Banks Wince as Wells Fargo Gets a Harder Than Usual Wet Noodle Lashing from the Fed

On her way out the door, Janet Yellen administered a punishment to serial miscreant Wells Fargo that she’d threatened if they hadn’t cleaned up their act sufficiently, which at a minimum translates to putting on a really good show of being contrite. As we’ll describe, while it was a bit tougher than what financial regulators have seen fit to dole out since the bank-friendly Clinton Administration, and other banks were whinging as a result, it is lame even by not-all-that-remote historical standards.

The Fed is forcing Wells to find three new directors by April and one more by year end, following through on a threat made last July. That is a necessary but far from sufficient condition for effecting real change at the bank, which has the hallmarks of having created a toxic culture that will take a concerted effort to change. However, with a CEO who was promoted internally, Tim Sloan, there’s every reason to expect that all will happen are cosmetic changes, and Sloan’s conduct to date is consistent with that.

The Fed also took the unusual step of putting a hard balance sheet cap on Wells Fargo, and saying it stays in place until the Fed sees fit to lift it. That move appears to have created a wee frisson across the banking world, even though Wells Fargo claims will cost them an estimated $300 to $400 million a year, which is still a “cost of doing business” level punishment. And mind you, Wells Fargo has every incentive to play up how much they are supposedly losing.

Bloomberg’s Gadfly column questioned Wells Fargo’s claim that it would suffer financially, at least in the near term:

The Fed also took the unprecedented step of prohibiting Wells Fargo from growing any larger than its total asset size at the end of 2017, or $2 trillion, without clearance from the central bank. Ironically, this sanction actually provides an element of cover for the lender, which has found growth to be a challenge lately.

Readers may recall that the fake accounts scandal at Wells came to light in September 2016, when the bank announced it had entered into a settlement with the Consumer Finance Protection Bureau, the Office of the Comptroller of the Currency, and the Los Angeles city attorney. The initial outrage stemmed from the puny fines relative to the scale of the fraud. The regulators look to have accepted the Wells Fargo point of view, that the total dollar amount stolen, via fees on unauthorized accounts being debited from deposits, was puny (at the time, estimated at $4 million tops). But the idea that the bank had created millions of phony accounts, potentially hurting customers’ credit score, and had stolen from hundreds of thousands of bank accounts, proved to be a lightening rod. It’s one thing for banks to have made an art form of dining customers for all sort of charges they didn’t realize they could incur. It’s another to practice embezzlement on an industrial scale. As we wrote when the scandal broke:

This was an astonishingly brazen, large-scale effort, clearly a systematic, institutionalized campaign. It is virtually impossible for senior executives not to have known what was going on. The big reason that Wells has managed to cultivate the myth that it is better managed than other large banks is that it is largely a traditional bank, as in it is not seriously involved in free-wheeling, high-risk, hard to manage investment banking activities.

But traditional banks, and above all retail banking operations, are extremely routinized. Customer-facing staff have virtually no discretion. For decades, bank branches have been operated as retail stores, with employees offering standard products. Similarly, the activities of call center staff are similarly highly circumscribed, set forth in clearly defined routines, which includes strict scripting for some interactions.

In other words, there is no way to defend the lack of punishment of executives in a fraud of this scale that extended over five years.

Yet Wells Fargo’s board was remarkably slow to act. I thought the CEO and Chairman John Stumpf would be turfed out within ten days. Even with two disastrous Congressional hearings and news of more frauds breaking, including illegally repossessing cars of active servicemembers and force placing auto insurance, which led to an estimated 20,000 wrongfull repossessions, it took over a month.

Even then, Wells Fargo’s board couldn’t bring itself to do the right thing, which was bring in an outsides who would be credible as a turnaround leader. Georgtown law professor Adam Levitin said via e-mail that Wells’ best move would have been to bring in Shiela Bair.

Instead, the board elevated Tim Sloan, who was apparently deemed to be remote enough from the scandals by virtue of not being in the reporting line of the retail operations. The wee problem with that logic is that it implies Sloan was either terrible at his job or he also knew full well what was afoot. He was the Chief Financial Officer from 2011 to 2014, during height of the fake accounts scandal. That meant among other things that he was giving Sarbanes-Oxley certifications as to the adequacy of Wells Fargo’s controls. If you buy the garbage barge that Wells Fargo has kept trying to sell, that the scandal was all the handiwork of evil lower level employees, you have to believe the controls were inadequate and therefore Sloan was giving false certifications. Or else the top brass knew and Sloan should be turfed out too.

