law.

Yet even as Mr. Tarullo has helped engineer a broad regulatory overhaul, he also rejected what in 2009 he called “reform by nostalgia,” a return to Depression-era rules separating Main Street lending from Wall Street investment banking.

Instead, he has argued that large financial firms have a role in the economy, and the government should regulate them commensurate with the risks they pose. Mr. Tarullo has been less enthusiastic about liberal priorities such as the Volcker rule, a provision of the Dodd-Frank law named after former Fed Chairman Paul Volcker that bans banks from making bets with their own capital. Mr. Tarullo has publicly supported the goals, but worried privately the rule would be difficult to enforce, people familiar with the matter said.

Mr. Tarullo said he is open to the idea that more needs to be done to tamp down risks at big banks, but prefers to set tough capital requirements and let banks react rather than say, “Do it this way.”

At the Fed, Mr. Tarullo in his early years sometimes yelled or swore when staff produced what he viewed as substandard work or bankers disagreed with him, according to people familiar with the matter. Bank executives said they still feel he rarely budges when presented with data and arguments that support the industry’s perspective.

When the Fed was developing a proposal that would require Wells Fargo to raise about $40 billion in long-term debt to absorb losses and prevent bailouts, the bank argued the change was unnecessary and asked repeatedly about Mr. Tarullo’s reasoning. The bank felt that Mr. Tarullo and his aides listened but didn’t meaningfully consider alternative views, people familiar with the conversations said. Wells Fargo began issuing the debt last year.

“Sometimes when they don’t agree with you, they think that you’re not hearing them,” Mr. Tarullo said.

Mr. Tarullo’s influence will be felt on the campaign trail, as Democrat Hillary Clinton has drafted a platform deferring populist calls to break apart big banks yet imposing costs on firms that pose economic risks, in line with the formula Mr. Tarullo has long advocated.

Mr. Tarullo’s next move isn’t clear. His Fed term ends in 2022, but he is widely expected to depart when a new president picks the next Fed regulatory guru. Yet his imprimatur is likely to last well past his term in office, having steered what appears to be a long-lasting shift in the balance of power between Washington and Wall Street.

Later this year, the Fed is expected to incorporate still-stricter capital rules promoted by Mr. Tarullo into the annual stress tests. He has also discussed in speeches the need to turn more attention to shadow banking, a less regulated part of financial markets.

“Has what we have done been effective?” asked Mr. Tarullo. “If we say, ‘No,’ then maybe we need to return and do more. And, intellectually, I am totally open to that possibility.”

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