Abusing Our Trust Is the Business Model of Modern Finance

Wed, Oct 5, 2016 - 8:14am

Following on the story of how aggressive cross-selling requirements spurred employees to abuse customers and commit fraud at Wells Fargo, this week the Massachusetts Secretary of the Commonwealth William Galvin accused Morgan Stanley of “dishonest and unethical conduct” within the state and Rhode Island relating to employee contests that were run to push securities-based loans onto customers from January 2014 to April 2015. See Morgan Stanley unit accused of high pressure sales tactics:

“This complaint lays bare the culture at Morgan Stanley that bred the high-pressure effort to cross-sell banking products to its brokerage customers without regard for the fiduciary duty owed to the investor,” Galvin said in a statement. “This contest was relatively local, but the aggressive push to cross-sell was company wide.”

There should be no shock in any of this. Anyone who has dealt with an investment bank the past few years will have experienced cross-selling first hand. Employees are trained to recommend customers with any apparent resources (assets or income) to one of the bank’s army of ‘advisors’.

Cross-selling is the business model of today’s finance sector. It has been the motivation for merging different product and advisory firms since the 1990’s when Glass Steagall (1933) divisions between deposit taking and product sales were eroded and then rescinded in 1999. This chart shows the massive consolidation since 1995 which has created the 4 largest US banks today: Citi, JP Morgan, Bank of America and Wells Fargo.

As we explained in our September 30 client letter available here, the recent cross-selling stories bear a strong resemblance to the tactics that were common in investment banks leading up to the crash of 1929. As in the Wells case, it also took a senate hearing years after the event before the public came to understand the systemic way in which the finance sector had used and abused their trust–and the devastating costs society had paid.

In 1933, after years of political inertia, state prosecutor Ferdinand Pecora was asked to take over as chief counsel in the floundering U.S. Senate’s Committee on Banking and Currency hearing charged to illuminate the causes of the 1929 crash. Though bondholders, shareholders, and depositors had lost life savings, and thousands of business owners and employees lost their livelihood, the heads of the big investment banks had escaped personal reproach. Pecora subpoenaed the still wealthy head of National City Bank (now Citibank) to answer questions on sales practice he and his management team had demanded of their workers. One former National City employee had described the bank’s culture this way:

“All day long the message was the same—hurry up, hurry up, hurry up, send some orders…When things slowed up a little, some genius would hatch up a contest of some kind and then we would be under extra pressure from every direction sometimes for weeks.”(Julian Sherrod, Scapegoats (1931).

A sample sales memo to bank staff from Mitchell’s office in 1928 offers the flavor:

“I should hate to think there is any man in our sales crowd who would confess to his inability to sell at least some of any issue of either bonds or preferred stocks that we think good enough to offer. In fact, this would be an impossible situation and, in the interest of all concerned, one which we would not permit to continue.”

In other memos and meetings, management reminded workers that even the ‘smallest crumbs’ of customer savings could be ‘rolled into loaves’ of bank profits if employees were sufficiently diligent in their efforts.

Under Pecora’s cross-examination, Mitchell admitted that he and his top officers had set aside millions in cash from the bank in interest-free loans to themselves before the collapse and had pawned off bad loans by packaging them into securities and recommending them to their customers as investments. In the end, despite collecting a $1 million+ bonus in 1929, Mitchell had paid no income taxes thanks to tax planning strategies he had done with his wife. (Any of this sound familiar?)

There were no live broadcasts or YouTube clips of Senate hearings in 1933. But as newspapers reported the revelations to the American public, outrage spread and public ire turned on the banking elites. In the end, politicians who had remained deferent and preferential to the bankers after the crash finally passed The Banking Act of 1933 (aka The Glass-Steagall Act) which prohibited commercial banks from engaging in the cross-selling of investment products to bank depositors.

For the last 25 years, we have born witness once more to the devolution of big finance into a protected class emboldened to break laws, purchase political favor, minimize tax, lie, steal, cheat and mislead its customers. In the process, they have made a mockery of long-standing standards of professional advice and fiduciary responsibility. As lawmakers, regulators and central banks were enlisted to this cause, finance profits boomed in the greatest leveraging supercycle in human history. While asset prices soared, so did the commissions, fees, and interest extracted by finance, while the financial stability of their customers and the real economy weakened.

Since the 1980’s the amount of financial products sold to bank customers has more than doubled. Today finance captures 25% of S&P 500 profits while providing just 4% of the jobs. The concentration of fortunes has allowed this one sector to buy influence and control over everything from academics to media, public relations, education, accounting, reporting and regulation as well as enforcement, procedure, and penalties. Here, in particular, the limited liability corporation has been used as a near impenetrable armor from personal accountability for the directing minds within it. In the process, the rule of law (that no individual is above the law)—a founding principle of democracy since the Magna Carta—has been mocked and undermined.

We must demand better. As the New York Times points out, if war can have a code of ethics, then investment banks certainly can be required to as well. Fresh models and thinking are needed to help workers and savers build and retain the proceeds of their labor into capital loaves that feed themselves, their beneficiaries and the real economy ahead of the bankers.

We have ample long-standing antitrust, racketeering, money laundering, tax and fraud laws on the books to curb and punish finance malfeasance. In addition, the 21ST Century Glass-Steagall Act has already been proposed by bipartisan US Senators in 2013, to once more end cross-selling of financial products to bank customers. This division is critical: security underwriting and speculation must be cordoned off from taxpayer guaranteed deposits and returned to stand alone firms and partnerships that live and die on their own risk management, as they all did before 1999.

Our financial system is a critical utility and history proves that it is too important and vulnerable to allow a self-serving, sales driven culture to dominate it. Allowing finance to run wild has bankrupted the free world. If the real economy is to finally rebuild, we must stop worshiping and protecting these false prophets, sever their access to tax-payer funds, and revoke the ‘Get out of Jail Free’ card so widely enjoyed by offenders.

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