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Time to clean house at Wells Fargo

Earlier this month, Wells Fargo, the third-largest bank in the United States, acknowledged that it improperly foreclosed on 545 distressed homeowners after they asked for help with their mortgages.

The bank has exhibited a seemingly established pattern of negative behavior, from creating 3.5 million fake accounts to charging 570,000 customers for auto insurance they did not need to illegally repossessing vehicles from hundreds of service members.

At the start of the year, Wells ranked 26 on the Fortune 500’s 2018 rankings of the largest U.S. corporations by total revenue. It is also the second-largest retail mortgage lender and the largest debit card issuer by purchase and transaction volume.

These facts establish the bank as a systemically important financial institution. My firm’s economic models suggest that the next recession may very well start with a major hack at a SIFI like Wells Fargo. This underscores the importance of stemming the ongoing problems at Wells as quickly and as efficiently as possible.

Wells Fargo has signed several consent decrees with banking regulators, including one with the Federal Reserve Board in February. Financial institutions that have settled allegations of wrongdoing are supposed to have certain aspects of their business activity limited as a result of the (settled) infraction, and, although Wells has signed several of these agreements, this hasn’t had the punitive effect we’d hope for.

More broadly, the current practice of letting institutions off the hook is simply not enough to prevent bad banking behavior — if left unchecked, this behavior threatens the stability of the entire U.S. banking system. Just look back at the financial crisis of 2008.

What now? The best response for regulators is to immediately replace all board members and the top 100 managers at Wells Fargo. Under federal banking law, “any institution-affiliated party who has violated any law, any order to cease and desist, any condition imposed in writing, or engaged or participated in any unsafe or unsound banking practice may be removed from his/her employment at a banking organization and prohibited from being involved in the affairs of any insured banking organization without prior regulatory approval.”

The board members and top managers at Wells Fargo had one job: “to keep the organization from collapsing under the weight of its own complexity,” including complexity tied to ethical factors. They failed. But remember that on Jan. 23, 2017, Wells Fargo admitted to retaliating against workers who tried to blow the whistle on its fake-accounts scandal. I'm willing to bet that those at the lower levels of management know exactly how to fix the organization. They are likely to have the skills that current senior managers lack: a real ability to put the interests of customers first. (Although if they don’t, there’s an argument that the bank should simply be shut down.)

Assets do not need to be placed into receivership, since I am not suggesting the bank be liquidated. Yet given the size and complexity of the institution, steps have to be taken to “ring fence” systemic risk. In this context, this means that assets and the systems that support them in critical areas of the bank, like retail mortgage lending and debit card issuance, should be separated from other assets and supported with backups on backups to make sure these product areas remain fully functional as the board and senior management are replaced. The bank’s “living will” should serve as a guide. The effort would be made easier by the fact that assets are not being liquidated. Some, but not all, ownership is being transferred. Corporate management is simply being replaced, albeit at a scale and scope that has not been tried before at a continuously operating banking institution.

The removal process could be phased, so that all directors and officers would not leave overnight. Transition management firms, who assign specialists to banking companies on an as-needed basis, might be hired to manage the process. Disruptive? Sure, but relative to the disruption caused by the 2008 financial crisis, it pales in comparison. By transparently planning for this change, regulators could limit the impact of such a unique effort.

Trust is central to the proper functioning of the nation’s banking system. While this may not have been a critical issue in earlier crisis periods, the current environment is complicated by the fact that there now exists a substitute for the banking system as we know it: bitcoin and other cryptocurrencies. In the event of a further precipitous decline in trust, we can expect to see a massive movement to these newer monetary tools. As I noted back in 2006, “competitive advantage with respect to capital access is available to any country with significant economic potential and a modest communications infrastructure.”

To mitigate the risk of seeing the U.S. banking industry fall into a position of competitive disadvantage, regulators must take aggressive, innovative and disruptive steps — and they should start with Wells Fargo.

William Michael Cunningham Founder, Creative Investment Research

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