Tax-Credit Investigation May Trip Up Wells Fargo

In late June, Wells Fargo took out a two-page advertisement in the New York Times meant to rehabilitate its reputation, trumpeting its financing of billions of dollars in low-income housing. But that signature effort has become just the most recent example of its failure to revamp its troubled culture, which has featured a phony accounts scandal, the improper alteration of documents of business borrowers and the improper collection of fees in its pension fund business. The bank's wealth management unit is also under investigation for pressuring clients into rolling over their low-cost 401(k) accounts into more expensive alternatives.

The tax-credit program at the heart of the investigation was created during the 1980s to add market discipline into the subsidized housing market. The tax credits are funded federally, but local agencies hand them out to developers, who receive bids for the credits from banks and other investors looking to offset income taxes. The banks are the biggest buyers of the credits because they not only receive a tax write-off but also get credit under the Community Reinvestment Act, which requires banks to invest in poorer neighborhoods where they have customers.

About $9 billion of low-income housing tax credits are issued each year, and among the banks Wells Fargo is the largest purchaser. Last year, Wells Fargo announced that it had invested $9 billion in the program during the previous five years.

According to two people close to the investigation, the Department of Justice is looking into whether Wells Fargo colluded with developers to drive down the price of the credits over the past decade. In return, Wells Fargo would offer the developers better loan terms or agree to fund less desirable deals. Cox, the former developer, said he knew about instances in which Wells Fargo would move tax-credit dollars from one deal to another, which is not allowed. Cox also said that Wells Fargo would make the price of tax credits on one deal contingent on what it would pay for tax credits in other deals. By law, each deal is supposed to be bid individually.

Paying less for the tax credits not only drives up the cost of providing the credit for the U.S. government, but it might also require some deals to be allocated more credits than they would normally need, depriving them from other developments. It also essentially drives up the return a bank can make on the tax-credit investment.

Based on the deals that have been examined so far, according to a person close to the investigation, Wells Fargo's actions may have defrauded hundreds of millions of dollars from the federal tax program. And according to Cox, a number of the people he worked with on these deals are still working at Wells Fargo.

CEO Tim Sloan, who has been at Wells Fargo for more than two decades, has survived the current slate of scandals by saying that they were the result of bad incentives and a few bad apples and that the bank had cleaned up its culture. As this latest investigation demonstrates, Sloan is going to have a harder and harder time making his line stick. It's impossible to say your house is in order without actually having it in order.

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Stephen Gandel is a Bloomberg Opinion columnist covering banking and equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.