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22nd May, 2008

Bill Clinton, Glass-Steagall and the Current Financial and Mortgage Crisis, Part Two of an InDepth Investigative Report

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bill clinton signs repeal of glass-steagall

Bill Clinton Signs Repeal of Glass-Steagall

The banking and financial industry complained about the Banking Act of 1933 even as Congress debated it. As the Act worked its way through Congress, banks vigorously opposed it, causing some doubts about whether it would pass, especially with the provisions Carter Glass advocated that prevented banks from entering into the stock market.

Initial Banking Opposition to Glass-Steagall

The centerpiece of the debate over Glass-Steagall was a three-week filibuster by Louisiana Senator Huey Long, which would stand as the longest filibuster in Congressional History until Strom Thurmond’s filibuster of the Civil Rights Bill. This so incensed Glass that he accused Long of being in the pockets of the banks. The American Banking Association opposed the bill. According to a paper by Jill M. Hendrickson

in 1932, 36 percent of national bank profits came from their investment affiliates (Wall Street Journal 1933b, p. 1).

Glass, in his typical style, made this point more forcefully:

Nobody can conceive of the damage done by these affiliates. They literally loaded the portfolios of interior banks with foreign securities approved by this abominable State Department. [New York Times, December 6, 1933]

Many believe the key moment that changed opposition to Glass-Steagall came with the release of the text of investigative hearings held by New York Senator Ferdinand Pecora. His investigation into banking practices uncovered abuses including:

Reputable investment houses that pushed on unsuspecting investors the securities of a company in which they were closely associated; speculation on the stock exchange; and evasion of income taxes on huge earnings by investment bankers. These questionable activities were aided by the commercial banks as they advised their depositors to use their affiliates’ security salesmen for investment advice.

The hardball tactics by Pecora’s committee seem to come from an America and a Democratic Party the exist only in dim memory, but the Committee’s findings aroused such an outcry that newly-elected President Franklin Roosevelt knew something had to be done. Hendrickson adds that perhaps as instrumental was the impact of the stock market crash itself which made investing in securities less attractive to banks.

Whatever the reason, Glass-Stegall survived Long’s filibuster and became law. Ever since the Act has been a thorn in the side of American financial industry which like the proverbial lion has howled about the thorn in its paw.

Investment Company v Camp

The most notable moment in the attempts to scuttle Glass-Steagall came with the 1971 Supreme Court decision Investment Company Institute v. Camp. In that complex case the Court issued one of the most ringing and unequivocal defenses of Glass-Steagall:

Congress was concerned that commercial banks in general and member banks of the Federal Reserve System in particular had both aggravated and been damaged by stock market decline partly because of their direct and indirect involvement in the trading and ownership of speculative securities.

The legislative history of the Glass-Steagall Act shows that Congress also had in mind and repeatedly focused on the more subtle hazards that arise when a commercial bank goes beyond the business of acting as fiduciary or managing agent and enters the investment banking business either directly or by establishing an affiliate to hold and sell particular investments.

Many arguments the Supreme Court advanced in support of Glass-Steagall, would prove prophetic three decades later.

Rising Opposition

As the Republican Counterrevolution gained power, the GOP began nibbling away at Glass-Steagall. These challenges had both symbolic and legal implications. The two pieces of New Deal legislation the have most irked the Counterrevolution have been Glass-Steagall and Social Security. One dared assert that the government in the interests of the greater good had the right to regulate the nation’s financial industry and the other established the principal that the government had a duty to help the less fortunate to insure a level playing field.

It would take too long to recite all the actions that chipped away at Glass-Steagall but a few highlights stand out. In the mid-1980s a Federal Reserve Board stocked with Reagan-Bush appointees began reinterpreting Glass-Steagall in a series of actions that slowly expanded the ability of banks to engage in other financial operations. In 1990, the Fed, under former J.P. Morgan director Alan Greenspan, permitted guess who–J.P. Morgan–to become the first bank allowed to underwrite securities. It is noteworthy that if William Jennings Bryan had had his way about the Federal Reserve Act, Greenspan would have never ascended to the position that allowed him to weaken the act named for the father of the Federal Reserve System.

