Federal Reserve Hits Wells Fargo With $85 Million Fine for Predatory Lending

The Federal Reserve finally imposed penalties on the banking industry for its role in predatory lending practices that enabled the housing bubble to expand prior to the market crash of 2008. In particular, the Fed fined Wells Fargo $85 million for its role in writing and pushing predatory subprime loans. Further, even though Wells Fargo did not admit wrongdoing, it agreed to pay back those borrowers who were steered into expensive subprime loans, but qualified for prime loan rates.

The Fed found that between 2004 and 2008, Wells Fargo Financial, a subsidiary that went bankrupt last year, swindled as many as 10,000 borrowers. Wells Fargo employees were falsifying income statements in order to increase their own commissions, despite the fact that borrowers should not have qualified for the subprime loans written and approved by the bank. Wells Fargo will be working with the Fed to pay back those deceived homeowners, but it was quick to state that the fault came at the hands of just a few loan officers. Still, "[t]he Fed blamed compensation and sales quota policies at Wells Fargo Financial for encouraging employees to falsify documents. It also faulted the bank for having inadequate controls in place to manage risk." Wells Fargo did significant damage to each effected homeowner, with the Fed estimating that compensation for the 10,000 borrowers will range from $1,000 to $20,000 each.

While the fine of Wells Fargo represents an appropriate, albeit late, exercise of Fed power, will an $85 million fine motivate a company like Wells Fargo to forego reckless profit grabs like its predatory loan writing practice between 2004 and 2008, particularly when it made almost $4 billion in the last quarter?

The Federal Reserve We Need

Professor Timothy Canova has recently published “The Federal Reserve We Need” in The American Prospect. Therein, Professor Canova details, painstakingly, the path that The Federal Reserve has taken from a governmental agency charged with safeguarding the American economy through sound monetary policy to an organization that has simply adopted the private banking interests and agenda as its own. Professor Canova highlights the groundbreaking work of former Fed Chair Marriner Eccles during and after the Great Depressions and juxtaposes the role that Eccles played in assisting the American economy with that of Alan Greenspan and Ben Bernanke and argues that Greenspan and Bernanke have co-opted the private interests of banks rather than safeguarding the best interests of the American economy. Read his excellent article here: The Federal Reserve We Need

Additionally, Reuters has just published an investigative report, entitled “Cozying Up to Big Investors at Club Fed,” that details the many conflicts of interest that continue to exist at the Federal Reserve, including what amounts to very nearly insider trading engaged in by members of the Federal Reserve and the clients that subscribe to a specific member’s consulting services. The full article can be read here: Club Fed

Federal Reserve Bank Director's Conflict of Interest Faux Pas or Breach of Fiduciary Duty to the Public?

Last week, the Federal Reserve Board announced revisions to the policy governing eligibility, qualifications, and rotation for directors of Federal Reserve Banks and their Branches. The revisions addressed situations where, as a result of a company changing character, affiliations and stockholdings that were previously permissible may become impermissible for Class B and Class C directors. Like many Americans, I was unsure as to what had gone wrong. Nor did I truly comprehend the magnitude of what the Federal Reserve was disclosing. After all, it is rare that the Federal Reserve makes any announcements other than raising or lowering interest rates or providing much needed liquidity into the banking system. Issues concerning the Federal Reserve’s governance policy are rarely shared with the public. The answer to deciphering the question required research regarding the structure and purpose of the Federal Reserve. Much of the data was readily available on the Federal Reserve’s website.

In the early 1900s, financial panics plagued the nation, leading to bank failures and business bankruptcies that severely disrupted the economy. The failure of the nation’s banking system to effectively provide funding to troubled depository institutions contributed significantly to the economy’s vulnerability to financial panics. In 1913, Congress passed the Federal Reserve Act “to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.” Congress designed the structure of the Federal Reserve System to give Congress a broad perspective on the economy and on economic activity in all parts of the nation. It is a federal system, composed of a central, governmental agency—the Board of Governors—in Washington, D.C., and twelve regional Federal Reserve Banks located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas and San Francisco. Each Federal Reserve Bank has at least one Branch (there were 25 Federal Reserve Bank Branches as of 2004). The Board and the Reserve Banks share responsibility for supervising and regulating certain financial institutions and activities, for providing banking services to depository institutions and the federal government, and for ensuring that consumers receive adequate information and fair treatment in their business with the banking system.

Each Federal Reserve Bank has its own board of nine directors chosen from outside the Bank as provided by law. The boards of the Reserve Banks are intended to represent a cross-section of banking, commercial, agricultural, industrial, and public interests within the Federal Reserve District. Three directors, designated Class A directors, represent commercial banks that are members of the Federal Reserve System. Three Class B and three Class C directors represent the public. The member commercial banks in each District elect the Class A and Class B directors. The Board of Governors appoints the Class C directors to their posts. From the Class C directors,the Board of Governors selects one person as chairman and another as deputy chairman. No Class B or Class C director may be an officer, director, or employee of a bank or a bank holding company. No Class C director may own stock in a bank or a bank holding company. The directors in turn nominate a president and first vice president of the Reserve Bank, whose selection is subject to approval by the Board of Governors.

Each Branch of a Reserve Bank has its own board of directors composed of at least three and no more than seven members. A majority of these directors are appointed by the Branch’s Reserve Bank; the others are appointed by the Board of Governors.
Directors of the Reserve Banks provide the Federal Reserve System with a wealth of information on economic conditions in virtually every corner of the nation. This information is used by the Federal Open Market Committee (FOMC), which is made up of the members of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four other Federal Reserve Banks, who serve on a rotating basis. The FOMC oversees open market operations, which is the main tool used by the Federal Reserve to influence overall monetary and credit conditions. Timely market information is used by the FOMC and the Board of Governors in reaching major decisions about monetary policy.

