NEW YORK - Asked about whether the Fed now had a third mandate -- the pursuit of financial stability -- along with price stability and maximum employment, Federal Reserve Governor Daniel Tarullo Wednesday answered with a history lesson on the Fed's origins.

"If you think about the origins of the Federal Reserve, nearly 100 years ago," the creation "arose out of a financial crisis, the Panic of 1907," he said in Q&A following a speech Wednesday at the Council on Foreign Relations in New York.

Then, as now, in the more recent U.S. financial crisis, it became "difficult for private banks" to utilize the traditional mechanisms that had been successful in the past, he said.

"It's not insignificant that the motivation for the creation of the Fed was not monetary policy as we classically think of it, but instead was a financial crisis," Tarullo said

Financial stability is interwoven with the Fed's current mandates, he said.

"The pursuit of price stability and maximum employment cannot, in a sensible and effective way, be achieved without being very mindful of financial stability consequences; the last four to five years are testament to that," he said.

"One can achieve neither price stability nor maximum employment, if one is going to have highly unstable financial circumstances that produce crises or regular periods of stress," Tarullo said.

So instead of "engrafting some third aim" into the Federal Reserve Act, it is better to merely recognize the "pursuit" of the Fed's dual mandate "requires substantial attention to financial stability," he said.

To this end, Tarullo noted steps taken to keep the Fed up to date on events unfolding in the financial industry.

"Our movement over the course of the last three years, towards a much more horizontal, interdisciplinary, simultaneous way of supervising the largest financial institutions, is a way of bringing financial stability concerns, more of an overview on what's happening in the financial industry as a whole, more to the fore, allowing us to get a better synthesized view of what's going on," he said.

Among other agencies providing this information, he pointed to the Office of Financial Stability, which "has the responsibility for, and indeed does, generate regular reports and briefings on financial stability  matters that are not necessarily connected to our regulated institutions at all."

He stressed that "financial stability is a mandate, not just to the Fed, but to many U.S. government agencies."

Tarullo said of the initial question "so have things changed at the Fed" in terms of its role, "I think the answer is an unqualified yes."

Asked about U.S. banks' participation in Basel 3 regulatory reform, the Fed Governor voiced confidence in bank compliance.

"On whole, we're quite confident that our banks are well ahead of even our accelerated expectations," Tarullo said.

As part of the recently concluded "stress tests," the Fed required financial institutions to "show us their path for Basel 3 compliance, quite separate from the current stress testing exercise," Tarullo said.

"We indicated our expectation that they comply more quickly than the transition requirements of the Basel agreement itself does," he said.

The Basel 3's transition timeline is "backloaded," so that requirements start next year and are gradually phased in, with "the out years" having heavier requirements, he said.

"This didn't strike us as the best course," he said, noting the Fed was troubled by the risk of implementing more onerous requirements at a potential time of economic downturn, "so we basically have straightlined it."

The Fed wanted to be sure that U.S. banks have met these Basel 3 obligations well ahead of time, he said.

On the mortgage market, Tarullo was asked about a "restart" time for private sector involvement.

"It's reasonably clear to me, that we're not likely to see the restart of a sustainable, well developed, well functioning, private securitization market, until there is more clarity, on ... what role the GSEs are going to play in the future," he said.

Tarullo said he won't "prejudge that" and saw the GSE with "some role between zero and much more than they did in the past and it's not up to me to decide where that falls."

"But I think until private market actors have some sense of that, their steps into private securitization, which i think are beginning now and we hope to see more of, will probably not be as ambitious, because people just won't know how much space there is going to be there for them to occupy," he said.

Also, there is a need for mortgage market regulations to be finalized, so legal structures are well understood by private market actors and "they can make judgment as to what kind of securitization or other financial activities are going to be profitable and which are not," Tarullo said.

"Until we kind of get to these points, I think it's going to be hard to see more than a moderate increases in private securitization activity," he said.

When asked about the issue of recent Fed transparency, Tarullo saw "substantially more transparency."

"The administrative process for rule making is one that says we want the agencies notions of proposed, their ideas how to regulate a congressional authority, to be formulated in a provisional fashion and then published so that anybody who wants has an opportunity to comment," he said.

This "comment period" has been successful, as evidenced by the 17000 submissions on the Volcker rule and multiple thousands on many others as well, to a point where Fed staff has two lines, "number of submissions" and "number of so called 'unique submissions,'" i.e. not form letters, he said.

"Absorbing all the comments is actually a fairly substantial undertaking, which is one of the reasons why some of these rules are not out yet," Tarullo said.

Nevertheless, the Fed governor stressed that this "is the right process to pursue."

Asked about insurance company regulation, Tarullo acknowledged that some insurance companies, the ones that own thrifts and savings and loans as holding companies, would presumably need to comply with Basel 3 standards with regard to capital requirements.

"Capital requirements which we have are obviously intended to provide buffers against loss," he said.

Some insurance products and practices were not contemplated when Basel 1 was being decided, instead Basel 1 was more directed at banks, so this "residual category" will need to be addressed, Tarullo said.

In a final question, he was asked about the timing of regulatory implementation.

Tarullo said two questions need to be asked: "At what point does it become reasonably clear to people what that fully elaborated framework is going to look like?" and "at what point is that fully implemented?"

"I would say, as to the latter," given Basel and Volcker Rule conformance, "it would be several years before the full implementation of the major sets of reform that we are talking about would actually be in place," he said.

"It is my hope and expectation that, as to the former, we're going to be there considerably more quickly," Tarullo said.

Regarding proposed and final rules, "it seems to me reasonable to expect that, some time next year, the basic outlines, and I don't just mean the ideas, but I mean the details associated with major reform elements, should be reasonably clear to people, even though questions will inevitably arise in implementation," he said.

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.