Let us stress that the Congresscritters that called Wells Fargo a “criminal enterprise” were on the mark, yet as usual, the bank has gotten away with a wrist slap. The fake accounts scandal was neither the beginning nor the end of bad conduct by Wells Fargo.

As we have recounted, during the foreclosure abuse scandal, Wells Fargo had consistently taken a sanctimonious posture, pretending it wasn’t engaging in the same predatory behavior as other bank servicers. Yet among other things, it was caught out with having created a mortgage document fabrication manual, ruled to have engaged in “reprehensible,” systematic foreclosure abuses, and as whistleblowers told us, not even making a serious effort of investigation during the mandated Independent Foreclosure Review in 2012.

Since the fake accounts scandal broke, Wells ‘fessed up to having created even more phony accounts. Mind you, it had earlier claimed it had come clean. From CNN last August:

Wells Fargo has uncovered up to 1.4 million more fake accounts after digging deeper into the bank’s broken sales culture…

Wells Fargo now says it has found a total of up to 3.5 million potentially fake bank and credit card accounts, up from its earlier tally of approximately 2.1 million. In other words, there are two-thirds more fake accounts than previously realized.

The additional fake accounts were discovered by a previously announced analysis that went back to January 2009 and that further reviewed the original May 2011 to mid-2015 period.

About 190,000 accounts were slapped with unnecessary fees for these accounts, Wells Fargo said. That’s up from 130,000 previously.

Oh, and while we’re at it:

Wells Fargo also discovered a new problem: thousands of customers were also enrolled in online bill pay without their authorization. The review found 528,000 potentially unauthorized online bill pay enrollments.

It’s worth watching Elizabeth Warren grill CEO Sloan last September, when he been in place for almost a year. It’s obvious that as someone who was in a senior role when so much bad conduct was happening that he is far too vested in defending the status quo:

Notice he has the nerve to try to stand up to Warren when she clearly has the goods on him (at 7:35). All he does is put his hand in a buzz saw. 1

One bit (and we do mean bit) of good news is the wee spine stiffening on Wells Fargo isn’t likely to be reversed now that Jerome Powell is taking the helm as Fed chairman. Even though this is a comparatively mild move towards better governance, it is so out of keeping with the decades-long posture of deference that bank boards are gobsmacked. Mind you, they also have every incentive to play up this move as tough in order to deter the leash being tightened further. From the Wall Street Journal:

A letter Friday from departing Fed Chairwoman Janet Yellen to Sen. Elizabeth Warren (D., Mass.), showed that the central bank is thinking more broadly than just Wells Fargo. Ms. Yellen wrote that the Fed is raising expectations for boards of directors across the banking industry…

The letter cited guidance for boards the Fed proposed in August, which Mrs. Yellen wrote “marks the first time that the Federal Reserve has issued stand-alone expectations for boards of directors as distinct from management.”..

But banks shouldn’t necessarily think Mr. [Jerome] Powell will change course. As a Fed governor, he took a leading role in pushing the Fed to adopt the new regulatory guidance for board members.

And as to, “What could the authorities have done?” spare me. Warren is right that nothing will change until senior execs are tossed out, and by regulators, rather than by boards because the bad press can’t be tamped down.

In 1992, Salomon Brothers had been engaged in a Treasury bond market rigging scandal. Without going into the details, the investment bank had failed to curb a trader even after having been told in no uncertain terms to cut it out, allowing him to break the rules even after the Treasury had sent Salomon evidence that they had caught him out in a new version of cheating. The central bank, which runs bond auctions on behalf of the Treasury, found out about the continued defiance via a Wall Street Journal story. Salomon’s chairman/CEO, vice chairman, general counsel, and head government bond trader resigned days later. Salomon was such a large bond trader that those operations were arguably systemically important, yet the Fed wasn’t about to be cowed.

By contrast, Wells Fargo is largely a retail bank. They have vastly more stable operations that an old-style investment bank, which are much more “eat what you kill” environments, and entire profit centers can be poached. There is nothing special about being a big dog at Wells Fargo. There are plenty of former senior banking executives who could fill those roles. That is why the failure to turf out the CEO and get someone who was not part of the problem in is so inexcusable. Wells Fargo is not only where it needs to happen, it is where the authorities could have flexed their muscles with very little downside.


1 It was a nice touch that Warren didn’t bother making her hair look nice for this hearing. It was a subtle way to register her lack of respect for Sloan.

