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Wells Fargo Debacle Again Shakes Confidence in Wall Street

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Image: YP
In another blow to Wall Street’s reputation with the public, it was recently uncovered that Wells Fargo employees had created over two million fake accounts for customers in an attempt to meet ambitious sales targets. The bank is to pay USD 185 million in fines and 5,300 employees have been fired. 

Wells Fargo CEO John Stumpf was hauled before incensed lawmakers on the Senate and House banking committees late last month to testify on the matter. He has agreed to forfeit USD 41 million in pay and to end the banks controversial sales incentive program that purportedly led to the illegal behavior. Lawmakers lambasted the banks activities as akin to theft, and condemned what they saw as a weak reaction from Stumpf in handling the situation.

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 employees involved in the scandal, it is difficult to claim that there was not a more systemic issue at play. 

This is scarcely the first time that big banks have been on the hook for unscrupulous practices. Following the financial crisis, several banks were widely criticized for their role in precipitating the crisis and inflicting massive financial losses on their customers and the general public. A number of banks are still settling nine to ten figure fines stemming from that time. 

This particular episode promises to again reignite questions about the degree to which banking should be regulated. It is also a useful study into the power of incentives, and the difficulty in creating incentives that will elicit 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…” Those on the fiscally conservative side of the spectrum do feel the need to loosen regulations they see as onerous and inefficient. 

Milton Friedman, the twentieth century economist known for his impassioned arguments against government interference, might argue that banks engaging in unethical activities would ultimately lose customers over time, thus creating a natural disincentive against misconduct. As it happens, there tends to be a lot of inertia in banking: Wells Fargo executives have noted that there have not been a significant number of customers looking to suspend their relationship with the bank. 

In a perfectly efficient system, Wells Fargo would be punished through a loss of business; in reality, this is unlikely to occur. Thus the need for regulation and less reliance on the elusive self-correcting nature of such industries.

In addition the scandal also 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 felt they were falling shy of their performance targets felt incentivized to take illegal action in order to save their jobs. The consequence for the bank was that a program put in place to increase revenues has ultimately led to a massive financial loss and an even larger dent to its 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. The answer is neither overregulation nor no regulation at all; it is not to create fewer incentives or ever more complex ones. Rather, what is required is a delicate balance that fosters the human desire to succeed and limits the opportunity immoral behavior in the pursuit of success.

A version of this article appeared in the South China Morning Post's Young Post on Thursday, October 13. http://yp.scmp.com/over-to-you/columns/article/104602/wells-fargo-debacle-shakes-confidence-wall-street-%E2%80%93-again

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