The Federal Reserve System is considered to be an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive branch of government. The system is, however, subject to oversight by the U.S. Congress. However, Congress has rarely exercised its power to do so, but that may change in this long overdue age of enhanced financial regulation. For example, House Financial Services Committee endorsed a bill by Representative Ron Paul that would subject the Federal Reserve System to sweeping Congressional audits. Additionally, the chairman of the Senate Banking Committee, Christopher Dodd has proposed legislation that would strip the Federal Reserve Board most of its bank regulatory power. The Federal Reserve System and Reserve Banks operate very much the same way that it did almost 100 years ago when it was established. So then how did this conflict of interest arise? The answer may have more to do with how our economy has changed as opposed to how the banking system has remained unchanged.

The Federal Reserve’s change in governance policy addressed the conflict of interest situation regarding Stephen Friedman, a director and former top executive at Goldman Sachs, who was also serving as a public board member of the New York Federal Reserve. Class B public board members may not be officers, directors or employees of commercial banks or bank holding companies. Class C public board members may not own stocks in commercial banks or bank holding companies. The Friedman conflict came to fruition when the Federal Reserve Banks were bailing out Goldman Sachs last year, by permitting Goldman Sachs to change its status from an investment bank to become a commercial bank to be able to receive federal bailout funds. This, of course, made Goldman Sachs subject to the Federal Reserve’s authority. When Mr. Friedman accepted his post as a public director, Goldman Sachs was still an investment bank outside the banking supervisory authority of the Federal Reserve. However, the financial crisis last October changed the course of history. Goldman Sachs, the first investment banking firm on Wall Street, would be bailed out by the government and become part of the Federal Reserve Banking System. Lehman Brothers, the second investment banking firm on Wall Street, would be allowed to file for bankruptcy. (See, Cabrera Pierre-Louis’ prior corporate justice blog post regarding Lehman Brothers’ tragic demise on Sept. 8th and Sept. 15th.) It is ironic that Lehman Brothers was permitted to slip into oblivion, whereas the New York Federal Reserve Bank negotiated Bear Stearns' acquisiton by J.P. Morgan Chase, a commerial bank that changed its status from J.P. Morgan, an investment bank, to a commercial bank renamed J.P. Morgan Chase in its merger with Chase Manhattan Bank in 2000. It is as if the financial banking world had gone topsy tury.

I have a simple question. If it is true that Mr. Friedman had a conflict of interest, does that also mean that Mr. Friedman breached his fiduciary duty to the public, in particular his duty of loyalty? If the answer is yes then under an intrinsic fairness test would Mr. Friedman’s conduct in voting for a transaction in which he was personally interested be appropriate? To be fair to Mr. Friedman, we do not know whether his 8 fellow public directors were also personally interested in matters on which they voted on behalf of the public? Which begs the question--what is the remedy when a majority of a public board is personally interested in matters on which it has voted? Rescission? These are difficult questions. They are exactly the questions that Congress should consider during its deliberations regarding proposed enhanced financial regulation.

The Federal Reserve's new conflict of interest policy prompted Mr. Friedman to resign in May 2009 from the New York Federal Reserve Banks’ board. It is interesting that Mr. Friedman did not elect to resign as a director of Goldman Sachs' board. After all Mr. Friedman was representing the public in his capacity as a director of the New York Federal Reserve, what greater honor and duty could exist?

Lydie Nadia Cabrera Pierre-Louis

Federal Reserve Bank Leadership Remains Intact Despite the Collapse of the Financial Markets

President Obama nominated Ben S. Bernanke to a second four-year term as chairman of the Federal Reserve Bank, which is the central bank of the United States. Chairman Bernanke has led the biggest expansion of the Federal Reserve Bank’s power in its 95-year history to handle the current financial crisis which many claim is the worst economic crisis since the Great Depression.

The financial industry is thrilled with the decision that Bernanke will remain as Chairman of the Federal Reserve. Morgan Stanley’s Richard Berner who serves as head of Global Economics stated that “it’s not just that he’s done a great job of dealing creatively with the financial crisis but that he brings certainty.” The financial industry applauded President Obama for maintaining the stability of the Federal Reserve by nominating Bernanke for a second term. However, there are many in Congress that are displeased with Bernanke’s decisions especially in terms of the independence that Bernanke has displayed. Bernanke decided to cut the main interest rate almost to zero, he decided to funnel $1 trillion into the crippling banking system and he decided to rescue Bear Stearns Cos. and American International Group Inc. from collapse, although he permitted Lehman Brothers to collapse.

Many members of Congress believe that Bernanke overstepped his authority as Chairman of the Federal Reserve and used “emergency powers” to deviate from sound monetary policy. Bernanke was also criticized as too slow to respond to the housing crisis and inaccurately referred to the housing crisis as “contained” before reversing course in August 2007 and cutting interest rates. As a result, there is pending legislation in the House which would subject the Federal Reserve’s monetary policy to audits by the Government Accountability Office. If the legislation is adopted, the Federal Reserve would need the Treasury Department’s approval before invoking the emergency powers that Bernanke used to coordinate the financial bailouts and to make loans to non-bank financial institutions.

President Obama believes that Bernanke has provided extraordinary leadership during the most difficult financial crisis that America has faced since the 1930s. The President further believes that Bernanke is the person to guide America through renewed growth in the years to come. Recently, at the Federal Reserve Bank’s annual symposium, Bernanke stated that “prospects for a return to growth in the near term appear good.” However, “we have an enormous amount of work to do.”