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.”
The Green Book didn’t accomplish all this on its own. By the late 1990s the direct pressure for action was coming from the lobbying efforts of financial giants. And Dugan was a critical part of the lobbying effort. When he left Treasury in 1993, Dugan took a job as a partner at the Covington & Burling law firm, where he began advising big banks on skirting the very regulations he had been writing for years. A top client was the American Bankers Association, the chief lobby group for the banking industry. One of Dugan’s most important assignments was to help the ABA push through Gramm-Leach-Bliley. “ABA helped craft nearly every significant part of the Act that affects the banking industry,” Dugan boasted in a 1999 letter to ABA bankers.
Of course, for this lobbying push to be effective, Clinton’s top economic advisers had to be receptive to Dugan’s overtures. “These ideas really cannot be enacted until you get a takeover of the Democratic Party and a Democratic president who is willing to push them,” says economist James Galbraith, “that neutralizes the opposition on the left that would otherwise organize to block this legislation.”
Things could have been worse. Even former Congressman Jim Leach, the author of Gramm-Leach-Bliley, believes that Dugan’s proposal to allow commercial firms to acquire banks would have been a catastrophe. “If Glass-Steagall’s prohibition on combining commerce and banking…had been repealed, the contagion of misjudments in finance and financial regulation would have spread even more deeply,” says Leach.
General Electric serves as a useful example. It’s one of a handful of companies that have broken the commerce and banking barrier, and it needed a huge bailout when markets hit the skids in 2008. The company has issued nearly $74 billion in debt guaranteed by the government since December 2008.
The Green Book policies did not invent too big to fail, but they transformed a relatively controlled imbalance into an economic wrecking ball. When the FDIC invoked “too big to fail” in the late ’80s and ’90s, those troubled banks actually did fail–their shareholders were wiped out and their management teams were fired. The bailout went not to the bank but to its creditors–other banks that it owed money. Here’s how the Green Book explains it: “The phrase ‘too big to fail’ refers to a situation in which the FDIC…is unwilling to inflict losses on uninsured depositors and even creditors in a troubled bank.”
But by 2008 many banks had become so large and interwoven in different lines of business that policy-makers feared the consequences of shutting them down. The term “too big to fail” now means that government helps salvage not only creditors but shareholders and management teams.
There’s another critical difference in the scope of the problem. In 1984 the FDIC bailed out creditors of Continental Illinois, which would prove the largest bank failure until 2008. But the total cost of the resolution was just $1.1 billion, a price tag that included not only the cost of bailing out the firm’s creditors but also of backing its deposits. As It Takes a Pillage author Nomi Prins documented with Christopher Hayes in our pages on October 12, 2009, over the past two years the government has committed more than $17 trillion to save the banking sector, in the form of direct capital injections, loans and guarantees. Not all that money will be lost, and some of it has already been repaid. But there is simply no way to imagine the bailout tab running so high without Dugan’s deregulatory work.
Too big to fail banks were a ticking time bomb, but they might not have ravaged the global economy in 2008 without major shortcomings in consumer protection over the previous five years. As head of the Office of the Comptroller of the Currency, Dugan played a leading role in gutting the consumer protection system, allowing big banks to take outrageous risks on the predatory mortgages that led to millions of foreclosures.
“For years, the OCC has had the power and the responsibility to protect both banks and consumers, and it has consistently thrown the consumer under the bus,” says Harvard University Law School professor Elizabeth Warren, chair of the Congressional Oversight Panel for the Troubled Asset Relief Program. “The result has not only been no consumer protection but also a collapsed banking system. That is why we so urgently need a separate agency in Washington that is specifically focused on protecting families from credit tricks and traps.”
Although Dugan continues to press the assault on consumer protection today, the OCC’s effort to insulate big banks from consumer complaints predates his appointment in 2005. Between 1995 and 2007, the OCC issued only thirteen public enforcement actions against national banks on consumer protection issues, for the more than 1,600 banks it regulates. Over that same period, zero public actions were taken against the eight largest national banks, even though these banks were at the heart of the predatory mortgage explosion. Through 2006, the OCC staff devoted to handling consumer complaints numbered fifty or fewer. OCC-regulated banks process millions of mortgages every year.
Ever since it became apparent in 2007 that reckless mortgage lending had spurred an economic catastrophe, Dugan has been defending himself, his agency and the banks he supposedly regulates. His favorite talking point is a claim that OCC-regulated banks issued only 10 percent of all subprime mortgages in 2006. But that statement is a distortion, since many of the largest subprime players were regulated by the OCC, according to data from the National Mortgage News, a banking trade publication. Wells Fargo, Citi, Chase and First Franklin–all OCC charges–were among the top ten subprime lenders through the peak years of the housing bubble. In 2006 alone, Wells Fargo extended nearly $28 billion in subprime loans, while Citi issued more than $23 billion. The OCC had authority over more than nine of the twenty-five biggest subprime offenders identified by a Center for Public Integrity investigation.
A recent study by the National Consumer Law Center found that national banks and thrifts issued 31.5 percent of subprime mortgage loans, 40.1 percent of toxic Alt-A loans (predatory mortgages that don’t qualify as subprime) and 51 percent of the predatory payment-option and interest-only adjustable-rate mortgage loans made in 2006. The OCC is responsible for national banks but not thrifts. A separate Federal Reserve study found that banks and thrifts accounted for about half the exotic mortgages originated in 2004 and 2005, 54 percent of those issued in 2006 and 79 percent of those from 2007.
