How could we not have anticipated the rise and fall of FTX?When has letting just anyone solicit the public’s money, store it and use it for just about anything ever gone wrong?As a former financial regulator whose career has centered on financial collapses, I believe the FTX story underscores just how blind both legislators and consumers may choose to be when mesmerized by shiny new financial objects and buckets of money.
Crypto may be new, but the stories of financial collapses like it are not. In 1907, a similarly dangerous combination of global economic red flags simmered, driven in part by the rapid growth of thousands of brand-new unregulated U.S. trust companies engaged in a seemingly unlimited list of activities for people dissatisfied with traditional banks. The bubble burst when Charles Barney’s high-flying Knickerbocker Trust in New York became entwined with several high-profile stock speculators and his pleas for financial assistance were rebuffed by JP Morgan. Faced with what he described as “troublous times,” Barney shot himself. U.S. legislators eventually emulated Britain and France and established a central bank in 1918 — the Federal Reserve System. They said that it would end financial panics for all time.
Eighty years later, both as a regulator of and counsel to financial institutions, I had a front row seat to the U.S. savings and loan crisis and the 1989 failure of Lincoln Savings & Loan. This time, another high-flying Charles – Keating – was at the helm. When Lincoln collapsed, many of its more than 20,000 customers lost their life savings because they had purchased debentures in Lincoln Savings thinking that they were just as safe as FDIC-insured deposits. Congress again enacted legislation, but also found itself having to launch high-profile hearings to investigate five U.S. senators accused of intervening with regulators on behalf of Keating after he had made $1.3 million in political contributions to them.
The FTX scandal has already revealed many interesting subplots driven by curious personalities. But it appears to be the same old story dressed in crypto clothing. A high-flying, self-proclaimed industry leader attracts customer and institutional money with a compelling new financial spiel, only to be accused of abusing their trust as suspicious transactions are exposed and the business collapses when the euphoric air goes out of the balloon.
So why didn’t policymakers remember the lessons of Knickerbocker, Lincoln, Drexel, Arthur Andersen, Washington Mutual, Bernie Madoff and the many other financial collapses the world has experienced over the last two centuries? It is plausible that they didn’t appreciate the risks created by trillions of dollars pouring into an unregulated business run by people whose credentials were less scrutinized than they would have been at a South Beach nightclub.
Perhaps there were other factors at play. For example, about $73 million was allegedly contributed by FTX and Alameda-related executives and entities to U.S. legislators. Taking a page from the Keating Five script, in March 2022, eight U.S. representatives – the “blockchain eight”, a group of Democratic and Republican legislators – wrote to the Securities and Exchange Commission (SEC) with “questions” regarding the use of its authorities to obtain information related to cryptocurrency and blockchain firms such as FTX.
If global legislators and regulators had acted as cryptocurrencies grew over 14 years from nothing into a massive $10 trillion global business, the FTX debacle would likely not have occurred. No matter how technology changes the nature and delivery of financial products, we should know by now that when something acts like money, it should be regulated as money. When it resembles an investment, it should be required to comply with applicable disclosure and conflict of interest laws. When companies function as fiduciaries, custodians and financial pipelines, they should be supervised the same way traditional companies are.
Shockingly, there are still no barriers to entering the crypto business, so it should not be a surprise that people with limited financial expertise bring their high wire acts to the business, along with levels of risk that would not be tolerated in a regulated environment. Even an investor wishing to purchase more than 10 percent of a bank must spend months enduring a rigorous regulatory evaluation to determine its integrity and experience, and yet, a convicted felon can potentially start issuing cryptocurrency tomorrow morning.
Sadly, the most basic traditional “fuddy duddy” limitations on the care and control of customers’ funds, such as using third-party custodians, might have prevented the alleged abuses by FTX executives, but they are still nowhere in sight. One-stop-shopping seems convenient, efficient and cool to the crypto culture. But feel-good decentralized systems lacking any government oversight or transparency have always been incubators for the financial risks that traditional systems are designed to avoid.How do we keep getting fooled again and again?
Feigning shock at the collapse of so many crypto companies is part of the script. In the end, official excuses will be offered, and sacrificial boogeymen will be hung in the town square to satisfy the thirst for economic revenge. But that won’t prevent a repeat performance of this well-worn tragic story or reform the role of political donations.
Names like Charles Barney, Charles Keating and Samuel Bankman-Fried may change, but the well-worn tragic story will remain the same unless the role of money in politics changes.It is not a good look for a United States trying to maintain global economic and moral authority.
Thomas P. Vartanian was a financial services regulator and counsel who is now executive director of the Financial Technology & Cybersecurity Center. His latest book is “The Unhackable Internet: How Rebuilding Cyberspace Can Create Real Security and Prevent Financial Collapse.”
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