The Federal Reserve’s move against Wells Fargo & Co. late last week is the kind of thing regulators usually do only to community bankers, the kind who can’t be trusted to keep from doing things like paying themselves fat dividends out of an already undercapitalized bank.
There’s a reason for this, too. Wells received a sweeping regulatory action because the bad acts were not isolated to some small corner of the company.
Issuing lots of fake debit cards and fraudulent car insurance bills couldn’t have happened without a companywide sales growth strategy that had board members nodding their heads in approval for years. That had to stop.
The formal agreement is called a cease-and-desist order, signed by the Fed and board members of San Francisco-based Wells Fargo. While much of it reads like legal boilerplate, it demands actions that suggest there was nothing short of a routine failure of board members to do their jobs. And unless and until the bank has directors who do, the Fed through this agreement will keep a lid on the size of the Wells Fargo balance sheet.
That’s a big deal. In a growing economy, Wells Fargo could have been looking at a big growth year in 2018.
The bank’s executives said there are ways to still take care of its customers, like by getting rid of assets held by its trading operations to free up some capacity under the cap to keep making new loans. It could certainly be the case, though, that some lending groups could be asked to stop looking for new customers.
That’s a message that probably won’t go over well with the front-line lending officers.
As if this wasn’t enough, the Fed also decided that some public shaming was in order. It released copies of harsh letters it sent former Wells Chairman and CEO John Stumpf and former lead independent director Stephen Sanger, the retired CEO of General Mills.
What’s far more typical for a big bank is what the Federal Reserve did after JPMorgan Chase & Co. embarrassed itself by letting a guy in London, part of an investment office that was supposed to offset risks incurred in other parts of the bank, lose more than $6 billion trading derivatives a few years ago.
Plenty of critics blasted the bank’s management once the full story was out, asking things like how managers at the bank allowed its own risk limits to be breached at least 300 times.
JPMorgan did end up in a big financial settlement with regulators. But the cease-and-desist orders the Fed announced in early 2013 only wanted JPMorgan to tweak some risk management and compliance practices. No line of business was reined in. No one at JPMorgan appeared to get a scathing letter on Federal Reserve System letterhead, either.
To find something like the Wells Fargo order you really have to look at community banks whose balance sheets were battered after the Great Recession.
In one cease-and-desist order slapped on a central Minnesota community bank in late 2010, pulled from a federal regulator’s database, there was a list of things the bank’s board members and executives had to do and a separate list of what they couldn’t do.
They had to raise capital right away and have a plan for having the necessary capital cushion a year out. They had to submit a realistic strategic plan. They had to change how they determined the right amount to set aside for bad loans and come up with a separate plan for reducing the number of them, including a detailed action plan to work out of every bad deal they had.
The list of what they couldn’t do started with not making any more loans to shaky borrowers. They also couldn’t pay any dividends or enter into any new employment contracts with executives without written approval from the regulators.
But here’s the big thing in the cease-and-desist order: They couldn’t grow their balance sheet, at least not until they were able to prove they knew how to run the bank without putting the depositors’ money at risk.
Through the eyes of a bank regulator, capping the growth of the bank makes perfect sense. The problems were companywide, with not enough capital and too many bad loans, so why let the problems get bigger?
Community bankers who received cease-and-desist orders like that will recognize what they can read in the Wells Fargo order. Beginning in the second quarter, Wells Fargo’s total assets can’t grow past the amount on the balance sheet as of the end of last year. The cap will be lifted once the Fed is satisfied that Wells Fargo has an effective board of directors and risk management process.
While you could read this as simple punishment of a company without many friends in government, what the Fed did also looks a little like how the regulators handled small community banks that were struggling. Like in those cases, there was a bank-wide problem at Wells, not some sort of isolated issue with a derivatives trader gone rogue.
The creation of fake accounts that blossomed into a scandal in 2016 happened in much of Wells’ sprawling community banking system. Within a year a new scandal erupted when news broke that hundreds of thousands of Wells car loan customers also got billed for auto insurance that they didn’t ask for or need.
So why cap the growth of the Wells Fargo balance sheet? Well, why would the Fed want to let the problem get bigger?