No matter what government regulators propose, corruption continues to plague the banking system. Today’s headline news of a record settlement against Wells Fargo shows how much good the Dodd-Frank Wall Street Reform and Consumer Protection Act has done for the average bank consumer.
Signed into law in 2010, Dodd-Frank was supposed to prevent the recurrence of events that caused the 2008 financial crisis. The Wells Fargo sales scam, in which sales people manipulated customer accounts without their knowledge, is not another financial meltdown. But it certainly undermines confidence in the U.S. banking system.
A Record Fine
The U.S. Consumer Financial Protection Bureau (CFPB) has slapped Wells Fargo with a $100 million fine for illegal sales practices for opening as many as 2 million deposit and credit card accounts without consumers’ approval. That’s more than double the previous largest civil penalty from the bureau, a $40 million fine against Morgan Drexen Inc. in March for allegedly charging illegal fees, according to The Wall Street Journal.
The fines against Wells Fargo actually total $185 million, including penalties assessed by agencies besides the CFPB.
Wells Fargo ran a full-page ad in today’s Wall Street Journal taking responsibility for the sales scam and bullet-pointing the steps it is taking to refund affected customers and prevent future such instances.
One thing the crisis points out is that technology is not a silver bullet for consumer financial protection. Bank technology enabled certain Wells Fargo sales-people to set up additional accounts for customers without their approval. The employees also transferred funds to unauthorized accounts, resulting in fees for insufficient funds.
According to a 2015 lawsuit against the bank by the Los Angeles City Attorney, employees also advised some customers that certain products were only available as part of a package with additional accounts, retirement plans or insurance.
These employees were motivated to do this by the bank’s incentive compensation program.
CFPB said the bank has terminated about 5,300 employees for engaging in improper sales practices.
One lesson is that technology, the focus of much excitement in today’s financial community, is only a tool – to be used or misused.
The Bigger Issue
The bigger story here is financial regulation gone amok.
Dodd-Frank was intended to keep financial institutions honest and responsible. What it has done, however, is strengthen large banks at the expense of small ones.
The number of U.S. community banks (those with less than $10 billion in assets) fell 14% between Dodd-Frank’s passage in 2010 and late 2014, according to The New York Times. The newspaper noted that when regulations drive consolidation, banking system risks increase.
Dodd-Frank’s requirements saddle smaller banks with regulations designed for larger banks. As a result, the law forces well-managed institutions to unnecessarily divert resources to compliance, or worse, to close their doors.
By driving small banks out of business, Dodd-Frank has opened the playing field for bigger banks. And what Wells Fargo’s fiasco shows is that mega-banks often have a hard time managing their employees. Will the government now come up with a new set of regulations for bank employee incentive plans?
Dodd-Frank was supposed to prevent future mortgage meltdowns like the one that shattered the U.S. economy in 2008, an event U.S. politicians regularly characterize as a crime orchestrated by Wall Street. Due to the complexity of the mortgage industry, the politicians have largely been able to get away with such simplistic characterizations.
An honest assessment of what happened in 2008 cannot ignore the role that well-intended financial regulation played.
Much to Learn from the 2008 Collapse
The Clinton and Bush administrations, seeking to expand home ownership, encouraged relaxed credit standards to increase mortgage lending. As home buying rose, so did home values. The banks, in turn, used these higher values to justify loans to buyers with less-than-stellar credit worthiness.
Investors saw the mortgages as attractive investments and began buying them up, sending the associated risks of many questionable mortgages into the equities markets. Eventually, the housing bubble burst, taking much of the equities market down with it.
Financial institutions and credit rating agencies played a role in the 2008 mortgage debacle, but does anyone believe that the implied government protection for many unsound mortgages didn’t play a role?
CFPB Director Richard Cordray told The Wall Street Journal the bureau is now paying close attention to the harm caused by incentive compensation, including sectors such as debt collection and credit card add-on products.
Isn’t that encouraging?
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