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Wheels on fire


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Wheels on fire

Nancy Bush is a veteran bank analyst. The following does not constitute investment advice, and the views and opinions expressed in this piece are those of the author and do not necessarily represent the views of S&P Global Market Intelligence.

OK, this was how it was supposed to go. After Wells Fargo & Co.'s then-CEO John Stumpf announced in September 2016 that his bank had been found to have committed one of the most egregious frauds in modern banking history — the opening of thousands of fake customer accounts in order to boost the bank's vaunted "cross-sell" ratio — my belief was that the resolution of this issue would proceed along the lines of the most recent bank "scandals." We had, after all, just seen the conclusion of (most of) the massive settlements from the mortgage mess resulting from the Great Meltdown, and there was no reason to expect that the Wells Fargo scandal would not be resolved along a similar timeline.

The mortgage settlements — with Bank of America Corp., Wells Fargo, JPMorgan Chase & Co. and a host of others — eventually came to be seen as predictable affairs. There was the initial flood of press coverage and advocacy group media issuances, decrying the ways that the big banks had tricked homeowners into taking out mortgages that they could not afford. The waves of foreclosures — as well as the many homeowners who chose to simply walk away voluntarily from their "underwater" homes — presented a regulatory morass and a public relations nightmare that was only going to be resolved by the payments of massive amounts of cash to federal and state regulators (and those ubiquitous states' attorneys general) and by endless expensive and varied efforts to keep as many people as possible in their homes.

Theoretically the Wells Fargo settlement process was going to be a simpler one — right? After all, the number of people who were harmed could be known with some certainty, the amount of harm done to each could be somewhat accurately determined, and there would be additional punitive fines to be paid. The bank would — quite rightly — be put under some type of regulatory agreement that would go on until the whole mess was resolved, the management of Wells Fargo would tear the place apart to find out what happened and would simultaneously deal with the cultural issues that led to the high-pressure sales environment that had gone seriously and dangerously awry.

Well, it has not quite worked out that way. (Let me give my usual caveat here — I am a Wells Fargo customer and also a shareholder, so I do have a dog in this hunt.) It was obvious from the tone of CFO John Shrewsberry's remarks on the second-quarter earnings conference call that we are nowhere near the end of this saga, and that the expenses associated with getting there may stretch way beyond what had been anticipated only a couple of quarters ago.

The problem seems to be that the regulators are not yet satisfied that the bank's risk management processes can prevent a recurrence of the many irregularities that have been uncovered since 2016 — including the sale of auto insurance without customer knowledge and alleged illegal practices by wealth management advisers — and that have cost the company and its shareholders roughly $2.8 billion in fines and restitution. Add to those regulatory costs the expense of taking the company apart and finding and correcting the operational practices and systems that made the fraud possible — including technological spending and spending on professional services — and as we say here in the South, Lord only knows what all of this has really cost.

But the thing that John Shrewsberry pointed out that shook me out of my usual earnings conference call torpor and made my eyes lose their glaze was his remark about the advent of a new CEO. It has been pretty widely speculated in the press that the Wells Fargo board has considered a number of candidates (including my favorite, Richard Davis) but has had no takers for the spot, due both to restrictions on pay and on the likely shareholder pressure and regulatory scrutiny that will accompany the job. It has been reported that the interim CEO, Allen Parker, has put his hand up for the job but that the board remains committed (perhaps involuntarily so) to bringing in an "outsider."

And as Mr. Shrewsberry made plain on July 16, that outsider may have his or her own ideas about where the company should go from here, thus making it impossible for him to predict the path of expenses in future years with any degree of certainty. I must admit that a light bulb came on over my head at that point, as I had assumed that the new Wells Fargo would go on pretty much along the same lines that the old Wells Fargo had — an operator of ubiquitous branches, a very large mortgage company, a bank that enjoys a very low cost of funds, etc., etc. But that may indeed not be true, and it is entirely possible that the new CEO may embark on (with the assent of the Fed and others) a program to remake the bank, including the possibility of significant divestitures of both geographies and businesses.

I — along with a host of others, apparently including Warren Buffett and Charlie Munger — was not happy with the "retirement" of Tim Sloan, as I believe it was neither voluntary nor free of regulatory and political intervention. Perhaps Mr. Sloan was moving too slowly and deliberately for his critics, but he was a known quantity for both employees and shareholders alike and was well-regarded for his earnest efforts to correct the company's shortcomings without inflicting more damage along the way. As a shareholder, I'm not happy with the prospect of owning the shares of a bank where the likes of Senators Warren and Brown call the shots on who will be CEO, and I'm hoping that Tim Sloan's demise is not a sign of more regulatory insanity to come.

There are a couple of important implications for other banks in what is happening at Wells Fargo, and I hope that the CEOs of the large banks especially are taking notice. The first is that any whiff of scandal at the large banks will now be greeted with a sledgehammer, and I shudder to think what might have happened to J.P. Morgan Chase in the wake of the London Whale episode had this new regulatory regimen been applied. My other thought is ancillary to that one — how many banks could actually stand up to the scrutiny that is now being applied to Wells Fargo, and what would be revealed if Chase or Morgan Stanley or Goldman Sachs Group Inc. — or the new Truist, for that matter — really got taken apart in the search for operational and risk shortcomings? It's really not a thought that I wish to entertain, but it may be something that we all have to think about as a Presidential election looms and an economic downturn becomes more likely.

Baby Boomers will have instantly recognized that I took the title of this piece from a song that is one of the most iconic of our era, "This Wheel's on Fire" which was recorded by Bob Dylan and Rick Danko in 1967 in the basement of a house in upstate New York. (Lovers of British television will recognize it as the theme song from the hilarious "Absolutely Fabulous," which was one of the funniest things ever to appear on TV.) The phrase popped into my head as I was listening to Mr. Shrewsberry last month, and I can't escape my feeling that the wheels of the stagecoach are indeed on fire in a way that they have not been before. As a customer and a shareholder, I have to ask — will I be able to escape the conflagration, and what will be left at the end?