WASHINGTON — The Office of the Comptroller of the Currency is facing the biggest challenge to its preemption powers in a decade, but don’t expect Comptroller John Dugan to say much about it.
Since he was sworn in Aug. 4, 2005, Mr. Dugan has given almost 20 speeches. He has talked about credit risk, anti-laundering requirements, the proposed Basel II capital regulations, new guidelines on alternative mortgages, concentrations in commercial real estate, assistance to minority banks, privacy notices, the Home Mortgage Disclosure Act’s disclosure requirements, product innovation, and derivatives.
The omission of preemption is glaring, especially with the Supreme Court scheduled to consider the question Wednesday. But don’t read too much into that silence.
“Our position hasn’t changed,” Mr. Dugan said during an interview this month. “There was a lot of controversy, and I thought it was a good idea to lower the temperature about it without changing our position.”
The OCC’s enforcement of the Bank Secrecy Act dominated his confirmation hearings in July of last year.
In the opinion of some observers, including its inspector general, the agency failed to take appropriate action against Wells Fargo & Co., despite substantial violations of anti-laundering regulations. The case has fed the contention that the OCC curried favor with big banking companies by going easy on enforcement.
A Senate committee report released in mid-2004 had been sharply critical of the agency’s treatment of BSA violations at Riggs National Bank.
The volume and tone of senators’ questions at Mr. Dugan’s hearings left little doubt in his mind as to his priorities. He vowed to complete BSA examinations at all national banks within a year.
A little over 15 months later, Mr. Dugan said he is satisfied with the response by his agency — and bankers. He deemed a 300-page interagency manual crafted to answer bankers’ questions about regulatory requirements a “success,” even though he typically does not favor overly proscriptive advice.
“This is one area where there was enough confusion and enough concern about uneven application that it was really important to spell out our expectations,” he said. “I don’t think we get as many complaints about us raising the bar retroactively or unfairly.”
Though banks now have a good idea of what they must do to avoid problems, further enforcement actions — both confidential, informal ones and public orders — are inevitable, he said; knowing what to do is not the same thing as doing it.
“It’s the No. 1 area where I hear about compliance cost and regulatory burden — and not because we’re increasing it, but because the steady state of what we’ve got now demands a lot from … [banks] in terms of cost,” he said.
Mr. Dugan does not apologize for the compliance burden, but he acknowledged that regulators may have fallen short in explaining how compliance contributes to country’s efforts against terrorism.
“I don’t think that we in the federal government, particularly on the enforcement side, have done a good job communicating to the industry what the benefits are,” he said.
To that end, he invited Robert Werner, the outgoing director of the Financial Crimes Enforcement Network, to meet with bankers and explain those benefits. According to Mr. Dugan, those efforts are paying off.
He also counts the alternative mortgage guidelines among his accomplishments. Issued in September, the guidance puts a heavier onus on banks to prove borrowers’ ability to repay interest-only and payment-option mortgages.
Mr. Dugan remains involved with a similar interagency effort to safeguard banks from the risks of highly concentrated commercial real estate portfolios. The proposed guidelines have been roundly criticized by community bankers, who view commercial real estate as the last level playing field for profitable growth.
“We have spent an awful lot of time trying to make bankers understand that we don’t mean what some people have suggested,” Mr. Dugan said. “I don’t think we did enough in explaining that these were thresholds, not caps.”
The comptroller also has stepped squarely into negotiations on proposed capital regulations — generally thought to be the Federal Reserve Board’s turf — and put forth what proved to be a key breakthrough that moved the Basel II regime closer to reality. The compromise would limit how much regulatory capital could fall at individual banks and the industry in aggregate.
Large national banks vehemently oppose that approach, which they say slaps a set of suspenders to the Basel II belt.
“We brokered a compromise on Basel II within 45 days of my coming on the job — one of many compromises, but it was early on in the process, at a very critical point, about safeguards that would allow all of the regulators to agree to move forward to the next stage of the process,” Mr. Dugan said.
Banks and regulators have reached another “critical point for making a decision on Basel II,” he said, and a watered down version for small banks — known as Basel IA — may reach the Federal Deposit Insurance Corp. board on Dec. 5.
That Mr. Dugan leans toward free-market solutions is well known — and well documented. As a Treasury Department assistant secretary during President George H.W. Bush’s administration, Mr. Dugan had a leading role in writing a sweeping plan to overhaul the financial sector. Among its recommendations: letting banks own nonfinancial companies.
Today, Mr. Dugan is more circumspect about mixing banking and commerce, and he offered no hints about how he would vote on Wal-Mart Stores Inc.’s application for an industrial loan charter.
There has been “and continues to be a legitimate public policy issue about what kind of system we want to have,” he said. “It is something that deserves examination by Congress. When you have institutions that are competing with other institutions that are subject to different regulatory schemes, rationalizing that regulation seems to me a totally appropriate line of inquiry.”
Mr. Dugan and other OCC officials say they are keeping a close eye on easing underwriting standards but are not alarmed by what they are seeing. Still, systemic risks may be even more important than credit risk, and here Mr. Dugan is not quite as laissez-faire as his colleagues at the Treasury.
Fed and Treasury officials have testified that a system of “indirect regulation” is working to keep hedge funds in line. Under that system, hedge fund lenders — banks — enforce market discipline on their borrowers.
But Mr. Dugan said the structure has weaknesses. Though hedge fund lending is heavily collateralized, the reliance on collateral has a flip side: Decisions are based entirely on collateral valuation, rather than a more holistic assessment of balance-sheet strength.
Hedge funds “aren’t transparent, and our banks can’t see what else is on their balance sheet and what other kinds of trades they are making,” he said. “You can’t see the kind of things that might be relevant if there were a systemic event,” and a bank’s “exposure could end up being greater than the collateralized position, because it moves too quickly.”
In addition to his work at the Treasury, Mr. Dugan’s policy background comes from Capitol Hill, where he was the Senate Banking Committee’s general counsel, and the private sector, where he ran Covington & Burling LLP’s financial services practice.
So the delicate task of building consensus and crafting policy is home ground for Mr. Dugan. It’s running the supervisory side of the shop that has proved more challenging.
“I grew up in the policy world, and regulatory politics,” and “I felt comfortable in that world,” he said. “But actually to get to know the 85% of the agency that supervises banks, and to work with them, understanding what they do every day and how the agency works, was newer for me.”
He said that the OCC’s supervisory strengths have compensated for his relative lack of experience, and that he has been comfortable enough with its top officials that he brought in only one person — John Walsh, his chief of staff — when he joined the agency.
What worries Mr. Dugan is the flight of talent, but the lure is not the private sector; it’s retirement.
“It was apparent to me after a couple of months on the job that one of the issues that I would face during my entire tenure here was staffing,” he said. “We have assets coming into the national banking system, and at the same time, like many organizations, we have a chunk of very experienced examiners who become retirement-eligible in the next five years.”
He said the OCC is hiring over 150 examiners each year as it prepares for the retirement wave, which will coincide with Mr. Dugan’s term, set to expire in August 2010.
