Why We Were So, So Wrong About Wells Fargo

This week's Industry Focus episodes are all about some of the most cringingly bad mistakes we've made on the podcast.

In today's Financials episode, Gaby Lapera and John Maxfield revisit some glowing comments they made about Wells Fargo (WFC -0.26%) in 2015 in light of news that was calling attention to some of the bank's aggressive management practices. Find out why the hosts got this bit so wrong and what they've learned from it, why it's so important to have an investing journal so that you can keep track of your mistakes as well as your wins, how to not get paralyzed by fear of all-too-inevitable mess-ups, and more.

A full transcript follows the video.

This video was recorded on Aug. 21, 2017.

Gaby Lapera: Hello, everyone! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. You're listening to the Financials edition, taped today on Monday, August 21st 2017. My name is Gaby Lapera, and joining me on Skype is John Maxfield, a super excellent contributor here at The Motley Fool. Hey John! How's it going?

John Maxfield: It's going great! Happy Eclipse day to you, and to you, Austin!

Lapera: I really like that. I wish that was a normal holiday. Happy Eclipse day, sir!

Maxfield: It's like Christmas and then birthdays, and I don't know what else, and then Mayan holidays thrown in kind of all together.

Lapera: Yeah. You're in the path of totality, right?

Maxfield: We are, 99.4%.

Lapera: Yeah, we only get 81%. I feel like that's ... a word that's not safe for work. Bullhockey. [laughs] Anyway, we're going to try to keep it short so that we can go do other stuff. But I wanted everyone to know that it's a theme week here on Industry Focus. The official title of the theme week is We Said What?. This week, all hosts will talk about mistakes that we've made, mostly on the show, but maybe also in real life, depending on the host. Let's go ahead and dive right in. Austin, I dug through the archives and found this gem from November of 2015. Can you hit that for us, please? 

Maxfield: This is where Wells Fargo has been caught up. But it's important still, particularly at this early stage in this whole process, that we keep in mind that these are stories that could be coming -- and I don't doubt that Wells Fargo has a very aggressive sales culture. They're known for cross-selling. You have to push your employees to sell if you want to cross-sell. That's just how it works. But, whether or not it actually crossed the line, and whether this is going to change the investment theory on Wells Fargo, that's something I really doubt. I would be surprised if this thing costs tens of billions of dollars for Wells Fargo.

Lapera: Right, and that is one place that Wells Fargo is ahead of a lot of the other big banks. They didn't have any large settlements that they had to pay post-2008 financial crisis.

Maxfield: Yeah, and it made a huge difference. I think Bank of America's tally -- and this is from Bank of America itself -- was $195 billion from the crisis. $195 billion is what the crisis cost them. So, the fact that Wells Fargo has largely avoided all that -- yeah, they could have a few hundred million here and there, and it shouldn't be doing things that, if they really are pressuring, I think we can all agree with that, they shouldn't be doing those things. But as an investment, this is still an incredibly solid bank.

Lapera: Yeah. I figure we should probably close with a quote from Wells Fargo, which is from Mary Eshet, their spokeswoman. "Wells Fargo's culture is focused on the best interest of its customers and creating a supportive, caring and ethical environment for our team members," which, that's what she's paid to say, so keep that in mind.

Maxfield: Yeah, you don't think she wanted to come out and say, "We tell our employees to make sure that customers buy things whether they like it or not?" [laughs] 

Lapera: Oh my god, why? [laughs] So, listeners, for a little bit of background on that, we were talking about a Wall Street Journal article that had come out on November 30th of 2015, so that was quite a while ago now, about how Wells Fargo had been accused of aggressively pushing their salespeople to make these quotas, and we were like, "Oh, no, it's totally fine, guys!" Maxfield, do you want to chime in on how that turned out for us?

Maxfield: [laughs] First of all, when you guys came out with this theme week, and Gaby, when you mentioned this episode, I mean, I just thought it was the perfect episode for us to talk about, and a great episode to start out the theme week on, because it's such a clear case of being wrong --

Lapera: So wrong.

