It won’t come as any surprise to you, I’m sure, that large financial institutions lie to their customers and rip them off. It would probably be more of a surprise if they didn’t. Let’s just take it as a given. The question then arises: what should be done about it? I’m not talking about “move your money” campaigns, I’m talking about the regulatory response. What should the government do, when they catch banks and lenders in such behavior?
In the US, the typical response seems to be a fine — and, what’s more, a fine which barely covers the excess profits made by the malefactors.
Exempli gratia: The Consumer Financial Protection Bureau has just forced M&T Bank to refund $2.9 million to some 59,000 account holders who were charged for their “free checking” accounts. I’m sure those account holders are happy — but M&T must be happier. It promised “no strings” free checking, it broke that promise, and the full extent of its punishment is that it has to give back the fees that it promised it wouldn’t charge. A rational bank, faced with such a regulator, will continue ripping off consumers at every available opportunity: if they don’t get caught, they get to keep all of the money, and if they do get caught, they just revert to the state they would have been in had they never even tried. The rip-off is all upside, no downside.
Or here’s an even bigger example. If your stockbroker works for Citigroup, there’s a good chance that he (a broker is nearly always a he, for reasons I don’t fully understand) works for something called Citigroup Global Markets Inc (CGMI), where the rack rate is a whopping 1.5% per year in advisory fees. What some clients understand, and other clients don’t, is that the rack rate is entirely negotiable, and if you ask for a discount, you’ll probably get one.
But here’s where CGMI was cunning. Clients would ask for a discount, and agree to pay, say, 1.2% instead of 1.5%. But then, CGMI would go ahead and charge them 1.5% anyway. Because, who checks? Well, it turns out that one of their clients actually checked, and complained to the New York State attorney general. Which in turn discovered that CGMI had overcharged its clients by some $16 million.
That’s bad, right? Well, guess what the punishment was. Citigroup had to pay back the $16 million in extra fees. That’s it. No real punishment at all: if the scheme had worked then Citi would have kept its $16 million, and if it got found out then it just needed to sheepishly return the cash.
Neither M&T nor Citi, then, had to pay any meaningful fine for the offense, beyond simply making good on their customers. And certainly neither bank needed to demonstrate that it was changing its procedures so as to prevent this kind of customer-gouging. A simple (and worthless) “sorry” seems to be enough.
Compare the UK response to a financial-services firm ripping off its customers. Subprime lender Wonga is writing off £220m ($350 million) of its customers’ debts, and radically reducing the number of people it extends loans to — as a result of “discussions” with the UK’s Financial Conduct Authority. (Oh, to have been a fly on the wall in those discussions.)
From here on in, Wonga will be a very different company; its chairman says the new lending standards will mean “accepting far fewer applications from new and existing customers”; the company also expects to be “smaller and less profitable” in future. And just because it will no longer make loans to people who can’t afford to pay them back.
This violates common sense: if you lend money to someone who can’t pay you back, don’t you generally lose money? And if you stop doing such things, won’t your profits go up? Not necessarily. When the interest rate on the loans is high enough — and it doesn’t need to be Wonga-high, it just needs to be above 30% or so — you can often make a startling amount of money even if the person you lent money to ends up in default or bankruptcy, and never pays off their loan in full. It’s called the “sweat box”, where the balance keeps on rising no matter how hard you try to pay it off, and the lender can make huge amounts of money even as the unpaid balance continues to grow.
Wonga, under its agreement with the FCA, has now said that it will no longer extend loans to people who can’t afford to pay them back. That’s on top of the $350 million of loans it’s forgiving, on the grounds that it should never have made the loans in the first place.
Now that’s a real punishment, and an example of a regulator doing its job. What do you suppose the chances are we’ll see anything like it happening in the US?