“It’s just amazing that after all that’s happened, Dugan still says nothing happened, and whatever did happen wasn’t the OCC’s fault,” says Kathleen Keest, a former assistant attorney general for the State of Iowa who serves as senior policy counsel for the Center for Responsible Lending, a consumer advocacy group. “Why did his banks need big bailouts if they were making such great loans? It’s like he’s standing in a room full of broken crockery and saying, ‘I didn’t break that cup.'”
Dugan repeated his narrative in a speech in September: “It is widely recognized that the worst subprime loans that have caused the most foreclosures were originated by nonbank lenders and brokers regulated exclusively by the states. Although the OCC has little rule-writing authority in this area, we have closely supervised national bank subprime lending practices. As a result, national banks originated a relatively smaller share of subprime loans and applied better standards, resulting in significantly fewer foreclosures.” Dugan then concluded that “nothing in federal law precluded states from effectively regulating their own nonbank mortgage lenders and brokers.”
Yet both Dugan and his OCC predecessor, Clinton appointee John Hawke Jr., have crusaded to defang state regulators. The OCC oversees federally chartered banks. Until 2004 states were able to enforce anti-predatory lending laws against any bank operating within their borders, regardless of whether the bank’s corporate charter came from the state or the federal government. But the OCC changed all that, insisting that while state laws did in fact apply to national banks, only the OCC had the authority to enforce them. The order was so broad, it prevented states from enforcing their own laws against state-chartered subsidiaries of national banks and even mortgage brokers who worked with national banks.
The pre-emption of state consumer protection laws was a deliberate attempt to preserve the ability of the nation’s largest banks to earn short-term profits from predatory loans. Every major OCC-regulated bank–Wells Fargo, Chase, Citi, Bank of America and Wachovia–had tremendous subprime and no-documentation loan operations. When state regulators tried to enforce their own laws, the OCC joined forces with a bank lobby group to sue the states. When courts sided against the states, the OCC became the sole agency responsible for cracking down on predatory lending at national banks–and it didn’t lift a finger. State investigations throughout the country shut down, and state legislatures stopped moving to enact stricter laws.
“It created a get-out-of-jail-free card for national banks and their subsidiaries to engage in dangerous underwriting practices, and then it put pressure on the states to relax underwriting standards” says McCoy, who served as a member of the Federal Reserve’s Consumer Advisory Council from 2002-04, warning the regulators about the dangers of predatory lending.
The big banks moved fast. When state regulators in Illinois took aim at a subsidiary of Wells Fargo, the company quickly reshuffled its legal paperwork and moved the offending sub-company under its nationally chartered bank, where the OCC could shield it from state action.
“It didn’t just affect national banks, either,” says Chuck Cross, a former regulator with Washington State. “Remember, the state-chartered banks can jump charters. They can go from a more restrictive state regulator to a less restrictive OCC. That creates a very tenuous political environment for a state trying to pass laws.”
But twenty-six states did tighten mortgage standards over the course of the housing bubble. Meanwhile, Dugan was actively looking the other way. In 2006 the OCC finally offered guidance on nontraditional mortgage lending, in lieu of formal regulations, and didn’t bother to enforce that guidance, since it was, after all, just guidance.
The OCC’s dramatic reinterpretation of banking law was initiated by Hawke, but Dugan ramped up those efforts. In the current debate over the creation of a Consumer Financial Protection Agency, Dugan has demanded that the OCC have exclusive power to enforce consumer protection laws over national banks, with no authority for state regulators or even the new CFPA.
Dugan’s aggressive stance against consumer protection extended even into the basic function of collecting data on foreclosures. In 2007 a group of state attorneys general formed the State Foreclosure Prevention Working Group (SFPWG), which tried to gather information from major banks about what kinds of loans were causing problems and what the banks were doing to solve them. The banks turned to Dugan, who instructed them not to work with the state officials. Federal pre-emption was so sweeping, according to Dugan, that banks couldn’t cooperate with state regulators on gathering data.
“So even though these folks are operating in our states, the foreclosures are affecting our communities and the banks are asking us to help them get in touch with the public to encourage them to contact their servicer–despite all that, we can’t know what the banks are doing,” says SFPWG member John Ryan.
Six months later, the OCC began issuing its own bank-friendly mortgage data. The first report, from June 2008, included no information on the quality or effectiveness of efforts by banks to work out loans with troubled borrowers–the primary purpose of the state AG effort. In December 2008, the OCC finally started publishing relevant data on loans that banks had modified, but it failed to distinguish between modifications that reduced borrower payments and schemes that increased their monthly burden. Dugan told a housing conference that month that he was shocked, shocked to learn that more than 50 percent of mortgages that banks had modified had quickly redefaulted.
The figure wouldn’t have surprised him if he’d been interested in gathering useful data. A study by Valparaiso University Law School professor Alan White found that less than half of loan modifications performed by banks had decreased borrowers’ monthly payments. In other words, the banks weren’t trying to help people stay in their homes; they were trying to squeeze them for just one more check.
Dugan’s term expires in August 2010, when President Obama can reappoint him or nominate someone else. But given Dugan’s record, it’s hard to see why he has been allowed to stay on the job for Obama’s first year. It is not customary for the president to discharge the comptroller in the middle of his term, but he does have the legal authority to do so.