Big changes at the Federal Reserve keep coming.

The past several days have seen President Trump announce the nomination of Jerome Powell to replace current chairman Janet Yellen. On Nov. 6, Randal Quarles sworn in as member of the Board of Governors and vice chair for supervision.

With that backdrop, New York Fed President William Dudley has announced that he intends to retire from his position in mid-2018.

Dudley joined the New York Fed in 2007 as executive vice president and head of the Markets Group, where he also managed the System Open Market Account for the Federal Open Market Committee. He was named the 10th president and CEO of the New York Fed on Jan. 27, 2009, taking over the remainder of his predecessor’s term. He was appointed for his first full term as president and CEO in 2011 and reappointed in 2016.

The eligible members of the New York Fed’s Board of Directors, those without bank affiliations, have begun the process for finding Dudley’s successor. The executive search firms Spencer Stuart and Bridge Partners have been retained to assist a search committee. The ultimate selection will be subject to the approval of the Board of Governors.

Dudley, after announcing his retirement, laid out his views regarding “Lessons from the Financial Crisis” during a Nov. 6 speech at the Economic Club of New York.

“We must ensure that the safeguards put in place in response to the crisis are fully appreciated and respected,” he said. “But, it also means that we need to finish the job—for example, by building out a fully workable regime for resolving a complex, global firm if one were to become insolvent.  We need to ensure that our financial system can continue to provide critical services not just during good times, but also during periods of stress.”

These objectives, he said, are particularly relevant today, when reopening the Dodd-Frank Act and modifying our regulatory framework are under consideration. 

“While it is appropriate to evaluate adjustments that might improve our regulatory regime, it is critical that we do not forget the hard-learned lessons of the crisis and—in the haste to reverse course—undermine the robustness and resiliency of the financial system,” Dudley said. “We as regulators must continually evaluate the financial system and monitor the landscape for new developments and innovations that, if taken too far, could lead to excess and put the system at risk.”

During the crisis, some examples of bad incentives that sustained the boom included:

So, where are we, post-crisis, relative to what is needed? 

“As I see it, there has been considerable progress,” Dudley said. “The nation’s largest banks are much safer as a result of substantially higher capital and liquidity requirements, as well as robust stress tests.  This enhanced resiliency has been achieved without a significant negative impact on the broad availability of credit—recognizing that it is now more difficult for households with low credit scores to obtain a mortgage.  Most importantly, improving the capacity of such firms to continue to lend during times of stress should make the overall economy more stable.”

“We have also made significant progress in addressing many of the structural weaknesses uncovered by the financial crisis,” he added. Money market reform has made the prime money market mutual fund industry smaller and safer. The elimination of the net asset value convention for institutional prime money market mutual funds has made these funds smaller and less prone to runs during times of crisis.

“Yet, we should not be complacent, as there are important areas where our work is not complete,” Dudley said. A particular challeng is the diverse structure of the U.S. financial system, in which non-banks and capital markets play a substantial role in credit intermediation. 

Although the Financial Stability Oversight Council “could conceivably play a greater role here, whether it will be able to do so effectively remains uncertain,” he said.

Another issue “that needs attention” is the ability to resolve large, complex financial firms that operate on a global basis, Dudley said. The Federal Reserve’s lack of authority to lend to a major securities dealer that gets into difficulty is another outstanding issue. 

The Dodd-Frank Act narrowed the Federal Reserve’s authority under Section 13(3) of the Federal Reserve Act. No longer can the Federal Reserve lend to an individual securities firm or non-bank financial intermediary.  

“Such authority may not be as necessary now that the Federal Deposit Insurance Corporation has the power to lend under Title II of the Dodd-Frank Act and firms are required to have sufficient resources to support their resolution plans, Dudley said. “But, I would prefer having such a tool available in extremis given the potential need to buy time for coordination and critical decision-making. I think it is important to ensure that one can ‘get to the weekend.’”

Despite numerous, post-crisis accomplishments “there are some areas where the pendulum may have swung too far, where the costs of regulation—including compliance costs and the potential impact on the provision of services—are likely to exceed the benefits,” Dudley said, adding that he favors regulatory relief for smaller banking organizations. 

“First, such firms individually are not systemically important, and therefore do not pose a significant risk to the viability of the U.S. financial system.  Second, the regulatory burdens on smaller firms can be heavy because they don’t have the scale over which compliance and other regulatory costs can be spread,” he said. “Regulatory requirements should be appropriately calibrated to avoid inadvertently creating a competitive advantage for larger financial firms.”

Dudley says that thw Volcker rule could be modified so that its implementation would be less burdensome. “As I see it, regulators could review the criteria for permissible market-making,” he said. “Trading activity should be viewed as market-making when it is customer-facing and inventories are not excessively large or stale. Market-making serves an important function, and it is important that trading desks can intervene and buy during flash crashes or sell during flash surges.”

Permitting this could provide greater liquidity and stability to financial markets,” Dudley said, adding that he “would also exempt smaller banking institutions from the Volcker rule since they rarely, if ever, engage in proprietary trading.”

Do no harm

“Many speculate that Congress will make changes to the Dodd-Frank Act.  If the scope is confined mainly to small bank relief and adjusting how the Volcker rule is applied, I have no objection,” Dudley said. “But, because the Dodd-Frank Act addresses many of the key lessons of the crisis, I think it appropriate that changes be made carefully—with a paring knife, rather than with a meat cleaver.”  He underscored the importance of preserving higher capital and liquidity requirements for systemically important banks; Title VII, which mandates the central clearing of standardized OTC derivatives; and Title VIII, which gives the Federal Reserve an oversight role for financial market utilities that are systemically important, and which helps promote more uniform risk management standards.

Dudley would also suggest preserving the authority of the FSOC to designate non-banking firms as systemically important and subject to supervision by the Federal Reserve. 

“As I see it, the designations of GE Capital and AIG were successful in two important respects. Federal Reserve supervision resulted in improved corporate governance and risk management. Second, it created incentives for the firms to alter their operations to become less systemically important in order to be de-designated,” he said.

“We should also retain this designation tool because we cannot predict which firms and activities may emerge and become systemically important in the future,” he added. “After all, I do not think many were focused on or worried about the activities of AIG’s Financial Products Group several years before the financial crisis, though in retrospect those activities proved to be systemically important. That part of the firm should have been better supervised and regulated.”