What's REALLY going on? Silicon Valley Bank, Coin Cloud and FTX. Recessions are the Perfect Hiding Place for Mistakes.
My dad and step-mom are driving from WY to CA across a mountain range. Fog rolls in.
My dad says, at least it's not raining. It starts to rain.
My dad says, at least it's not a big storm. It starts storming.
My dad says, at least it's not hailing. It starts hailing.
My dad says, at least it's not snowing. It starts snowing.
My dad says, at least it's not blizzarding. It starts blizzarding.
My step mom finally shouts: Jim SHUT UP!
They pull over and get a hotel for the night.
This week saw this same story in financial markets' contagion.
First little-known 3AC capital made a bad bet on a Sh*tcoin Luna. But they were levered. Alameda was the leverage. Alameda had loaned them money. But Alameda was propping up FTX. And FTX had tentacles and loans everywhere, including with Genesis Trading, which impacted Digital Currency Group, which runs the bitcoin trust.
As each layer declares bankruptcy, the markets say, much like my dad:
It's only a crazy hedge fund betting on Luna.
It's only a 26 year old running Alameda without controls.
It's only one of the largest crypto exchanges (FTX), but only in crypto.
It's only Genesis Trading, Gemini, Digital Currency Group, still all crypto.
It's only Silvergate, a mostly crypto bank, that is failing.
The problems with this line of thinking is in the margins.
3AC had real investors who lost real dollars
Alameda was the counterparty propping up FTX, where FTX US was taking in billions of real dollars from venture capital funds, which were investing for everyday people's retirement funds.
FTX "invested" in companies, politicians and stadiums. Those pledges have to be replaced or written off.
FTX contagion hit main street. CoinCloud went bankrupt, listing creditors that make ATM machines, hotels, landlords, tech consultants.
Silvergate was not only crypto. And they are not the only ones to bank to crypto. SVB was one of the early ones to bank to crypto. With SVB going under, many tech startups lost their cash reserves in one day. This will hurt innovation, jobs and more investors.
This is not about crypto. This is about how risk travels through markets.
In my blog, FTX'ed, I describe the setup.
Risk is like a dog.
Steady companies and economies are in the body of the dog. Not exciting. Which is good in bad times and boring in good economic times.
Tech companies, depending on size, are in the tail. Microsoft would be near the base of the tail, able to grow with some swings, but steady. Smaller, more volatile tech companies are in the middle of the tail. Private tech companies are further out than the middle. And the tip of the tail? Crypto.
It's all one dog, one continuum of market risk appetite.
That tail went from up and to the right to between the dog's legs in retreat as interest rates rose and markets went risk-off.
This is why crypto matters. This cycle, crypto is the canary in the coalmine for markets' risk appetite. Crypto had more volatility AND more leverage than the rest of the market.
But make no mistake. This is not staying in crypto.
Silicon Valley bank had assets of $209B. SVB is gone.
Those with over $250K each get an IOU. Then the administrator of the bank will take assets minus liabilities and see what percentage of deposits each customer will get back.
People are still unpacking SVB.
To my outsider's view and first-principles mind, several things coincided:
Interest rates rose at one of the fastest rates in history. Our economy is complex, and the global credit market in aggregate is about three times the size of the global equity market. Bonds always put a wrench in things as the economy downshifts. Every time.
Risk Seeking: SVB management went the Lehman/Bear Stearns route of taking on risk in the name of profits. They lent to startups, lent to startup founders, and held cash for startups and VCs. They were 3X levered to startups.
Duration Mismatch: They invested their cash in long-duration bonds to get more interest income (to be able to offer higher yield to clients) assuming they would hold the bonds to maturity. Interest rates go up, long bond prices go down the most of all bonds. Worst of all, the duration of their deposits (as measured by how long startups last) is short and got shorter with the recession, and this was not matched with the duration of what they invested in (long bonds).
Finally, they messaged poorly. Too little, too late. I'm not sure good messaging would matter much. After Silvergate went, they were the next likely candidate, and VCs could do the math, and did, at the same time, causing a run on the bank.
