Three kinds of bank behavior contributed to the financial crisis, and President Trump’s personal business activities appear to support that behavior.
We have finally emerged from a brutal financial crisis—a crisis caused in part by bad bank culture. Post-crisis, banks have spent significant amounts of time and energy trying to improve their cultures. How will the Trump Administration affect bank culture?
To address this question, it is helpful to consider how bank culture contributed to the behavior that caused the financial crisis. My University of Minnesota Law School colleague Richard Painter and I take up this inquiry in our book, Better Bankers, Better Banks. In the book, we identify three types of problematic banker behavior which are at least tolerated—if not encouraged—by bank culture.
One area of problematic behavior is irresponsible risk-taking, from both a financial and legal perspective. Banks, like most other larger businesses, are generally organized as corporations, with limited liability. If the risks the banks (and bankers) take pay off, they win. If the risks do not pay off, the broader society may bear a significant part of the losses, as happened in the financial crisis.
Another troubling type of behavior is conflicted behavior. For instance, a bank might sell a product it thinks is bad, to customers who it thinks will not figure out that the product is bad (or perhaps, for their own reasons, do not care). Notably, the customers at issue have included nominally sophisticated investors, who ultimately proved to be rather less sophisticated than the law assumes them to be. For instance, Goldman Sachs bankers were incentivized to sell securities in one complex transaction, “Timberwolf,” that internal emails described with a crude expletive, with “‘ginormous’” sales credits.” The sales were to be made to “‘non-traditional’ buyers and those with little [ ] familiarity” in the type of transaction at issue.
The third type of behavior is what we call “financial maneuvering.” This behavior involves banks—whether on their own behalf or for their clients—crafting and executing end-runs around regulations or contract provisions. Examples include the cross-currency swaps that Goldman Sachs helped arrange for Greece that made Greece’s debt seem much lower than it was, and “Repo 105,” an accounting technique that Lehman Brothers employed to appear to have far less debt than it actually had.
These behaviors did not end with the crisis. Consider various large banks’ manipulation of the London Interbank Offered Rate. Consider also the “London Whale,” which was supposed to be a hedge, but which caused J.P. Morgan to lose in excess of $6 billion. Other examples include various banks’ involvement in money laundering and tax evasion. For instance, in 2014, BNP Paribas settled allegations that it had concealed transactions that violated U.S. sanctions by pleading guilty and agreeing to pay fines of $9 billion. Also in 2014, Credit Suisse pleaded guilty to a felony, participating in a tax evasion scheme that spanned decades, and agreed to pay a $2.5 billion fine.
A recent example of both conflicted behavior and irresponsible risk-taking, in this case involving legal risks, was Wells Fargo’s creation of “ghost accounts.” Wells Fargo’s salespeople were pressured into cross-selling additional products to existing customers. Much of this pressure stemmed from the company’s “Great 8” objective, whereby employees were expected to sell eight financial products to every household. Those who achieved this goal presumably received additional compensation. Those that failed to meet it may have been at risk of losing their jobs.
Presumably, the salespeople tried their best to sell additional products to customers. But they sometimes did not succeed. Their solution to this challenge was to make it appear as though customers who did not buy eight products had in fact done so, opening two million additional accounts in customers’ names without the customers’ consent or even knowledge. The customers in question allegedly included particularly vulnerable individuals, such as the elderly and Mexicans without social security numbers.
The then-head of Wells Fargo Bank, John Stumpf, blamed “bad apples,” and 5,300 salespeople were fired. Stumpf himself was forced into early retirement. Although his successor has vowed to restore trust in Wells Fargo, the bank nevertheless is trying to force lawsuits concerning the ghost accounts into arbitration, on the theory that the customers entered into mandatory arbitration agreements when they opened their accounts—that is, the accounts that they actually did open. However, more recently, the bank has fired four additional top-level managers and withheld bonuses from the CEO and seven other top executives.
In all of these cases, the pursuit of profit potentially exposed parties, sometimes the bank’s customers and sometimes third parties, to severe negative consequences—consequences that the customers may not have understood, and that the third parties had not consented to. Granted, to some extent, customers are chargeable with understanding what they are buying. And, of course, a bank’s pursuit of profit is wholly legitimate. But in these cases, the pursuit of profit was conducted without (sufficient) regard for the consequences.
A bank’s concern for its reputation surely serves as a constraint, but it is not always an adequate one, apparently. Banks that engaged in the problematic behavior described here had cultures that at least tolerated, and probably in many cases encouraged, the behavior. Law has not proven to be a sufficient counterweight to prevent banks from behaving this way.
Consider again the Wells example, and consider also one of the of the financial crisis’s major causes, mortgages made on the basis of fraudulent information about the borrower’s income, the value of the property the borrower was purchasing, or both. Certainly, ghost accounts are illegal, and nobody would propose legalizing them. The same is true of lying about the income supporting mortgage repayment or the fair market value of assets such as houses. Better enforcement might have caught such conduct before serious damage had been inflicted, but why were a non-trivial number of people employed at financial institutions engaging in this conduct in the first place? This is where culture comes in. A firm’s business practices of course reflect, and are shaped by, its culture. In the period leading up to the crisis, such practices included selling financial instruments to customers who should not have been buying the instruments, taking very large risks where much of the downside risk was externalized, and cleverly maneuvering around regulations—or simply ignoring them altogether if detection was thought to be unlikely.
Bleak as all of this may seem, there had been reason to be optimistic. In an effort to promote their responsibilities to their customers and to society at large, banks have been instituting a variety of cultural changes.
Will this trajectory continue? What will happen to bank culture under the Trump Administration? Donald Trump’s own business dealings offer considerable reason for pessimism. Trump was quoted in an article describing his Atlantic City casino business as saying that “Atlantic City fueled a lot of growth” for him. “The money I took out of there was incredible,” he said. He may have done well—but his businesses did not: “a close examination of [various documents] by the New York Times leaves little doubt that Mr. Trump’s casino business was “a protracted failure.” “[E]ven as his companies did poorly, Mr. Trump did well. He put up little of his own money, shifted personal debts to the casinos and collected millions of dollars in salary, bonuses and other payments. The burden of his failures fell on investors and others who had bet on his business acumen.”
Trump’s dealings in connection with Trump University provide another troubling example. In a class-action lawsuit against, among other defendants, Trump University and Donald Trump, one of the “university’s” former salesmen, Ronald Schnackenberg, stated in an affidavit that “while Trump University claimed it wanted to help consumers make money in real estate, in fact Trump University was only interested in selling every person the most expensive seminars they possibly could.” Schnackenberg further stated that “[b]ased on [his] personal experience and employment,” he believed that “Trump University was a fraudulent scheme, and that it preyed upon the elderly and uneducated to separate them from their money.”
Trump also touts his own ability to do end-runs around regulation. When information surfaced revealing that he had used an aggressive loophole to avoid paying income tax for many years, he responded that doing so made him “smart.” He tweeted, “I know our complex tax laws better than anyone who has ever run for president and am the only one who can fix them.”
There we have it: irresponsible risk-taking, with significant externalization of risks; conflicts of interest; and maneuvering (with pride!) around regulations—precisely the kind of behavior that got banks, and the broader society, in so much difficulty.
We can only hope that the past is not prologue.