Why Is It So Hard To Hold Wall Street Accountable?

The Financial Crisis Inquiry Commission hearings continue to be a boring mess, peppered with a few moments of significant insight. Throughout most of yesterday's hearing featuring the nation's top bank regulator, Comptroller of the Currency John Dugan, Commissioners treated their witness as a credible expert, rather than a culpable catalyst of the crash.

You'd never know it from Dugan's calm, mousey demeanor before the FCIC, but he spent several years working as a high-powered bank lobbyist [1] before being appointed to his current job by George W. Bush in 2005. Since then, he's been a major defender of big banks, pushing to defang consumer protection regulations and provide legal cover for subprime predators.

Nobody on the Commission ever pressed Dugan on his lobbyist background. Who he lobbied for, what he lobbied for, and how much he got paid were never under discussion. Nobody asked him why he's been receiving lobbying talking points from major bank executives [2] in secret during the debate over financial reform. Nobody asked him what sort of job he's likely to take after his term as Comptroller expires in August. This is a tremendous problem: Wall Street's political influence is so tremendous that they can secure top-level regulatory jobs for their own lobbyists. It's as if someone appointed Phrma lobbyist Billy Tauzin head of the FDA.

And in Dugan's warped history of the past decade, both he and the banks he regulates never really did anything wrong. "We made very clear that predatory lending . . . was not something we would tolerate," Dugan said. "Honestly, those practices never really took root."

This astounding claim is impossible to square with any credible account of the explosion in subprime lending over the past decade, an explosion in which Dugan's banks were some of the top players. In a 2007 speech, FDIC Vice Chairman Martin J. Gruenberg [3] said, "It now appears that the most elementary notion of predatory lending--failure to underwrite based on the borrower's ability to pay--became prevalent in the subprime mortgage market."

Throughout his testimony, Dugan claimed it was not banks, but independent mortgage companies like New Century and Ameriquest who created the subprime debacle. These other companies that didn't accept consumer deposits, and thus were not subject to bank regulations, were able to get away with terrible practices, but the banks were generally innocent.

Yet according to an analysis by the National Consumer Law Center [4], Dugan's banks issued 31.5% of all subprime mortgages in 2006, along with 40.1% of exotic Alt-A mortgages, and 51% of tricky option-ARM loans (Alt-A and option-ARMs were often worse for consumers than subprime). Late in the hearing, FCIC Chairman Phil Angelides hammered home an equally important point: the Ameriquests and the New Centurys were being directly supported by the banks Dugan regulates. In fact, 21 of the 25 largest subprime lenders relied directly on support financing from national banks. The Wall Street behemoths were fueling the subprime machine, even when they weren't issuing the loans directly.

But the gravest sin committed by Dugan's agency, the Office of the Comptroller of the Currency (OCC), was an aggressive effort to block state regulators from enforcing consumer protection laws against big banks. The OCC regulates federally chartered banks, but until 2004, states still had the right to enforce their own laws against national banks operating within their borders. That meant that for national banks, the OCC's rules served as a regulatory floor-- state regulators couldn't enforce weaker standards than those imposed by the OCC, but they could enforce stronger rules.

That changed when Dugan's predecessor, John Hawke Jr., asserted sweeping preemption powers, insisting that the states' authority was invalid. Dugan continued this crusade throughout his time as Comptroller, and at yesterday's hearing, he defended the move in his opening statement.

"If it were true that federal preemption caused the subprime mortgage crisis by preventing states from applying more rigorous lending standards to national banks, one would expect that most subprime lending would have migrated from state regulated lenders to national banks. One would also expect that all bank holding companies engaging in these activities that owned national banks would carry out the business through their national bank subsidiaries subject to federal preemption, rather than their nonbank subsidiaries that were subject to state law . . . neither of these conjectures is accurate."

In fact, preemption spurred a race-to-the-bottom in regulatory standards, and was a major cause of the subprime explosion. But nobody challenged Dugan on the assertion seriously until Angelides took the reins around 3:00 p.m., two-and-a-half hours after the hearing began.

"You tied the hands of the states and then you sat on your hands," Angelides said.

Angelides was exactly right. State and federal bank regulators are funded by taxes they levy against the banks they regulate. Banks game this system, flocking to whatever regulator will give them the most leeway. Preemption sent a clear message to the states: if they want to keep their bank tax revenue, they have to go easy on their banks. And so about half of all states in fact lay off after preemption came down.

But another half of the states decided at some point or another to go after predatory national banks. Anytime that happened, the OCC would intervene, deploying every legal excuse it could come up with to protect the bank. There are dozens of examples of the OCC engaging in this activity, but the most egregious case is its lawsuit against First Franklin, a bank whose sole raison d'etre was subprime lending. There is no way to construe the OCC's assault on First Franklin's state regulator as anything other than an attempt to protect a subprime predator.

Big banks operate dozens of subsidiaries that are regulated by different agencies. When state regulators got aggressive with a subsidiary of a big national bank, the bank would move its predatory mortgage operations under the OCC's jurisdiction. Since the OCC had preempted state authority, the states would be powerless to do anything about it. As a result, the OCC was actively promoting the subprime mortgage operations of these companies, including Wells Fargo, Countrywide, Capital One and others.

Preemption is still a major battle in the current financial reform legislation. The bank lobby is pushing hard in favor of it, and the OCC is supporting them.

People like John Dugan should never be put in charge of bank regulation, but he isn't the only person to screw things up at the OCC. The agency has two duties—one is to protect consumers, the other to make sure that banks don't fail. In practice, this second duty (combined with a desire to attract big banks and their tax revenue) leads the OCC to defend anything that results in short-term profits for banks.

There's a clear solution to this problem: establish a new Consumer Financial Protection Agency that only cares about keeping consumers safe from predators, with the power to both write and enforce regulations on any lender. Sadly, if the FCIC can't demonstrate the OCC's outrages to the public, it's much harder to build momentum for that reform.