Politics of Finance on Full Display Thanks to Wells Fargo
By Heritage Foundation Financial Regulations Scholar Norbert Michel
Politics should not trump sound economic policy, but it often does, especially with regard to regulating financial markets. And that’s precisely what we can expect to see arising from the mess that Wells Fargo has gotten itself into.
There’s no excuse for what those employees did. And their misbehavior raises at least three key policy issues. Yet in all likelihood, these reform ideas won’t be addressed for years to come. Instead, Congress is out for (political) blood.
For anyone who missed it, here’s a quick rundown of the Wells scandal and last week’s hearings:
- Prior to 2015, Wells Fargo bank employees opened fake accounts – perhaps as many as 2 million – in the names of existing customers and make-believe people.
- The Los Angeles Times uncovered the problem, with investigative reporting based on lawsuits and complaints in the state of California.
- After the Times broke the story, the information made its way to federal regulators, and in early September the company agreed to pay a $185 million settlement.
- In the Senate, Elizabeth Warren (D-Mass.) called for CEO John Stumpf to resign, as well as for a criminal investigation. (This one shouldn’t come as a surprise).
- In the House, Republicans and Democrats piled on so much that Rep. Mike Capuano (D-Mass.) joked that Stumpf had “brought true bipartisanship to Congress.” Everyone is outraged.
Again, there’s no excuse for fraud, and it should be punished. The question of how best to accomplish that goal, however, is sort of being ignored right now. An excellent case can be made that weaknesses in the current legal framework made what happened at Wells more likely to occur.
For example, if policymakers were to design a fraud deterrence regime from scratch, they would do well to (among other things) concentrate on individual rather than corporate liability, impose stricter corporate civil (rather than criminal) penalties in a manner that better aligns shareholder incentives, and make clearer distinctions between federal and state enforcement responsibilities.
Our current system is deficient in each of these areas. While all the political outrage aimed at Stumpf is understandable, unless the attention helps to fix these underlying problems, it serves only as great theater.
Another issue obscured by the political fog is that the Wells case should have nothing to do with the broader push for freeing firms from overly burdensome financial regulations. People commit fraud due to a flaw of human nature, not because of a defect unique to free markets.
Politico’s Victoria Guida reports that Rep. Mick Mulvaney (R-S.C.) chastised Stumpf for undermining arguments against why banks should be regulated more intensely. In one exchange with Stumpf, Mulvaney said:
“I can’t tell you how disappointed I am to even have to be here today as one of the many members of this committee who every single day in here defend the banking system, defend capitalism, defend free markets.
To sit here and have to watch you essentially validate everything that the other side has said about you and your business and your industry, I don’t know, for the last three or four generations, is extraordinarily disappointing to me. The damage that you have done to the market, to your industry, far exceed[s] the damage that you’ve done to your own business.”
Mulvaney is frustrated, and rightfully so. Still, policymakers need to stick to their guns.
Relieving financial firms from burdensome capital restrictions, stress tests, and reporting requirements are necessary reforms that are separate from preventing fraud.
No matter how extensively federal regulators dictate and micromanage firms’ lending activities, something like what happened at Wells could still happen. Even if the financial sector were fully nationalized, protecting taxpayers from being forced to cover private losses would be just as important.
The fact that federal regulators, who have been embedded in Wells Fargo for years, didn’t uncover this scheme proves the point. And Congress should hold regulators just as accountable as they’re holding Stumpf for failing to protect consumers.
Luckily, several members of Congress (including Mulvaney) have pressed this argument. All of this was (at the very least) discovered well after Dodd-Frank and the CFPB. Even if you want to absolve the CFPB, the Truth In Lending Act (TILA), passed in 1968, was amended in 1970 to prohibit unsolicited credit cards.
Regardless, the whole mess obscures an even bigger policy problem: federal regulators overseeing large financial firms now have more incentive than ever to sweep fraud under the rug. Dodd-Frank gives the Federal Reserve, the Treasury, and the Securities and Exchange Commission (to name but a few), an explicit mandate to maintain financial stability.
The Wells episode is just one example of why stability should not, itself, be a goal. The mandate is in direct conflict with protecting people from fraud by the so-called systemically important financial institutions.
Is it more important to maintain the solvency of Wells Fargo, or to publicly flog their CEO, potentially destroying the company’s net worth, for failing to stop lower level employees from signing people up for credit cards they didn’t want?
Dodd-Frank created a clear conflict in this area. And it’s one of many things Congress should fix now, regardless of what happened at Wells Fargo.
*Originally published on Forbes, click here.