That's my outsider view.
Now for an insider view of another part of the contagion.
When I die, if there's an afterlife, my wish is to be able to go back through many questions I've had and find out what was really going on.
Narrative Control
Why take responsibility for your actions/bets when you can hide under the current narrative?
FTX Contagion or simply bad bets?
Nearly any company remotely tied to FTX can simply blame FTX for their own mis-management when they go under.
CoinCloud, a company I worked for, listed a $100,000,000 loan with Genesis Trading and FTX contagion as their reason for going bankrupt. But WHY did they have that loan?
To make directional bets on crypto... while running their business. And those crypto trades went wrong.
That wasn't FTX contagion. That was thinking bitcoin was going up, borrowing money, and losing because bitcoin went down. That's the same as you or me buying a stock on margin and getting wiped out because the stock goes down to less than we owe.
Even if it might be more economically efficient to index, it is a fantastic exercise and practice to have an opinion on the value and direction of markets.
Being wrong on that, and going against common sense, were what caused many bankruptcies in crypto, not FTX contagion.
The same happens in equities.
One company misses earnings and others say, well, that was their unique issue. We all control our own destiny. But economic numbers roll over and more companies miss numbers, well NOW you have an excellent umbrella to hide under! Blame the economy and investors won't ask why your management failed to control their own destiny.
Ben Hunt writes exclusively on narrative management in markets.
Who is controlling the narrative? What do they want us to believe today? Why do they want us to believe it?
Ask these questions as you see news coming out. It will get you closer to the dream of knowing what's really going on, even before we die!
Cyclical Low Tide
When the economic cycle's tide goes out (the economy weakens), frauds are exposed like dead fish on the shore. Right next to frauds, those who got too far over their skis, pushing risk to the limit, also get caught.
We are entering this part of the cycle.
First, we see more frauds exposed.
Second, we see regulators emboldened to take action in the name of preventing the same thing from happening again. In the process, regulators will increase government power and control. As one does!
Next cycle we will have different frauds that seep through different cracks.
Tides go in and out, for the ocean and economy.
Closing the Loop: FTX and Crypto Regulations
We have had a DECADE of the SEC reminding us (through lawsuits, warnings, and many speeches) that if it quacks like a duck, waddles like a duck, and swims like a duck, it is a duck. The Howie test says that if you buy something expecting a return based on the work of others, that is a security. But they didn't want to be seen as stifling innovation (especially during a bull market run), so they have been going one-by-one at the biggest frauds.
Now, we have some big juicy frauds exposed with the receding tides, especially Celsius, which blew up 3AC, which blew up Alameda, which blew up FTX which was a combination of Enron (accounting and general fraud), Madoff (making up performance and keeping their own custody), and Lehman (interconnectedness)
As I mentioned in my FTX article , with every economic downcycle, we see the cracks and regulators try and fill them. Predicting which ones they go after is tougher, especially with FTX, which was a regular all-you-can-eat buffet of fraudulent activity. Where to begin?
It look like they are beginning with crypto's must be registered as securities AND must use a registered custodian.
Like the 1996 Telecom Act, what seems like a simple rule (keep your crypto with a registered custodian, not a fly-by-night, unavailable to US investors, international exchange like FTX), will have broad implications.
Are there any registered custodians in crypto?
(Coinbase came out and said they are, but that may be up for debate because having a NY BitLicense may not be what the SEC meant when they said registered custodian).
What if you don't use a registered custodian (because they don't exist for crypto)?
First glance, if you are a Registered Investment Advisor (RIA), larger hedge fund, or running money for other people, you could be in violation. What's worse than going askance of the SEC? Going askance of FINRA (unelected officials with incredible power). FINRA regulates investment advisors.
Does a $800B business (crypto) go away? Unlikely. Every crypto winter looks like the last. What is more likely is that new ways of doing business under these new rules will be invented, and with it we will see another bull wave like we did with DeFi in the last upcycle (but with some new innovation flowing through regulatory cracks).