Regulators on the Prowl: Wells Fargo Joins BofA in the Lineup



Wells Fargo (NYSE:WFC), currently the nation’s largest mortgage lender, has long been a member of the pantheon of financial institutions under investigation by the government for its role in the financial crisis. In August, news broke that the firm, along with Bank of America (NYSE:BAC) and Bank of New York Mellon Corp. (NYSE:BNY), were wrapped up in a series of lawsuits filed by lawyers under Manhattan U.S. Attorney and Wall Street watchdog Preet Bharara. More recently, sources revealed to Bloomberg that Wells Fargo is among the financial firms being targeted by U.S. attorneys in San Francisco.

The case is noteworthy not just because it seeks compensation from Wall Street firms for the financial crisis, but because it is based on what some consider a novel interpretation of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989.

In August, U.S. District Judge Jed Rakoff, who has worked his way into infamy as one of the top judges involving cases against major Wall Street firms, announced that a “straightforward application of the plain words” of FIRREA allowed Bharara and the Justice Department to bring a case against Bank of America, Wells Fargo, and others related to toxic mortgages sold during the financial crisis, Reuters reports.

The government’s case against Bank of America argues that a process to streamline the sale of loans to often unqualified people pretty much amounts to criminal neglect. The process, known as “hustle,” removed quality checks and resulted in the creation of thousands of toxic mortgages. FIRREA states that the government can prosecute firms that commit fraud against federally insured deposit institutions. The interesting part of the interpretation of the act is that the government may prosecute Bank of America for hurting itself as an FDIC-insured firm.

This means that the government can seek civil penalties against Bank of America because it committed fraud against itself by selling toxic mortgages to Fannie Mae and Freddie Mac, an act that it paid billions of dollars to resolve. The Federal Housing Finance Agency, which oversees Fannie and Freddie, is currently seeking as much as $6 billion in damages against Bank of America related to the sale of $57.5 billion in securities.

JPMorgan (NYSE:JPM) is currently embroiled in talks with the U.S. Department of Justice over a proposed $13 billion settlement, with as much as $5.1 billion going to the FHFA. If the penalties sought against JPMorgan and Bank of America are any sort of guide post, Wells Fargo could be in for a rough ride. The proposed settlement with JPMorgan would be the single largest fine imposed against a single financial institution by the DoJ.

However, Wells Fargo revealed on Wednesday that it had agreed to pay $335 million to the FHFA as part of a settlement for allegedly misleading Fannie and Freddie when it sold institutions mortgages. This is a slap on the wrist compared to what JPMorgan and Bank of America are facing. If Wells Fargo has similar limited exposure under FIRREA, the bank could get through the probe relatively hassle free.

FIRREA was born out of the savings and loans crisis. In the 1980s and 1990s, nearly one in four savings and loans associations in the United States failed. These institutions perform the familiar function of turning long-term savings deposits into economically and socially valuable loans like mortgages and carry out other banking and financial services, and their aggregate failure was the backbone of the crisis. At a glance, these associations experienced mass failure in the ’80s and ’90s because high interest rates forced them into insolvency. The benchmark Federal Funds Rate was nearly doubled by then-Chair of the U.S. Federal Reserve Paul Volcker between 1979 and 1991 from 11.2 percent to 20 percent in an attempt to curb inflation, which averaged about 10.8 percent between 1979 and 1982.

The prime rate — the rate at which banks lent to “favored” customers — climbed as high as 21.5 percent, dramatically reducing demand for new loans, and unemployment continued to creep higher, from 5.9 percent at the beginning of 1979 to a peak of 10.8 percent in November and December 1982. The economy was in a bind. People drained their savings accounts at the same time when savings and loans associations could not sell any new loans. The associations were pincered, and at the end of the day, 747 thrifts with assets worth about $400 billion were either closed or otherwise resolved.

The thrifts were resolved or closed by the Resolution Trust Corporation, a special purpose, government-owned asset management company created by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 for the sole purpose of liquidating the assets of savings and loans (S&L) that had been declared insolvent by the Office of Thrift Supervision — a department of the U.S. Treasury also created by FIRREA.

All told, the number of federally insured S&L associations declined by about 50 percent — from 3,234 to 1,645 — between the beginning and end of the crisis. Taxpayer losses have been estimated at $123.8 billion, which at that time was considered by the Federal Deposit Insurance Corporation to be the greatest collapse of financial institutions since the Great Depression.

But then the late-2000s financial crisis tore through the global economy and left a path of ruin in its wake. The S&L crisis quickly became the second-greatest collapse of financial institutions since the Great Depression. The financial institutions of the 21st century proved to have a much greater capacity to cause economic damage because of their immense size and interconnectedness.

Don’t Miss: Here’s Why Investors Will Be Risk-Averse This Week.