Four legislative attempts were made to weaken or repeal parts of Glass-Steagall from 1988-1996. One reason they failed is because smaller banks feared that opening the doors to allow banks to trade in securities would lead to the domination of larger banks–a fate that has come to pass. The biggest change came in 1996 when Alan Greenspan issued a ruling allowing bank investment affiliates to have up to a quarter of their business in investments.

The Rise of Sandy Weill

In the up-tempo financial atmosphere in the years surrounding the Greenspan ruling, all sorts of financial innovations took place, some ingenious and some illicit. Of the latter the most notorious was Enron. In this go-go market it was all but inevitable that mortgages should be drawn into this activity.

For most Americans prior to the 1990s, subprime mortgage lenders had a reputation not far removed from pawnshops and slum landlords. Like them most subprime lenders preyed on people who had no alternative and like them subprime lenders often operated on that narrow line separating the shady and the illegal. In 1986 a young man named Sanford Weill grew bored with Wall Street and purchased one of these subprime lenders, Commercial Credit, a loan company based in Baltimore. In his paper “Banking on Misery Citigroup, Wall Street, and the Fleecing of the South,” Michael Hudson notes Weill drove employees to sell more. He quotes employee Frank Smith:

Over a period of time, it went from a family, employee-oriented company—doing the right thing, trying to help its customers—to this cutthroat thing of anything that will get us more business. They need the money or by God they wouldn’t be at the finance company. They’d be at a bank.

This kind of practice resulted in multiple lawsuits that surfaced in the late 1990s and early 2000s. Hudson cites one example:

Jackson, Miss., attorney Chris Coffer says, he obtained confidential settlements for about 800 clients with claims against Commercial Credit or its successor, CitiFinancial.

Starting with Commercial, Weill began wheeling and dealing until a little over a decade later he would head the largest financial institution in the world.

The Repeal of Glass Steagall

In the background of the go-go economy, the feeling grew among some economists and the financial community that Glass-Steagall hampered America’s financial competitiveness. Among the many voices favoring this was Alan Greenspan along with former Goldman Sachs partner Robert Rubin, Bill Clinton’s Treasury Secretary. In a 1995 speech and testimony to Congress Rubin signaled the Clinton Administration was ready to repeal Glass-Steagall:

“The banking industry is fundamentally different from what it was two decades ago, let alone in 1933.” He said the industry has been transformed into a global business of facilitating capital formation through diverse new products, services and markets. “U.S. banks generally engage in a broader range of securities activities abroad than is permitted domestically,” said the Treasury secretary. “Even domestically, the separation of investment banking and commercial banking envisioned by Glass-Steagall has eroded significantly.”

Anyone who thinks the repeal of Glass-Steagall was forced on an unwilling Bill Clinton need only read Rubin’s testimony.

A year later Sandy Weill set in motion the forces that would finally end Glass-Steagall. Weill proposed the most audacious financial merger in American history: he would merge one of the largest insurance companies (Travelers), one of the largest investment banks (Salomon Smith Barney), and the largest commercial banks (Citibank) in America. The problem was the merger was illegal in terms of Glass-Steagall.

Independent Community Bankers of America CEO Kenneth Guenther captured the audacity of the deal in an interview with Frontline:

Here you have the leadership — Sandy Weill of Travelers and John Reed of Citicorp — saying, “Look, the Congress isn’t moving fast enough. Let’s do it on our own. To heck with the Congress. Let us effect this.” And so they move towards effecting it, and they get the blessing of the chairman of the Federal Reserve system in early April, when legislation is pending. I mean, this is hubris in the worst sense of the word. Who do they think they are? Other people, firms, cannot act like this. … Citicorp and Travelers were so big that they were able to pull this off. They were able to pull off the largest financial conglomeration — the largest financial coming together of banking, insurance, and securities — when legislation was still on the books saying this was illegal. And they pulled this off with the blessings of the president of the United States, President Clinton; the chairman of the Federal Reserve system, Alan Greenspan; and the secretary of the treasury, Robert Rubin. And then, when it’s all over, what happens? The secretary of the treasury becomes the vice chairman of the emerging Citigroup.

