Have you ever given consideration to the ultimate destination of huge fines levied on U.S. banks and other financial institutions in recent years? Billion dollar fines do not grab the attention they commanded a few years ago simply since it is occurring more frequently. And that’s not saying anything about the smaller multi-million dollar fines that barely make the headlines these days.
Various sources indicate the fines fall into basic categories, i.e., civil money penalties, and disgorgements or required restitution.
Disgorgements or Required Restitution
Disgorgements or required restitution payments make sense in theory, since they are intended to provide recovery for damaged businesses or consumers. However, the determination of damage is complex. For example, scores of home buyers contend their financial well-being was damaged by unaffordable mortgages obtained during the housing boom in the mid-2000s. These damages were caused by loans with balloon payments, payment choices that resulted in negative amortization, step-up mortgages, and other sub-prime loan terms. Some borrowers were qualified on “stated income.” In other words, the lender took the loan applicant’s word for what his or her income was. In many cases, the applicant’s income was grossly overstated.
Borrowers have a personal responsibility to basically understand their business transactions and deal honestly, or so it would seem. Having faith in our justice system, one would expect a balance to be struck between personal responsibility and wrongdoing on the part of the bank. Thus, settlements with businesses and consumers would take into consideration their culpability in the failed transactions and be distributed appropriately.
Civil Penalties: Where Does the Money Go and Who Ends Up Paying?
What about civil money penalties? In a recent multi-billion dollar settlement, over half the settlement was allocated to civil money penalties. Where does that money go – to enforcement efforts and development of other programs? Federally regulated banks and other financial institutions are typically billed directly for the cost of exams conducted by their regulators. Don’t regulatory exams encompass “enforcement”? If an institution is determined by the regulators to be out of compliance, memorandums of understanding or cease and desist orders are issued and regulatory monitoring is increased until compliance is once again accomplished. In extreme cases, regulators can take control of an errant institution. The increased costs of monitoring are also passed along to the institution.
Once again, what about civil money penalties?? Who ends up paying? General business economics says money coming in to a business must exceed money going out or the business will become insolvent and eventually be forced to close. Assuming the business provides relevant goods and services that are in demand, price increases are the most likely method of covering cash shortfalls and maintaining profit margins. So, who pays the tab? Good customers, businesses and consumers who need the services to conduct their daily lives. Ultimately, the penalty is nothing more than a speed bump for the business as costs are passed along and customers pay the increased cost.
What percentage of business owners and consumers would you assume read a news article and understand exactly what their bank was penalized for? Those articles most likely do not cause customers to pack up and move their accounts elsewhere. Rather than levying unreasonable penalties that affect innocent businesses and consumers, perhaps there are other more basic solutions that put an institution’s reputation on the line and informs its customers there is a problem. One such solution may be to require a noncompliant institution to prominently post notices in each of their business locations and website stating: Banking regulators have found this institution to be out of compliance with Regulation ___ because it has a pattern and practice of ______.
Ok, so maybe that’s at the other end of the penalty spectrum, but the point is that all factors must be considered and penalizing innocent people is unacceptable.