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  1. HopeLB

    Where could Warren wield the most power, as Head of the Fed, Sec of Treasury, SEC or some other position?

      1. False Solace

        Never happen. Trump hates Warren. She called him a lot of bad names during the campaign when auditioning for VP and he continually calls her Pocahontas.

        1. Arizona Slim

          Recall that LBJ and RFK had the same level of hatred. But they were still part of the Kennedy administration.

  2. The Rev Kev

    Quite a video that. I would invite commentators to watch the segments of it featuring CEO Sloan but to watch the guy to the left instead as he is unintentionally hilarious. You can see the sweat build up on his face and the look he gives Sloan seem to be saying “She’s not buying it.” No deadpan looks for that boy!
    Seriously, nothing is going to stop these CEOs as they know that not one of them will ever be wearing an orange jumpsuit. They know that it is going to end eventually in a disaster which is why people like Thiel are preparing boltholes in places of New Zealand but they cannot help themselves. They are drawn by the money and the power to take part in it, to help it fail but they cannot stop it. The only way that you will clean out Wall Street is the same way that Ellen Ripley cleaned out the Alien nest-

  3. Off The Street

    Warren Buffett’s name and influence should be in evidence, but are curiously, or not, lacking. Given his past influence at Salomon in the wake of that scandal, and his long-term ownership stake in Wells, just where was he? Or did he magically delegate all of his celebrated economic moat maintenance to his minions?

  4. jfleni

    Wells-****off will never reform without SIGNIGANT fines and loss of business! That is the truth which never can be changed by flogging with wet noodles!

  5. McWoot

    Forcing out directors that will quickly resurface on other boards is definitely wet noodle territory. The criminal activities will continue until perpetrators are a) jailed and b) have compensation clawed back

    1. Exlcus

      Exactly McWoot. Wake me up when that happens. Until then, this is all just theater and Warren is nothing but an actress to me. And I am not entertained.

  6. Javagold

    They should look into how many houses wells fargo stole thru fraudclosure with robo signed documents as they are nothing more than a lowlife debt collecting sevicer, who lent NO money to any homeowners they stole their houses from……these criminals showed up approx. 10 years into my mortgage and with never being one day late and managed to get me fruadclosed upon with incorrect balances, robosigning and post dated documents , which were all bought to the courts attention WHO STILL ALLOWED THE CRIMINALS TO FRAUDCLOSE!!!!

    1. Expat2uruguay

      That’s horrifying. I don’t understand why people don’t go postal on this type of crap at least once in a while. I keep thinking that it is going to happen, but nope. US americans just keep taking the abuse until they kill themselves, rather than take out some criminal enterprises on their way out the door.

      I was acting out in some rather bad ways before I decided to leave the country… My favorite TV series was Burn Notice, because they were good at blowing up bad guys! Still is my fav, actually….

      1. Exlcus

        Off topic, but do you have a blog or can you point me into any information about Uruguay that you know is out there?

  7. Chauncey Gardiner

    A decline of over 8.5 percent in the stock price today, or around $28 billion in market cap… Poof!! Don’t think this is being perceived as a slap on the wrist.

    1. Yves Smith Post author

      Banks are down 2.1% per the KBW index.

      As Bloomberg Gadfly notes, if anyone was expecting growth from Wells, they were expecting too much. Plus banks are going to have a tough time in a rising interest rate environment. They are structurally long. $400 million max in lower earnings for, what, a year or two, on a bank that earned IIRC $22.7 billion last year does not translate into 8.5% lower value. This is Mr. Market not reacting enough to the new world, particularly as it applies to Wells, and finally baking it into the price.

    2. Yves Smith Post author

      To elaborate on my earlier point, this seems to be Mr. Market finally digesting what it should have absorbed earlier.

      It came out in Congressional testimony that other banks have something like 4.5 products per customer. Wells IIRC has over 6 or at least claimed they had over 6 products per customer. They had set a target of 8.

      What the scandal and related testimony revealed was that this was not attainable by legitimate means, which meant no way could Wells achieve more growth via cross selling, which had been its central story for years. This was not a function of a regulatory crackdown, this was a function of its growth model having hit the end of its runway and the customer abuses being the result of that.

      The under-reaction to the fake accounts scandal was a symptom of denial of fundamental problems with Wells’ growth story. The Fed’s action shook investors out of their delusion.

  8. Tom Bradford

    Hey, you guys. What are you trying do do?

    My portfolio managers have put 1% of my portfolio in WFC. You trying to bankrupt me?

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