Financial Insights on the Crypto Crisis
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The film The Big Short, directed by Adam McKay and based on the book by Michael Lewis, follows hedge fund manager Mark Baum (played by Steve Carell) as he collaborates with Deutsche Bank executive Jared Vennett (Ryan Gosling) to bet against the housing market right before the subprime mortgage crisis. A memorable dialogue highlights their grim observations about the financial system, mixing humor with a stark reality.
Jared Vennett: Didn’t I warn you that the ratings agencies, banks, and SEC were oblivious? Now, after a crisis, you’re surprised?
Mark Baum: That’s not just incompetence; it’s fraud.
Jared Vennett: Define the difference between stupidity and illegality, and I’ll get my brother-in-law arrested.
What once felt humorous now resonates deeply, given recent banking failures linked to cryptocurrency activities that rocked the financial sector. Although a major disaster was averted, the underlying conditions leading to the crisis have not only remained but worsened. With deregulation and significant political clout, the crypto sector is once more set to threaten the banking system, making any potential fallout greater than before.
March 2023 marked a critical moment when three U.S. banks—Silvergate, Silicon Valley Bank, and Signature Bank—collapsed rapidly, with First Republic following suit in May. These banks collectively managed over $400 billion in assets, and as the situation escalated, more banks faced severe liquidity issues. The Federal Reserve intervened to guarantee depositor funds, momentarily quelling the panic, yet investigations revealed that exposure to cryptocurrency was a key factor in the failures of these banks.
In a paper released in March by Steven Kelly and Jonathan Rose, they highlighted that the crisis was exacerbated by a business model heavily reliant on cryptocurrency and venture capital. Many crypto firms faced significant losses the previous year, leading to a rush of withdrawals that strained the banks serving them. This dynamic created a chain reaction reminiscent of traditional bank runs, ultimately resulting in a liquidity crisis.
Despite the Fed’s efforts to stabilize the situation, the crypto companies and their investors faced little accountability. With retained capital, major players in the crypto industry were able to exert considerable influence over political processes, resulting in a legislative environment that increasingly favors them. Their financial contributions during the 2024 election cycle helped secure favorable outcomes for numerous pro-crypto candidates.
Looking ahead, a scenario unfolds where crypto-inclusive legislation paves the way for broader bank engagement in the sector. Combined with a potential economic recession, which historical trends suggest is inevitable, a sell-off of risky assets, particularly in crypto, could trigger widespread bank failures. This would create a situation similar to the last financial crisis, presenting a daunting challenge that we appear unprepared to confront again.
