Wells Fargo does not have comparable capital concerns, but its own scandal involving creation of around 2 million fake customer accounts has undermined its core strategy of cross-selling financial services to exploit scale.
Clawbacks of compensation paid to the executives responsible for strategy and business execution when these scandals were brewing might not have a meaningful financial impact in the near term.
But they would send a clear signal that lessons have been learned, and could reduce the eventual cost of slow responses to the crises at the two banks.
The need for action is particularly acute at Deutsche.
The fall in its shares in late September to lows not seen since the 1980s was caused by an impending US fine for mortgage-securities abuses.
Deutsche had already disclosed that it was in discussions with the Department of Justice (DoJ) about settlement of claims surrounding its origination and securitization of residential mortgage-backed securities.
When it emerged that the DoJ was seeking $14 billion, Deutsche’s share price fell sharply, as the amount far outweighs the bank’s litigation reserves and would drive its capital below the regulatory levels needed to remain active in markets.
Deutsche’s current management then engaged in a game of chicken with the US government by stating that it had no intent of settling anywhere near the DoJ proposal. If that stance was intended to stiffen the sinews of the German government in opposing a threat to the health of the nation’s biggest bank from US authorities, it seems to have backfired spectacularly.
When reports were published that Chancellor Angela Merkel’s government had ruled out a rescue package for Deutsche before the German elections next year, the bank’s stock fell further – to a level where the entire capitalization of the firm was barely above the cash total being sought by the US.
Cryan nevertheless has a chance to make a symbolic statement of intent – and maybe cancel some unvested share awards – by pursuing former executives who presided over the value destruction
The details of the misconduct for which Deutsche will be fined have not yet been made public. As well as issuing $84 billion of private label mortgage securities and $71 billion of whole loans in the US between 2005 and 2008, Deutsche was among the most active traders in the securities, with an especially high profile in the creation of related credit derivatives.
These trades were used to enable short positions for the bank and its hedge fund customers and helped to extend the pre-crisis credit bubble and exacerbate the severity of the eventual crash in 2008.
There is accordingly no guarantee that the DoJ will accept a settlement that is based purely on the volume of securities issued by Deutsche, which might point to a fine nearer the level around $3 billion that the firm was supposedly hoping to pay.
Deutsche CEO John Cryan received plaudits for his attempts to reform the firm’s business practices and settle outstanding litigation following his appointment in 2015.
After just over a year in charge he now seems to be falling prey to the institutional capture and conflicted interests that stopped his predecessors from dealing with Deutsche’s many regulatory and reputational challenges.
A reversal of Cryan’s policy of amnesty for former senior executives could help him to revive his reputation as a reformer.
That is where an attempt to recover compensation from former executives – from the top of the executive suite to business unit heads – could play a role.
Euromoney urged Cryan to adopt an aggressive clawback policy earlier this year, arguing that Deutsche’s compensation guidelines give the firm wide scope to pursue the return of bonus payments where the original award was inappropriate because a transaction had an adverse ultimate effect for the group.
It would not be difficult to maintain that executives in charge of businesses that eventually saddled Deutsche with fines that could put it out of business have passed this threshold.
Deutsche paid over €4 billion in bonuses to its investment bankers for each of 2006 and 2007 and around €2 billion for 2008. That is a total of well over €10 billion of bonus payments for the years covered by the coming DoJ fine.
If that amount could be clawed back, it would come close to balancing the $14 billion that the DoJ is seeking from Deutsche for its misconduct in those years.
The money has effectively gone, of course. Any cash has been spent and employees who were stuck with Deutsche stock either through bonus vesting policies or their own poor investment judgment have seen the value of their holdings erode by over 50% this year alone.
Cryan nevertheless has a chance to make a symbolic statement of intent – and maybe cancel some unvested share awards – by pursuing former executives who presided over the value destruction.
Serious about change
The financial equivalent of a truth and reconciliation commission for Deutsche, rather than a policy of amnesty, would at least signal that its current management is serious about change.
If the German government does eventually feel compelled to act as a backstop for Deutsche’s liabilities it will almost certainly want to exact a price from both current and former executives. The current incumbents would be better advised to initiate the process than to fight a hopeless rearguard action against reform.
Wells Fargo would also benefit from a move to punish senior executives for its own misdeeds. Wells does not face a threat to its financial viability comparable to the crisis at Deutsche. The $185 million fine that it recently paid for setting up around 2 million fake client accounts was almost inconsequential for a bank that generated $23 billion of profit last year on $86 billion of revenue.
Wells Fargo does face a threat to the product cross-selling business model that has been at the core of its success, however. The bank’s marketing is almost exclusively built around promotion of the supposed benefits of cross-selling and it even trademarked the motto a ‘Culture of Caring’, which seems laughable now that the extent of its customer manipulation has been revealed.
The bank’s policy of mass firings of the junior employees who set up fake accounts – over 5,000 dismissed already and counting – has done virtually nothing to calm its own crisis, as it has not been accompanied by sanctions for the senior executives who were actually in charge at the time.
Carrie Tolstedt, head of the retail bank unit where the abuses took place, was allowed to retire with a compensation package (as estimated by one investor lawsuit that has already emerged) at over $120 million. Chairman and CEO John Stumpf will retain more if he departs on the amicable terms that are customary even when a senior bank officer exits in a bear market for the firm.
Their successors should pursue their predecessors to claw back some of these outlandish gains, if only to demonstrate that they have learned the errors of former ways.