Weill convinced Greenspan, Robert Rubin and Clinton to sign off on a merger that was illegal at the time, with the expectation that Congress would repeal Glass-Steagall. Charles Geisst, a professor of finance at Manhattan College adds in a Frontline Interview:

Part of [Weill’s] deal with the Federal Reserve was to get rid of all Glass-Steagall violations in the new Citigroup within two years. Otherwise, he would have been faced with a divestiture of a company which had just been put together, because of an old law which is still on the books. So it clearly behooved him, and many other people in the financial services industry who wanted to accomplish essentially the same sort of thing in the future, to push to get Glass-Steagall repealed. So they pushed hard? Pushed very hard. … They pushed so hard that the legislation, HR10, House Resolution 10, which became the Financial Services Modernization Act, was referred to as “the Citi-Travelers Act” on Capitol Hill. ..

The Gramm-Leach Bliley Act

The ” Citi-Travelers Act” went under the benign-sounding name of the Financial Services Modernization Act of 1999 and, like Glass-Steagall it has become known for the key sponsors of the bill as the Gramm-Leach-Bliley Act, for Republican Senate Banking Committee Chair Phil Gramm, House Banking Committee chair James Leach, and Virginia Representative Thomas Bliley. As the bill took form in Congress, the financial industry, particularly Citibank and Sandy Weill increased the pressure. Charles Geisst notes:

In the year previous to the Financial Services Modernization Act, the thing that overruled Glass-Steagall, Citibank spent $100 million on lobbying and public relations, which is a good indication. Yes. They spent a small fortune, a king’s ransom, if you will, getting rid of Glass-Steagall. In fact, when thrown in with other financial firms’ lobbying, it was closer to $200 million over the short period of time.

To give you some idea of the magnitude of this effort, the Center for Public Integrity reports

The pharmaceutical and health products industry has spent more than $800 million in federal lobbying and campaign donations at the federal and state levels in the past seven years, a Center for Public Integrity investigation has found. Its lobbying operation, on which it reports spending more than $675 million, is the biggest in the nation. No other industry has spent more money to sway public policy in that period. Its combined political outlays on lobbying and campaign contributions is topped only by the insurance industry.

In other words, in one year Sandy Weill and his buddies spent 1/4 of what the next biggest lobbying effort on record spent in 8 years! In a paper on the repeal of Glass-Stegall in the American Journal of Economics and Sociology Jill Hendrickson wrote:

The Industry’s efforts to jump-start progress on the [Senate] bill is a case study in how a well-heeled and well-organized interest group can swiftly prod Congress to move, even on an issue about which most people outside Washington and New York have little knowledge. Nor is it surprising, according to both political science and economic literature, that the interest groups played a vital role in the timing of the 1999 deregulation. Without persistent lobbying by commercial and investment interests it is unlikely that reform would have taken place in this century.

GLB repealed Sections 20 and 32 of the Glass-Steagall Act:

  • Section 20 – prohibited any member bank from affiliating in specific ways with an investment bank;
  • Section 32 – prohibited investment bank directors, officers, employees, or principals from serving in those capacities at a commercial member bank of the Federal Reserve System.

There was only one problem: the bill had to reconcile differences between the House and Senate versions. The House version differed in two important ways: 1) It took regulatory authority from the Federal Reserve and gave it to the Secretary of the Treasury and 2) it refused to extend to insurance companies obligations under the Community Re-investment Act to provide information about their patterns of mortgage lending.

Democrat Barney Frank was among those who especially opposed the second, telling the BBC

We can we try to do a little bit for those who are being left behind. This is an inappropriate continuation of a pattern of helping those who need a benefit but ignoring those who are left behind.

It was the Community Reinvestment Act provision in particular that threatened to derail the conference committee. Here is the now oft-quoted Frontline description of what happened:

On Oct. 21, with the House-Senate conference committee deadlocked after marathon negotiations, the main sticking point is partisan bickering over the bill’s effect on the Community Reinvestment Act, which sets rules for lending to poor communities. Sandy Weill calls President Clinton in the evening to try to break the deadlock after Senator Phil Gramm, chairman of the Banking Committee, warned Citigroup lobbyist Roger Levy that Weill has to get White House moving on the bill or he would shut down the House-Senate conference. Serious negotiations resume, and a deal is announced at 2:45 a.m. on Oct. 22. Whether Weill made any difference in precipitating a deal is unclear.

Frontline‘s pregnant pause says it all.

What Happened That Night

So why did Well call Clinton, and what did Clinton do? One take comes from a National Housing Institute article by Malcolm Bush and Katy Jacob.

