A Master of Disaster | The Nation


A Master of Disaster

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FRANK POLICH/REUTERSJohn Dugan speaks at the American Bankers Association convention in Chicago.

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Zach Carter
Zach Carter, a banking reporter for SNL Financial News, writes a weekly blog on the economy for The Media Consortium....

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Of all the architects of last year's financial crash, John Dugan remains the most obscure, despite his stature as one of the most influential. While regulatory errors have made Larry Summers, Robert Rubin and Alan Greenspan household names, most people have never heard either of Dugan or his agency, the Office of the Comptroller of the Currency. But as the chief regulator for the largest US banks, Dugan and his staff are one of the most powerful engines of economic policy in the world.

Over the course of nearly a quarter-century, Dugan has proved himself a staunch ally of the American financial elite as a Senate staffer (1985-89), a Treasury official (1989-93) and a lobbyist (1993-2005), building a career that culminated in 2005 when George W. Bush appointed him comptroller of the currency. When the financial system finally succumbed to its own excesses in September 2008, Dugan's fingerprints were all over the economic wreckage, but almost nobody noticed.

Dugan began navigating the intersection of politics and finance in the mid-1980s as an aide to deregulatory ideologue Republican Senator Jake Garn. But he didn't distinguish himself as anything more than a partisan workhorse until he entered the Treasury Department in 1989. That year, Congress ordered the Treasury to conduct a study on deposit insurance--the federal program that makes sure you don't lose all your money if your bank fails. Under Dugan's direction, the study ballooned into a nearly 750-page book that is perhaps the single most boring manifesto for sweeping economic change that has ever been written. Published in 1991 under the mundane title Modernizing the Financial System: Recommendations for Safer, More Competitive Banks, Dugan's tome became known as the Green Book, and it established him as one of the earliest architects of the "too big to fail" economy.

With the Green Book, Dugan pushed dozens of policies that were ultimately enacted, but three stand out from the pack. His first objective was to allow banks to expand into multiple states without incurring additional regulatory oversight. His second, more radical goal was to allow relatively safe commercial banks to merge with riskier investment banks and insurance companies. And his third, most extreme initiative was to allow commercial firms--General Electric, Sears--to purchase a bank.

Dugan was not the first to suggest these reforms. Congress poked holes in the wall between banking and commerce in 1987. That same year, Paul Volcker's tenure as chair of the Federal Reserve came to an end, in part because of his resistance to using the central bank to weaken Glass-Steagall. But the banking system of 1991 still largely resembled the banking system of 1951. The significance of the Green Book is that it expressed these radical deregulatory positions in a single, seamless policy platform.

"It was unquestionably the blueprint for the major Clinton-era deregulation," says George Washington University Law School professor Arthur Wilmarth Jr., a longtime banking scholar. "It was the first real recipe for too big to fail." (Dugan declined to comment for this article.)

The Green Book policies may sound like technocratic tweaks, but Dugan was injecting himself as a key player in a fundamental restructuring of the US economy. Since the 1930s, the Glass-Steagall Act had barred banks that performed essential functions like accepting deposits and extending loans from making risky bets in the securities markets. In the late 1980s policy-makers and free-market economists began questioning the usefulness of the law and urged that banks be allowed to expand their activities in the name of global competition and profit. The Green Book marked the first time that the repeal of Glass-Steagall entered the official economic policy platform of an administration.

"The time has come for change," Dugan wrote in the Green Book. "Laws must be adapted to permit banks to reclaim the profit opportunities they have lost to changing markets. Where banking organizations have natural expertise in other lines of business, they should be allowed to provide it.... Adapting to market innovation is critical."

The step was so radical that in 1991, the finance lobby had not even figured out how to approach the issue. Big commercial banks were salivating over the prospect of acquiring securities firms, but Wall Street investment banks actually fought to uphold Glass-Steagall to keep from being swallowed up.

"This report represented a big paradigm shift in saying that the government's task is not to restrict what banks do; it's to facilitate their expansion into new activities in the quest of profitability," says Patricia McCoy, a law professor at the University of Connecticut. "It was enormously influential."

Dugan's vision for hybridized banking and commerce has so far only partly been realized, but his other plans were enacted within a decade. Dugan was particularly effective in selling the Green Book to the Democratic Congress, whose relationship with George H.W. Bush's Treasury had soured in negotiations involving the 1989 savings and loan cleanup bill, according to Richard Carnell, an aide to Senate Banking Committee chair Donald Riegle Jr. from 1987 to 1993. Dugan and Riegle communicated frequently about new legislation, passing less controversial aspects of the Green Book platform in 1991. By 1994, Congress had abolished barriers to interstate banking with the Riegle-Neal Interstate Banking and Branching Efficiency Act. The mash-up of investment banking and commercial banking was approved in 1999 with the passage of the Gramm-Leach-Bliley Act, which repealed parts of the Glass-Steagall Act.

"It built momentum for significant reforms," says Michael Klausner, a former official at the White House Office of Policy Development, one of dozens who worked on the Green Book under Dugan. "There was a time during the first Bush administration when it looked like a lot of it might pass.... Ultimately, less of it was passed under Bush, but it set things in motion that allowed the Clinton administration to finish the job."

"There were two pieces of legislation that facilitated our migration toward too big to fail... Interstate Banking and Branching Efficiency Act of 1994, which permitted banks to grow across state lines, and the Gramm-Leach-Bliley Act, which eliminated the separation of commercial and investment banking," said Kansas City Federal Reserve president Thomas Hoenig in an August 6 speech before the Kansas Bankers Association. "Since 1990, the largest twenty institutions grew from controlling about 35 percent of industry assets to controlling 70 percent of assets today."

Citibank, for example, transformed itself from a credit card issuer and commercial lender into a multitrillion-dollar behemoth, running hedge funds all over the world and gorging itself on subprime mortgages at home. The same story developed at Bank of America and JPMorgan Chase. Every megabank opened its own securities shop and began packaging garbage mortgages into bonds to sell to investors, spreading risk around the globe. Even after these banks received billions in taxpayer funds, their political clout remains so strong that financial regulatory reform has been stalled for over a year.

Gramm-Leach-Bliley "was a horrible mistake," says Senator Byron Dorgan, one of just eight senators to vote against the act. "The risks of investment banking and securities trading became embedded in commercial banks. We were promised there would be firewalls, but they must have been gasoline-soaked firewalls, because they went up in flames pretty fast." Of Riegle-Neal Dorgan says, "It really gave a green light for banks to expand, letting the big get bigger."

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