Maxfield: So wrong. And, it's really relevant right now. In September of last year, Wells Fargo was caught opening up something like two million fake accounts for customers in order to push their cross-sell ratio. To make things worse, after this came out, we learned that there were thousands of employees that were fired, and potentially many of them were fired because they tried to bring this scandal to light inside of Wells Fargo. And then, after all of this -- you think that's all pretty bad, you're taking advantage of your customers, and you're then punishing your whistleblowers who are trying to do the right thing for your company -- but just recently it's come out that Wells Fargo also sold something like 500,000 of its customers, I've even read as many as 750,000 of its customers, this type of insurance that's called collateral protection insurance, which goes along with when you get an auto loan. If you have an auto loan with Wells Fargo and you don't have insurance on the car, Wells Fargo will charge you for this insurance to protect the collateral value of it. Well, 500,000 to 750,000 people had insurance but were nevertheless charged for it by Wells Fargo, which goes along with this whole cross-selling scandal. Then, on top of that, and I'm laughing not because I think it's funny but because it's so horrendous, something like 20,000 of those people had their loans go into default because of those additional payments, and their cars were repossessed. So, yeah, I think it's pretty clear that we were wrong on all that.

Lapera: We were so wrong. But, you know what? Making mistakes is part of being alive, and it's what you do once you've made a mistake that separates you. And we have done the first step, which is admit that we have a problem. [laughs] And we do. We were wrong. We were so wrong about Wells Fargo. But I think one of the really important things to realize when you're talking about investing is that no one has a crystal ball. And honestly, if you get a 50-60% hit rate when you're investing, you're doing incredible. So, mistakes are definitely going to happen when you're investing.

Maxfield: Let me dig into specifically why I was wrong. I was wrong for two reasons. Number one, and I actually didn't hear that clip, because it wasn't coming through on my side, but I listened to the show earlier today so I suspect this is the clip we're talking about -- in that show, I said that the allegations of potentially abusive selling practices at Wells Fargo would, number one, not change the investment thesis around Wells Fargo's stock; and number two, that it wouldn't end up costing Wells Fargo "tens of billions of dollars" like, say, Bank of America had to pay for its whole mortgage scandal. Both of those have been wrong. Number one, the whole investment thesis around Wells Fargo centered around its ability to generate more revenue per customer than other banks. You could see that in its efficiency ratio, which is the percentage of revenue that is spent on operating expenses. Its efficiency ratio has been traditionally lower than other banks, and the reason is because its revenue has been higher. Well, that efficiency ratio has taken a hit since then. And the reason it's taken a hit is because Wells Fargo -- one of the reasons, they have higher litigation expenses. But another reason is, Wells Fargo has totally changed its approach to cross-selling, as one would imagine. So, that changes the investment thesis. 

The second piece of all this is that, while it's true that Wells Fargo has not incurred tens of billions of dollars' worth of direct costs at this point as a result of this scandal, if you look at the performance of its stock over the past year, you'll see that it's gone up only 6%, whereas the rest of the market is up -- sorry, my son just walked into the room, he's here for the eclipse party -- the rest of the market has gone up by 32%. So, when you think of the opportunity cost associated with Wells Fargo, the lost opportunity cost on this, it's something like $70 billion. So, to put a bow on all this, I was wrong both in terms of the investment thesis and in terms of how much it would eventually cost Wells Fargo.

Lapera: Yeah. And I was wrong for agreeing with you. [laughs] But, hindsight is 20/20. When we were going through to make this show, one of the things that I did was I went back and I reviewed my notes to see if there was a time that really stood out to me that we were wrong, and that's a really key thing that I think is really important for investors to take away from this -- it's really important to keep notes, keep an investing journal, I think, so that you can look back at what your original thesis was and test to see if it still holds true against current conditions, because that's really the only way to know whether or not you've made a mistake, unless you have a perfect memory, which I definitely don't.

Maxfield: Another lesson in all this, Gaby, this is what I took away from this. You never know anything for sure. I was looking at Wells Fargo, and you know, I've talked on the show a lot about how I like to read about the history of banking. I mean, total snoozer, I'm aware, but I like to do that. And if you look at Wells Fargo, Wells Fargo was founded in 1852, 165 years ago, during the California Gold Rush in the San Francisco area. In 1855, it survived its first major market crash, whereas all of its competitors failed three years later. Since then, it's had some ups and downs, principally when it changed from being a stagecoach company to an actual bank. That was a difficult transition for it. But ever since then, Wells Fargo has been known and trusted by investors, by its customers, by analysts, by industry observers, by basically everyone. Every person that I've talked to in the wake of the scandal was totally surprised at what was going on at that bank. And what this drove home to me is, even when you think you know something based on a century and a half's worth of evidence, unexpected things can still happen. So, when you're buying stocks, when you're doing things financially, you should always keep that in the back of your mind and stay humble.

