Banks Linked to Cryptocurrency Community Collapse: Could New Regulations Have Prevented This?

Banking remains very much a local business and a people business.

Commentary

We’ve seen several banks fail in the first months of 2023. The failures seemingly came out of nowhere. However, there are a few commonalities among the banks that failed. I'll try to connect some dots for you.

I listened to a livestream from the law firm Foley and Lardner. Partner Pat Daughterty said all three banks had relationships with the cryptocurrency community. Biden appointee Gary Gensler, chairman of the Securities and Exchange Commission, was trying to break the on-and-off ramps between the cryptocurrency community and any fiat banking agency. Silvergate was the first to fall. Then Silicon Valley Bank. Then Signature Bank, in New York, where former Rep. Barney Frank (D-Mass.) was a board member. On March 13, Silicon Valley Bank’s largest competitor, First Republic, failed.

This wasn’t former President Donald Trump’s fault, as some claim. Barney Frank heavily lobbied to change regulations in 2018 on smaller banks. Applying Dodd-Frank regulations to smaller banks killed community and regional banking. Community and regional banking kept the banking industry decentralized. That’s a good thing for risk management. The more centralized things are, the larger the point of failure.

Would the world have stopped with no bailout? Certainly, you feel a lot of empathy for startup firms that used these banks. They would have felt a cash crunch, but based on a presentation I saw from the international law firm Cooley, most would have seen 100 percent of their cash in time as the bank went through the receivership process. Innovation would have continued, maybe at a slower pace. Venture capital (VC) firms would have had to either renegotiate deals with startups or extend loans to them. That’s really the reason the VC firms were yelling like two-year-olds having a tantrum.

Initially, the powers that be in Washington said “no bailout.” That was the correct thing to do, and it would have been correct in 2008 too, but the powers that were then bailed out banks when they should have let them go through bankruptcy. In this case, the Washington crew caved to wealthy venture capitalists.

Guess who the representatives for venture capital are. Democrat California Gov. Gavin Newsom, Vice President Kamala Harris, and former Speaker of the House Nancy Pelosi (D-Calif.). In the aftermath of the financial crisis of 2008–09, which was exemplified by Frank’s “roll the dice” policy, the Democrats wrote and passed Dodd-Frank. It was a sweeping change to regulation and bank law.

At the time, I wrote that it was one of the worst bills to pass Congress since the Affordable Care Act and that it would do nothing to stop future failures. I’ve since been proven correct. Capitalistic free market economies aren’t brittle. They bend but don’t break. Crony capitalistic economies are brittle and break constantly. The United States has a crony capitalistic economy today, and there are points of failure all over it in several industries because of over-regulation.

More regulation isn’t going to make the banks safer. These banks fell for two reasons. First were the intentional actions by Gensler to rein in cryptocurrency. Northwestern law professor John McGinnis was correct when he asked, “Will the government who creates fiat currency allow a competitor to exist?”

The second reason these banks failed is that they had terrible management teams that didn’t understand the difference between accounting numbers and economic numbers. That caused them to misprice and totally avoid hedging their risk. They were derelict in duty and failed in their fiduciary responsibilities to both equity holders and depositors. Writing new regulations can’t fix stupid.

First Republic doesn’t even list a risk officer as a member of its C-suite management team. The risk officer at Silicon Valley Bank was a political science major at Harvard and also a graduate of the Kennedy School of Public Policy. Both banks were more concerned with making points about social issues than they were with the blocking and tackling operations of running a bank. Does it feel good to the depositors at all these banks that bankers knew their carbon footprint better than they knew how to hedge their portfolios in the swaps and futures markets?

How, then, do we rectify this situation when we know writing more regulations isn’t an answer? In my past life, I was a commodity trader in a floor trading pit. When people made or lost millions of dollars, I watched with my own eyes. I think we can translate that experience to banks. If a bank doesn’t have a certain amount of assets, it can’t be a public company. It should have no access to capital markets. It must be formed like the old merchant banks before the cessation of Glass-Steagal. The management teams would have their money in the bank, and when the right arm was doing something the left arm didn’t like, they would have a face-to-face discussion about it. This was always the great thing about the old Wall Street partnerships at Lehman Bros., Bear Stearns, and Goldman Sachs. When one partner got out of line, another partner reined them in. That sort of internal peer pressure went out the door with the ability of those firms to access public markets.

How would that change banking? With no access to capital markets, they would have to get deposits to grow the bank. They also would have to hire qualified people who really understood banking and risk instead of hiring for reasons that made people feel good about themselves. Instead of a few super-banks, the banking industry would become more fragmented.

Don’t believe, then, the spin that the taxpayer won’t be on the hook for this. Bailouts aren’t free. There are opportunity costs and direct costs. If the Fed expands its balance sheet and takes in all the low-interest-denominated notes the banks bought, the Fed will lose money. Who backs the Fed? The taxpayer. If they charge banks higher rates for FDIC or other insurance, those costs will find their way to your bank statement and you'll bear the burden. If the Federal Reserve slows its interest-rate increases to fight inflation caused by profligate government spending, especially during COVID-19, that will have a different sort of economic cost to your pocketbook.

Don’t be confused. You, the taxpayer, are bearing the brunt of bailouts just like you did in 2008.