Wells Fargo debacle shakes confidence in Wall Street – again

Wells Fargo debacle shakes confidence in Wall Street – again

One of America’s largest banks has been hit with a US$185 million fine, while 5,300 workers have been fired


Wells Fargo has fired more than 5,000 employees.
Photo: Reuters

In another blow to Wall Street’s reputation, it was recently reported that Wells Fargo employees had created more than two million fake accounts in an attempt to meet ambitious sales targets. Many of the transfers resulted in a significant increase in fees and charges for customers, regulators say.

As a result, one of America’s largest banks has been hit with a US$185 million fine, while 5,300 workers have been fired.

Wells Fargo CEO John Stumpf was hauled before angry lawmakers on the Senate and House banking committees late last month to testify on the scandal. He has agreed to forfeit US$41 million in pay and to end the bank’s controversial sales incentive programme that purportedly led to the illegal actions. Lawmakers lambasted the bank, saying its dealings were similar to theft, and condemned what they saw as a weak reaction from Stumpf in handling the situation.

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Stumpf insisted at the hearings that the problem was not with the company culture, but rather with a set of dishonest employees. However, with 5,300 of them involved in the scandal, it is difficult to claim that there wasn’t a more systemic issue at play.

This is not the first time that big banks have been involved in “shady” practices. Following the 2008 financial crisis, several banks were widely criticised for inflicting massive financial losses on their customers and the general public.

Wells Fargo CEO John Stumpf agreed to forfeit US$41 million in pay and end the bank’s sales incentive scheme.
Photo: AP

The Wells Fargo episode promises to reignite debate about banking regulations. It is also a useful study into the power of incentives, and the difficulty in creating incentives that will bring the desired response.

Texas representative Roger Williams, a Republican, told Stumpf: “I came to Congress to deregulate and because of your actions it’s really making it difficult for me …” Many conservatives say some banking regulations are excessive and inefficient.

Late economist Milton Friedman, who opposed government interference, argued that banks engaged in unethical activities would ultimately lose customers, thus creating a natural disincentive against misconduct. But it seems that Wells Fargo has escaped this “punishment” since not many customers have ended their relationship with the bank. In a truly efficient system, the bank would have lost a lot of business, but this is unlikely to occur, experts say. Thus, the need for regulation and less reliance on the elusive self-correcting nature of industries such as banking.

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In addition, the scandal highlights something that economists have observed time and again: incentives often do not work as planned. What almost certainly compelled the 5,300 employees to knowingly break the law and create the fake accounts was a rigorous sales incentive system put in place by the bank. Those who were not meeting the required standards decided to take illegal action to save their jobs. So a programme that Wells Fargo hoped would help boost revenue ended up causing a massive financial loss and a big dent in the bank’s reputation.

Regulations and incentive systems are complex, and it is challenging, if not impossible, to predict how humans will react to gain a reward or prevent a loss. So the answer is not over-regulation or no regulations at all, nor fewer incentives or more complex ones. Rather, what is required is a delicate balance that nurtures the human desire to succeed while limiting the opportunities for immoral behaviour in the pursuit of success.

This article appeared in the Young Post print edition as
All’s not well in banking


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