Lapera: Yeah. And that's why diversity in your portfolio is so important. If you had had all your eggs in the Wells Fargo basket, it wouldn't have been disastrous, you still would have gotten a 6% growth from last year to this year, but it wouldn't have been great, either, and you would have missed out on so many other things. And who knows what else is going to happen, is the point. So it's important to put your eggs in all the baskets. Yeah, you really don't know what's going to happen, and that's OK. That doesn't mean you should not do things either, you know?

Maxfield: And the other thing, Gaby, is that, in this case, in the Wells Fargo case with this particular scandal, yeah, you wouldn't have lost money. The stock still went up 6% in the past year. That original fake account scandal was announced in September of last year. So, through that, it's still gone up by 6%. But when you're dealing with banks, because they're so highly leveraged, and because they borrow money on the short-term basis and lend it on the long-term basis, they're very vulnerable to liquidity crises. There could be much more significant things embedded in a bank and on its balance sheet that could come to fruition that could really hurt your portfolio. I think of Citigroup. In the financial crisis, Citigroup was the biggest bank in the country, everybody thought it was this sophisticated, amazingly run bank. It turns out, over the course of 12 months, it went from being this market darling to being -- well, it would have failed, like ten times over, had taxpayers not come in with something like $80 billion in direct capital that was injected into that bank. But then, if you look at all the loans guarantees behind it, it was trillions of dollars' worth of loan guarantees behind it that the federal government provided. The point being, if you look at what happened to Citigroup stock, it's still down something like 90% from its high before the financial crisis. The point being, you never ever, ever know until it's too late. That's why, to your point, that's a great point about diversity. It's really important to have a diverse portfolio.

Lapera: OK, so, let's turn to the second half of our show. I think that what I would like to call this show is "In defense of making mistakes," because ultimately, being wrong sometimes is good for you, as long as you react correctly. I think there are a few different steps to reacting to a mistake correctly. The first one is identifying what you did wrong, what your actual mistake was, and taking ownership of that, admitting that you made that mistake, and making sure that you're not blaming outside forces. Because sometimes stuff happens and you had no control over it. But acknowledging what you did have control over, I think, is super important.

Maxfield: You know, when you say that, Gaby, you know what I think of? You know when you're driving and you see somebody do some crazy thing and you're like, "What is that idiot doing?" Like, taking a U-turn in the middle of a road where maybe you shouldn't be taking a U-turn. But then, when that happens, you never think about those times when you've done that. And you never think about, maybe he's in an emergency. You don't think about the reason or the explanation behind why he could be doing that. And this all comes down to cognitive dissonance, which is, we've talked about this on the show before, confirmation bias. These tricks and these games that our minds play with us that, to your point, you really have to make a conscious effort to recognize the mistakes that you've made. That point you made earlier about having an investing journal is so valuable. It reminds me, we have a really good investor -- well, we have a number of really good investors who write for The Motley Fool. One of them is Brian Stoffel, and I've heard him talk in the past through the years about having an investing journal and how much that adds, and has made him a better investor. I just think that's such good advice.

Lapera: Yeah. To your point that you were getting at, I think there's a very famous Alexander Pope quote that probably everyone has heard, which is, "To err is human, to forgive is divine." Bottom line is, we all make mistakes, and as Alexander Pope noted, sometimes we have a lot of trouble forgiving others for their mistakes. I want everyone to take a moment to remind you that we're all human, and next time someone makes a mistake that affects you, try to think about the last time you made a mistake and how it felt, and how even though maybe you were doing it and you knew you shouldn't be doing it at the time, or afterwards, how terrible you felt, try and hold onto that feeling so that you can forgive other people for making similar mistakes and making other mistakes. Don't forget to be kind to other people. 

