The High Cost of 'Too Big to Behave' Banks

Imagine you're the chief executive of very big bank. Your operations span virtually every sector of American finance, from mortgages and credit cards to derivatives and Treasuries. You're under constant pressure from Wall Street analysts and shareholders to keep your stock climbing. You have tens of millions of dollars in personal wealth and annual pay tied to achieving that goal.

To succeed, you set financial targets for the various divisions of your company. You reward or penalize subordinates depending on whether they meet your bottom-line objectives. It's impossible for you to know every detail about their methods, and in many cases you're better off not knowing.

That's because to hit their numbers, your subordinates are frequently doing things that get your bank into regulatory and legal hot water. This isn't a story of outliers or rogue employees. It's one of people taking cues, if not orders, from above. It's a story of institutions where unethical and illegal conduct has become part of the business models and where the resulting fallout is just another cost of doing business.

Call them Too Big to Behave—banks that are so big the people running them know virtually nothing they do will get their institutions run out of business or their executives prosecuted.

A New York Times analysis of Securities and Exchange Commission enforcement actions found at least 51 cases in which Wall Street firms had broken antifraud laws over the last 15 years that they'd pledged in earlier settlements never to breach. Those cases involved 19 firms, including nearly all the megabanks: JPMorgan Chase (JPM), Bank of America (BAC), Goldman Sachs (GS) and Morgan Stanley (MS) among them. Despite the repeat offenses, the SEC issued at least 344 waivers from sanctions that would have curtailed the banks' activities, the Times found.

American Banker has similarly profiled a litany of bad big-bank behavior over the past few years. It includes:

• Imposing exorbitant force-placed insurance premiums on troubled homeowners
• Manipulating the order in which debit card transactions are processed to maximize the fees charged to customers
• Selling credit card receivables to debt collectors for which records were either faulty or nonexistent
• Threatening and firing employees who complained about spotty recordkeeping
• Defrauding local government
• Defrauding investors in collateralized debt obligations
• Selling credit card payment "protection" of dubious value and with payout ratios that would render them illegal in the insurance business

This last case is a prime example of the profit motive trumping questions of ethics, legality or fairness. Credit card payment insurance has been a sore spot among consumer advocates for years. Paying out just 21 cents of every premium dollar collected, it's a bad deal by definition for consumers. If such coverage were overseen by state insurance regulators, the low payout ratios would likely render it flat-out illegal. Yet for big banks and card issuers, it's been good for $1.3 billion in annual profits and thus far has cost only a fraction of that to defend from legal challenges (a cost that could rise considerably, depending on the outcome of ongoing federal investigations).
Aiding and abetting the banks in repeated wrongdoing are regulators and law enforcers who routinely look the other way or deliver financial wrist-slaps. The SEC has indicated to the banks that as long as they don't falsify their own financials, and instead limit legal and regulatory transgressions to abusing their customers, officialdom will grant them one waiver after another from truly painful sanctions, according to the Times. Why so? "To keep stock and bond markets open to companies with legitimate capital-raising needs," according to the SEC.

Judging by the lack of prosecutions coming out of the Obama administration's Justice Department, meanwhile, nobody in a senior role on Wall Street is likely to be scared straight either.

Given that shareholders pay for financial performance, it is perhaps naïve, and even unfair, to expect bankers to sacrifice their bottom lines to comply with matters of right and wrong that even law enforcers don't seem to take seriously.

In the long run, the chronic misdeeds and corruption of the system likely come at a far higher cost to banks and their shareholders than senior bankers care to admit. That cost includes the price of public distrust and a multi-billion dollar mortgage settlement. That's to say nothing of the price tag on giving those whom bankers generally regard as adversaries the opening to push through Dodd-Frank, the Volcker Rule, the Durbin Amendment and the Consumer Financial Protection Bureau.

Neil Weinberg is the editor in chief of American Banker and co-author of Stolen Without a Gun: Confessions from inside history's biggest accounting fraud - the collapse of MCI Worldcom. The views expressed are his own.