In an unusual move, the three key Republican Chairmen bypassed the usual conference committee debates by writing a “final compromise” themselves. That bill’s CRA provisions resembled the original Senate bill. (House Banking Committee Chairman Jim Leach had fought in the House for a bipartisan bill with no anti-CRA measures while Senate Banking Chair Phil Gramm had insisted on the Senate’s anti-CRA provisions.)

At this point, tremendous pressure was exerted on the Clinton Administration, which had earlier threatened to veto the Senate version, to sign the legislation, and intense negotiations continued over community reinvestment and consumer privacy provisions.

The Community Reinvestment Act required regulated banks and thrifts to offer loans and banking services throughout their service areas, including lower-income communities. But here is the wrinkle–the CRA essentially served to protect low and moderate income communities from predatory lending–such as subprime mortgages. In 1999, shortly after passage of GLB, National Community Reinvestment Coalition president John Taylor wrote:

We must step up our efforts to identify and eradicate predatory lending. Horror stories abound of minority and low- and moderate-income families losing their homes and wealth due to unfair and deceptive tactics. On a national level, the banking industry increased their subprime mortgage lending from less than 1 percent of all conventional mortgage loans in 1993 to 6 percent in 1998. Our efforts will be to support and promote state and/or federal legislation, similar to that recently passed in North Carolina, that curbs abusive lending.

So we know that the topic of that late night phone call between Bill Clinton and Sandy Weill, the man whose career began in the subprime mortgage business, was the Community Reinvestment Act. We know that Phil Gramm, who was the one most strongly pushing for gutting CRA (Leach actually supported it) threatened to torpedo the legislation if the White House did not reach an agreement.

By the way, Phil Gramm is also currently co-chair of John McCain’s Presidential campaign and one of his chief economic advisors. So if you are thinking about voting Republican because of Bill Clinton’s role in the repeal of Glass-Steagall, remember that the man whose name is on the bill will probably be in John McCain’s cabinet, possibly as Treasury Secretary. Gramm still remains unrepentant about repealing Glass-Steagall. In March Gramm told U.S. News

I see no evidence whatsoever that the subprime problem was in any way caused by making our financial structure more competitive by allowing banks and securities companies and insurance companies to compete against each other. I have seen no evidence whatsoever to substantiate that claim.

So why did Clinton go along? His writings are silent on the subject. He seemingly held the trump card with the threat to veto any legislation that did not meet his approval. And why is it Sandy Weill who makes the phone call to Clinton? Woodward and Bernstein where are you when we need you?

At this point not enough evidence is available to finally connect the dots, but whatever it is, it cannot possibly benefit Bill Clinton. Were the fingers of the leaders of both parties not all over this bill, you would hope a contemporary version of Senator Pecora might investigate the entire matter, but that will probably never happen. For those who believe Wall Street now calls the tune in this country, the story of the repeal of Glass-Steagall certainly fuels their paranoia.

Troubling Sections of GLB

The most troubling aspect of GLB is not only did it repeal Glass-Steagall but it did so in an especially aggressive way that purposely weakened many enforcement provisions, some of them so obscure most of the public is not aware of them. For example:

Governance of the Federal Home Loan Banks is decentralized from the Federal Housing Finance Board to the individual Federal Home Loan Banks. Changes include the election of chairperson and vice chairperson of each Federal Home Loan Bank by its directors rather than the Finance Board, and a statutory limit on Federal Home Loan Bank directors’ compensation.

Other provisions:

Provide for a “jump ball” rulemaking and resolution process between the SEC and the Federal Reserve regarding new hybrid products. Grants regulatory relief regarding the frequency of CRA exams to small banks and savings and loans (those with no more than $250 million in assets). Small institutions having received an outstanding rating at their most recent CRA exam shall not receive a routine CRA exam more often than once each 5 years. Small institutions having received a satisfactory rating at their most recent CRA exam shall not receive a routine CRA exam more often than once each 4 years.

