Graeme Sloan/Sipa USA via AP Images
SEC Chair Gary Gensler testifies during a Senate Banking Committee hearing, September 15, 2022, in Washington.
One of the great regulatory accomplishments of the Biden era was to keep the crypto bubble quarantined in its own realm, away from the banking system. As a result, the crypto touts and their suckers lost their own money, but did not take down the larger financial economy.
The hero of this achievement was SEC Chair Gary Gensler, who used his authority in a variety of ways. As the Prospect’s David Dayen has written, Gensler issued a bulletin last April, indicating that banks would have to mark digital assets as liabilities on their balance sheets for accounting purposes. Gensler prevented the creation of an exchange-traded fund made up of Bitcoin funds, which would have increased bank exposure to crypto. Gensler also made it much more difficult for crypto companies to go public with stock offerings after FTX’s collapse, by issuing 16 questions that it wanted crypto companies to address in public filings.
For the most part, the bank regulators have followed Gensler’s lead, most recently when the Federal Reserve denied Custodia, a Wyoming crypto-focused bank, access to a master account. But a notable hole in the system is a weakened FDIC regulation, gutted in 2020 by Trump appointees, that makes it much easier for FDIC-insured banks to accept brokered funds; and these can include crypto assets. When deposits are brokered wholesale, it’s too easy for banks to overlook what’s in them.
Last week, the trade publication American Banker ran an article attributing the collapse of one infected bank, Silvergate of San Diego, to the brokered deposits loophole. Silvergate suffered a massive run on its deposits in the last quarter of 2022, when it experienced an outflow of $8.1 billion, causing the bank to turn to the Federal Home Loan Bank of San Francisco for an emergency advance of $4.3 billion, and causing Silvergate’s own stock to fall by 84 percent. The bank has to sell assets at a loss to cover withdrawals.
According to American Banker, nearly all of Silvergate’s $4.6 billion in cash as of early January was the advance from the Home Loan Bank. That suggests Silvergate, which bet the farm on crypto, is close to insolvent. The Senate Banking Committee has been investigating since December, and a bipartisan group of committee senators is dissatisfied with Silvergate’s non-response.
But the linkage between brokered deposits and crypto may not be quite as American Banker depicts it. A closer look suggests that Silvergate simply pursued a disastrous strategy of positioning itself as banker to the crypto industry and ignored regulatory guidance from the SEC’s Gensler and other regulators to limit its exposure. When crypto firms that had placed massive deposits with Silvergate began losing their shirts, a massive run followed.
This suggests that the regulators need to be even more vigilant to make sure that banks are not willfully violating the law, and that lawbreakers need to be prosecuted. For the most part, big banks were kept in check by Gensler’s actions at the SEC, reinforced by other regulators. A joint statement issued January 3 by the FDIC, the Federal Reserve, and the usually bank-friendly Office of the Comptroller of the Currency warned banks to be wary of crypto assets and promised regulatory scrutiny. One regulatory agency conspicuous by its absence from that statement was the Commodity Futures Trading Commission, which has been a shameless cheerleader for the crypto industry.
Regulators need to be even more vigilant to make sure that banks are not willfully violating the law.
The Biden administration, which had played a little footsie with crypto previously, also recently slammed the door shut on the industry, in a guidance that “encourage[d] regulators to continue … to address and limit financial institutions’ exposure to the risks of digital assets.”
That said, the weakened brokered deposit rule is an accident waiting to happen. Brokered deposits were heavily implicated in the savings and loan collapse of the 1980s and 1990s. That experience, plus the abuses that led to the wider financial collapse of 2008, is what prompted the original FDIC rule limiting brokered deposits, which was gutted by Trump appointees.
The lone Democrat on the FDIC board in 2020, Martin Gruenberg, voted against weakening the rule and warned of dire risks to the banking system. Now Gruenberg is FDIC chair, and progressive regulators make up a majority of the board. The board members are expected to undertake a new rulemaking at some point, toughening limits on brokered deposits, though they have other priorities.
There are two morals to this story. One is that regulation is only as good as its regulators. The weakened rule against brokered deposits is a classic case of what happens when industry allies are put in charge of the rules.
The other moral is that the financial industry keeps inventing new ways for insiders to make fortunes by promising riches to the gullible and passing off the risks. Crypto joins a long list of such deceptive innovations, including credit derivatives and subprime mortgages. It takes very smart, public-minded, and courageous regulators to keep up with these schemes and protect the public, especially when new schemes don’t easily fit old regulatory categories.
Two such regulators are Gary Gensler and Martin Gruenberg. Ironically, crypto industry allies in the press who pilloried Gensler for being too tough last year when the crypto bubble was still inflating are now attacking him for having failed to do enough.
Sorry, every new revelation makes it clear that Gensler is a hero—and that still more needs to be done.
