Daniel Sutter: Wells Fargo, fraud and markets

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One of the nation’s largest banks, Wells Fargo, recently agreed to a $185 million settlement with the Consumer Financial Protection Bureau (CFPB) and other regulators regarding sales tactics and fraud in the opening of two million customer accounts. As first reported by the Los Angeles Times in 2013, employees desperate to meet monthly quotas created accounts for customers without permission. Bank executives’ claims that they did not intend for employees to use fraud strike me as willful ignorance: they did not want to know how employees attained sales four times the industry average.

This instance of fraud, sadly, is hardly unique. Recently we’ve seen Volkswagen cheat on emissions and for-profit colleges falsify job placement records. What do such cases mean for our market economy?

For starters, they make many Americans distrustful of business and receptive to government regulation. Free market economists interpret business fraud differently, based on how markets discipline corporate malefactors. But I think we economists are too dismissive of business fraud.

Markets generally harness self-interest, like business’ pursuit of profit, to increase prosperity. Market exchange is voluntary, so businesses must provide us with goods or services we want to buy. And competition results in many banks (or supermarkets, or restaurants) vying for our business, providing options if we are unhappy with quality, service or price.

But as the Wells Fargo case demonstrates, businesses can cut corners or even cheat. Selling customers extra accounts or services increased the bank’s revenue without providing value to customers. I do not know why bank executives decided to do this. Perhaps they thought customers would not realize that they were paying extra fees, or would not take their business elsewhere if they did.

If I wanted to downplay fraud, I could argue that such fraud is rare. Or that it illustrates the challenges of managerial economics and the design of incentives. Or that cheating customers is not profitable for businesses in the long run. All of these arguments, however, ignore the fraud.

We should, however, recognize how customers discipline even the largest corporations, through what economists call the power of the market. The Fortune 500 has tracked America’s largest companies for decades. Economist Mark Perry found that 88% of 1955’s Fortune 500 no longer made the list 60 years later, having either fallen out, gone bankrupt, or merged.

Consumers discipline firms through our actions. I am not a Wells Fargo customer, and will not be anytime soon. Perhaps some of you closed accounts following the scandal. Indeed, the Times interviewed a customer with a six figure line of credit who closed her accounts after an employee created an unauthorized $8,200 line of credit. Wells Fargo’s reputation and profitability will suffer for years.

We often fail to recognize our influence over corporations. In part, this is because customer punishment is collective; the loss of any one customer’s business is not a blow to a major corporation but losing thousands of customers is. Further, the loss of future business appears mild compared to the punishments we experience personally, like being grounded, spanked, fired, or even serving detention. That $185 million fine looks more like a real punishment.

Only regulation may fail to work as effectively as we might hope. The CFPB, established by the Dodd-Frank Act, should protect consumers against this type of fraud. And yet a newspaper, not the CFPB, revealed Wells Fargo’s misdeeds. Government regulators often have discretion to rule that misdeeds do not violate rules despite appearances. Today’s regulators may hope to work for banks at higher salaries in a few years, and consequently employ that discretion to overlook acts which should be punished.

The freedom indispensable for the innovations by businesses which grow our economy will also allow some businesses to take advantage of customers. Americans have every right to want to see businesses which cheat them punished. We will never be able to eliminate fraud entirely, but the vigorous competition for customers enables consumers to punish miscreants.

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Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. The opinions expressed in this column are the author’s alone and do not necessarily reflect the views of Troy University.

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