The most troubling section, though, is Section 108, titled USE OF SUBORDINATED DEBT TO PROTECT FINANCIAL SYSTEM AND DEPOSIT FUNDS FROM ‘‘TOO BIG TO FAIL’’ INSTITUTIONS. It provides for a study of:

The feasibility and appropriateness of establishing a requirement that, with respect to large insured depository institutions and depository institution holding companies the failure of which could have serious adverse effects on economic conditions or financial stability, such institutions and holding companies maintain some portion of their capital in the form of subordinated debt in order to bring market forces and market discipline to bear on the operation of, and the assessment of the viability of, such institutions and companies and reduce the risk to economic conditions, financial stability, and any deposit insurance fund.

Note the language of this section. For the first time in the history of the American economy certain financial institutions are being judged “too big to fail.” Think about the implication of that. A company now has such power and influence that the government cannot allow it to fail. This is corporate welfare at its worst. If a company gets to a certain size we will designate it “too big to fail.” How would you like your home to be designated too big to fail or your job?

This language as much as any other speaks of the end of the ideals that powered the new Deal.

After GLB

After the passage of GLB, the subprime market took off as if someone had attached a booster rocket to it. If anyone has doubts about Sandy Weill’s connections between GLB and the subprime market, just a year after the passage of the bill repealing Glass-Steagall, Citigroup had become the number one subprime lender in the country. Its vehicle for this was the newly formed CitiFinancial. Although he now was one of the wealthiest people in the world, some things had not changed for Sandy Weill since he bought Commercial Credit. CitiFinancial continued many of his original firm’s aggressive practices. Michael Hudson notes:

In 1999, the company agreed to pay as much as $2 million to settle a lawsuit accusing Commercial and American Health & Life of overcharging tens of thousands of Alabamans on insurance. Beasley, Allen, claim[ed] nearly 1,500 clients in Alabama, Mississippi, and Tennessee who had Commercial Credit or CitiFinancial loans.

Hudson notes Weill was especially enthused about the possibilities the repeal of Glass-Steagall had created:

Weill enthused about blending diverse units and creating opportunities for “cross selling,” which allows affiliates to market each other’s products. Primerica boasts more than 100,000 agents who can not only sell life insurance but also steer loan applicants to the parent’s subprime operations. In Weill’s vision, he’d created “a walking, talking bank.”

Not long after Hudson wrote his article and Weill made that statement, the subprime crisis hit America. While there are too many theories to go into here, one notable explanation comes from the Federal Reserve System itself. In a paper for the St. Louis Federal Reserve System, Souphala Chomsisengphet and Anthony Pennington-Cross point out:

The growth of subprime lending in the past decade has been quite dramatic. Using data reported by the magazine Inside Lending, Table 3 reports that total subprime originations (loans) have grown from $65 billion in 1995 to $332 billion in 2003. The structure of the market also changed dramatically through the 1990s and early 2000s…For example, the market share of the top 25 firms making subprime loans grew from 39.3 percent in 1995 to over 90 percent in 2003. Many firms that started the subprime industry either have failed or were purchased by larger institutions.

Meanwhile a few voices began to openly wonder if the repeal of Glass-Steagall had fueled the crisis. Thomas Kostigen of Marketwatch wrote

Glass-Steagall would have at least provided what the first of its names portends: transparency. And that is best accomplished when outsiders are peering in. Glass-Steagall forced separation. Something like it, where conflicts and losses can be mitigated, should be considered again.

Financial Week headlined, “Glass-Steagall Wasn’t Such a Bad Idea After All.” The article stated:

The credit crisis now afflicting the corporate debt and stock markets suggests Congress should revisit the work it did in 1999 that is at the root of much of today’s troubles. That’s right: It’s time to rethink the Gramm-Leach-Bliley Act, otherwise known as “Sandy’s Law” (after then-Citigroup chief executive Sanford “Sandy” Weill), which nailed shut the coffin of the Glass-Steagall Act of 1933.

Did the Repeal Contribute to the Mortgage Crisis?

So are these sources right? From an obvious, common-sense point of view they are. Had Glass-Steagall been in place Citigroup could not have formed CitiFinancial and Bear Stearns would not have needed a bailout. Many in the financial community believe the repeal of Glass-Steagall did contribute to the financial mess we are in. Scott-Cleland, founder and CEO of the Precursor Group, a research boutique for institutional investors, told Frontline

The repeal of Glass-Steagall was an important contributor to the bubble. Well, it added to the frenzy. It added to the investment banking fervor. It added to the amount of money that was staked on this. Essentially, you had a bigger shoulder pushing that rock up the hill.

