Last week, in a surprise move, the New York Federal Reserve Bank named Wells Fargo a primary dealer. With the appointment, the California-headquartered bank will be allowed to underwrite U.S. government debt and expand the bank’s bond market operations.
On the surface, the decision would appear to be a win-win for the mega bank and the New York Fed. But before the announcement, other regulators were already citing an increase in the potential harm the bank could cause the economy. In that light, the New York Fed’s decision is alarming. This is the same kind of bank regulatory disconnect and laxity that helped fuel the previous financial crisis.
Wells Fargo has been on a roller coaster ride recently. In early April, Wells Fargo agreed to pay a $1.2 billion settlement after admitting it deceived the U.S. government in its activities related to mortgage bonds.
On April 13, the Fed and FDIC revealed that the bank had failed to create a “credible” crisis plan, with specific issues cited in governance, operations, and “legal entity rationalization.” A Moody’s report said the feedback showed that Wells Fargo had not been “responsive” to regulators’ requests for “progress.” The Wall Street Journal noted that the regulatory findings marked a new low for the bank since it had passed the review process last year. Also in mid-April, the Office of Financial Research found that rather than becoming less risky, Wells Fargo’s risk to the economy had grown 18% over the past year.
In this backdrop, the New York Fed made the incredible decision to expand Wells Fargo’s business scope and complexity. To see what went wrong, we need to look at the application process the New York Fed used to arrive at its decision.
The current application form appears to date from February 2011. Even though it was never specifically updated to take into consideration new post-crisis requirements (like providing a workable crisis plan or passing a stress test), the form does have requirements that should have stopped the Wells Fargo application in its tracks.
The application asks for a business continuity plan. Wells Fargo's crisis plan should have been a part of this review and, if it was, the application should have been rejected. Another part of the form asks the applicant to describe “material past or pending legal or regulatory matters.” A $1.2 billion settlement for deceiving the government would seem to fit this description, especially since acting as a primary dealer involves a business relationship with the U.S. government.
A New York Fed spokesperson declined to provide comment for this article. And Wells Fargo declined to comment beyond what is publicly available on the matter.
In its policy on the primary dealer application process, the New York Fed says it will consult with other regulators concerning important legal or regulatory issues related to an applicant. Spokespeople for the Federal Reserve Board, the FDIC, and the Justice Department all declined to comment on whether the New York Fed contacted them regarding Wells Fargo’s application.
The Wells Fargo decision has obvious implications for the New York Fed’s board. Six of the New York Fed’s board members are supposed to "represent the public." They include the CEOs of Macy’s and Honeywell, the co-founder of Silver Lake and the founder of the Freelancer’s Union, the President of Rockefeller University, and the President Emerita of the Metropolitan Museum of Art. They will need to assess how the Wells Fargo determination affects their views of the New York Fed's performance, its management, and the effectiveness of its risk management practices.
Since the Great Recession, the public has had misgivings about the cozy relationship between the big banks and regulators. In March, Reuters reported that the Government Accountability Office was investigating the extent of “regulatory capture” at the Federal Reserve, with particular emphasis on the New York Fed. With the Fed’s decision to make Wells Fargo a primary dealer, that report is needed now, more than ever.
Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (http://www.thevaluealliance.com), an independent board education and advisory firm she founded in 1999. She has been a regular contributor to Fortune since April 2010 and has advised analysts, regulators, shareholders and banks of every size on the economics of financial services.