Anyway, back to what you need to do when you've made a mistake. So, you've identified it, you've admitted that you've made the mistake. The next step is to analyze why it happened, and come up with a plan for not making it again and again. This is where the notes that Maxfield and I were talking about earlier come in. It helps you figure out why you made that mistake. Then, the last thing that you need to do is work to actively implement that plan. Whether that starts with an apology or just an acknowledgement that you need to pay better attention in the future or whatever it is, you need to make sure that you actively work to respond to it, because ultimately, every time you make a mistake, it's an opportunity to better yourself. I know I sound really hippy-dippy, feel good-y, but that really is what it is. You have the power within yourself to decide how you will approach mistakes, and one way you can approach it is to throw up your hands and say, "Well, I'm terrible and I suck and the whole world is awful and there's nothing I can do about it." The other way that you can look at it is, "It's an opportunity to learn and better myself and be even better going forward."

Maxfield: Yeah. Let me throw another quote at you, Gaby. I actually used this quote on the show that's going to air next week that we pre-filmed a few weeks ago, but it's very fitting for right now. I'm paraphrasing now because I don't have it right in front of me, but it's that confidence doesn't come from always being right, confidence comes from being comfortable being wrong. I think that's a really good point, because the fact of the matter is, even if you're right 99% of the time, like in the business that we're in, writing, if you're right 99% of the time, that means 1 out of every 100 articles is going to be wrong. That's an issue. Or, that means there's going to be a tiny piece and a handful of articles that are wrong. Now, that's an issue, but if you're not comfortable proceeding with the fact, going forward with the fact that you're going to be making mistakes, and being willing to learn from those mistakes, it can really be a paralyzing thing and can really throttle your advancement. Then, one more thing that all this brings to mind is a Ryan Holiday quote --

Lapera: Oh, I love Ryan Holiday.

Maxfield: He's amazing! This guy is off the charts.

Lapera: Are you going to do Ego Is the Enemy or The Obstacle Is the Way? Because they're both great books, readers.

Maxfield: Yeah, both of them are great books, and both of them hit on this same thing. If you have too big of an ego and you can't admit mistakes, that's a problem. And Ryan draws all of this from his interactions with some of these top thinkers and business people in the country. The Obstacle Is the Way is the same thing -- if you're not willing to confront your mistakes and push through them, your advancement will be throttled.

Lapera: Yeah. Readers, I cannot recommend enough Ryan Holiday's The Obstacle Is the Way. I'm about to start Ego Is the Enemy, I just ordered it from Amazon, I've only read a couple chapters so far, but it is as inspiring, if not more so than The Obstacle Is the Way. If you're into stoic philosophy, it's going to be right up your alley. If that doesn't sound like it's for you, you should try it anyway, and if it's not, at least you learned something new, that you don't like stoic philosophy. [laughs] OK, so, I think this brings us to the end of our show. Austin, thank you, A, for being our wonderful producer, but B, Maxfield and I talked about a mistake that we have made. Can you tell us about a mistake that you have made?

Austin Morgan: I can. I don't know if all of our listeners know that The Motley Fool has five podcasts and a feature on the Amazon Alexa called The Motley Fool Flash Briefing. Last week, I was mixing the Flash Briefing, Market Foolery, and Industry Focus, and I posted the Market Foolery podcast on the Flash Briefing feed. So, for about four hours last Tuesday, if you asked her, Alexa, to play the Flash Briefing, you got the 30-minute Market Foolery. [laughs] 

Lapera: And how long is a Flash Briefing usually?

Morgan: The Flash Briefing is about one minute and 30 seconds.

Lapera: Oh dear. [laughs] 

Morgan: So, that was my bad.

Lapera: No worries, it happens to the best of us. Well, not that in particular to me, because I've never done that, and I don't think anyone will ever ask me to do that. But it does happen to the best of us. And that's the message that you all should take away, listeners. As usual, people on the program may have interests in the stocks they talk about, and The Motley Fool may have recommendations for or against, so don't buy or sell stocks based solely on what you hear. Contact us at [email protected], or by tweeting us @MFIndustryFocus, and let us know about your mistakes so that we feel better, too. Thank you so much for joining us! Thanks Maxfield! Thanks Austin! And everyone have a great week!