Former SEC Chair Arthur Levitt is another who worried about the repeal of Glass-Seagall:

The merger of investment bank and commercial bank interests has created conflicts of interest that clearly hurt the public investor. Only extraordinary activity by both the banking and security regulators can begin to address [the] issue.

But what about Gramm-Leach-Bliley helped to fuel the crisis, for it is easy to say that if banks had not been involved in securities we would not be facing the mess we are in. Curiously one of those converts is none other than Robert Rubin who has stated

If Wall Street companies can count on being rescued like banks, then they need to be regulated like banks.

Since it was Rubin who played a major role in the deregulation this statement is nothing short of incredulous. As the record shows, Rubin had a great deal to regret. When the mortgage crisis began to unravel, several of the changes in Glass-Steagall and several of the new provision in GLB came into play.

First, because of changes in the Community Reinvestment Act, banks no longer were examined closely. Had bank examinations continued in the fashion they had before GLB, they might have provided a warning of the crisis.

Second, in what is called the “sunlight provision” that was added to the CRA portion of GLB, 501c3 organizations that had worked as watchdogs to insure that banks followed the law were put under more scrutiny than the banks themselves.

Third, Section 20 of Glass-Steagall was gutted by Alan Greenspan’s ruling. LB buried it for good. Bill Clinton could have confronted Greenspan over his order or opposed the repeal of Section 20, but chose not to. The repeal of Section 20 enabled big players like Citi to gobble up the smaller banks covered by CRA. Depending on how the acquisition was structured, those newly-acquired smaller banks now came under the new liberal examination rules of GLB.

Fourth, in emphasizing the impact of the repeal of Glass-Steagall it is important to note that GLB repealed TWO of Carter Glass’ four sections: Section 20 and section 32. Much emphasis has been placed on Section 20, but Section 32 may be equally or more important in the current crisis because it forbid interlocking directorships. The repeal of Section 32 allowed interlocking directorships that made policing and unraveling the crisis like untangling a fishing reel backlash.

Fifth, the “Too Big to Fail” section of GLB–an idea that both William Jennings Bryan and Carter Glass would have found reprehensible–changed the business playing field in America for good. For all their worship of “the market,” the Republican Counterrevolutionaries had in one stroke of a pen made the market irrelevant for the likes of Bear Stearns.

Sixth, Glass-Steagall required member banks to keep a percentage of their deposits in reserve to cover a bank run. That percentage was sustantially changed in GLB so in the event of a crisis like Bear Stearns, the funds to cover the disaster were inadequate.

The Key to it All

GLB created a financial Brave New World where institutions have become “too big to fail,” even if they skirted or even violated regulations and the financial entanglements of banks, investment companies and insurers have become difficult to sort out and virtually impossible to regulate. The reason TBTF has placed the United States economy at risk is perhaps best stated by Ed Mierzwinski at the U.S. Pirg Consumer Blog:

The reason for the bailout, from the regulator point-of-view is simple: everything is now connected to everything else. Regulators thought that the interconnected economy would absorb and diffuse risks. Instead, these interconnections and use of exotic financial instruments no one understands — coupled with the moral hazard created by the repeal of Glass-Steagall, which allows would-be lords of the universe on Wall Street (their term, not mine) to play with taxpayer-insured deposits at commercial banks — has force-multiplied local or individual financial problems into world-wide financial crises.

So now we find ourselves in the midst of a Presidential campaign in which the chief financial advisor to one candidate authored the bill that repealed Glass-Steagall and another candidate’s husband acquiesced in the deal. The third candidate has already stated he would not reinstate Glass-Steagall. When asked if he would restore Glass-Steagall Barack Obama notes

Well, no. The argument is not to go back to the regulatory framework of the 1930’s because, as I said, the financial markets have changed substantially.

I would be remiss by not adding four of Obama’s top six contributors include Goldman Sachs, J.P. Morgan and–guess who–Citigroup.

None of this promise the next four years will be any easier on the American consumer. And meanwhile I am still waiting after six months for some reporter to ask Hillary Clinton what she thinks of her husband’s repeal of Glass-Steagall and whether she would favor rolling it back.

The reason for the silence may be that for the Clintons the repeal of Glass-Steagall may prove far more embarrassing in the long run than Monica Lewinsky.

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