'Too big to fail' is alive and Wells

While Washington debates whether Wells Fargo's $3 billion fine for defrauding customers with phony accounts is sufficient, the larger question of what to do about the nation’s persistent too-big-to-fail problem must remain the focus.

If a community bank were to behave similarly, it would have been shut down entirely long ago, its leadership financially ruined and facing prosecution.

Wells Fargo officials will surely face tough questions from Congress at the three committee hearings on the settlement scheduled for March, but the fine itself is roughly equivalent to the megabank's profits for the fourth quarter alone.

Wells Fargo's reputation may be in tatters for opening millions of fraudulent accounts and then firing thousands of employees when its practices were exposed, but it will survive.

Unfortunately, Wells Fargo's wrongdoing threatens to tarnish the good reputations of thousands of community banks who serve their communities and customers honestly every day.

The nearly $2 trillion bank had the audacity to call its retail arm a "community bank." Excuse me, but the nation’s fourth-largest bank is not a community institution and certainly didn’t act like one.

No community bank would establish a pressure-cooker sales culture designed to extort customers’ every nickel, and then fire employees for engaging in practices it generated. And community banks wouldn't at the same time face fines and lawsuits over violating servicemember protections, overcharging for home appraisals, discriminating against their own employees, falsifying mortgage records and forcing unneeded auto insurance on customers.

Wells Fargo’s wrongdoing also further distorts the regulatory system governing the financial services industry. The risky practices of the largest financial institutions have repeatedly resulted in a broad-brush response from Washington that fails to distinguish between too-big-to-fail financial firms and locally focused community banks.

Community banks have fought hard for a tiered system of sensible regulation that recognizes their smaller size and lower levels of risk, such as with the S. 2155 regulatory relief law.

The last thing local communities need is another round of costly regulations caused by the actions of the megabanks that hamper economic growth and fuel consolidation. Ironically, increased regulation only forces the banking industry further into the hands of too-big-to-fail entities.

Wells Fargo’s reckless behavior is a natural result of the very business model that has taken root at the nation’s largest financial firms — and the too-big-to-fail problem that accompanies it.

Within these massive institutions, profits are derived from the number of financial transactions that can be squeezed out of as many customers as possible.

For instance, Wells Fargo’s “Eight is Great” cross-sales mantra encouraged employees to sell customers eight of the megabank’s products, contributing to the scandal.

And with a taxpayer guarantee against failure realized during the federal intervention in the 2008 Wall Street crisis, and demonstrated by the continued presence of an artificial funding advantage, megabanks can take excessive risks knowing that taxpayers have their backs.

The result is moral hazard, private gains and socialized losses in a system where 0.2% of all US banks hold nearly 70% of industry assets.

By contrast, community banks are highly capitalized, nimble and thus better prepared than their larger competitors for economic crises. Unlike the megabanks' transaction-based, high-volume approach, community banks operate a relationship-based business model.

This model holds locally based institutions accountable to their customers because — as friends and neighbors — their livelihoods depend on honest dealing.

The too-big-to-fail problem hasn't gone anywhere in more than a decade since the last financial crisis. To truly address the problem, policymakers should continue considering enhanced capital, leverage and liquidity standards; stronger concentration limits; stricter resolution regimes; and restrictions on the use of the federal safety net.

Additionally, Congress and the administration should continue promoting localized banking and economic growth. That includes modernizing Bank Secrecy Act regulations; better tailoring rules on new bank applicants; and leveling the playing field with financial firms that have government-sponsored competitive advantages, such as credit unions, the Farm Credit System and industrial loan companies.

The debate over Wells Fargo's latest fine will come and go. But the fallout for its customers and employees, the reputational damage for the rest of the banking industry, and (perhaps most important) the persistent too-big-to-fail problem will remain. These issues shouldn't be lost amid the dispute.