When $30 trillion was destroyed in 2008, not a single Wall Street CEO saw the inside of a prison. As far as I recall, every one of those firms was onshore and regulated.
I upset a few bankers at the time when I suggested at a high-profile conference on compliance at the London Stock Exchange that this was the most egregious form of moral hazard in recent financial history.
What I meant is any person who is facing the choice between making huge gains on which they will be paid handsomely vs huge losses where they will incur no personal risk – other than maybe losing their job – face a dilemma, aptly called moral hazard. I believe it affected most, if not all, who sold complex leveraged loans, because greed, sad to say, wins out over morality in such cases.
Back in the 1980s and 1990s, hedge funds were treated as pariahs, much like crypto today. Short selling was regarded by the traditional markets as unethical and ought to be illegal.
No one, before or after, Marxists naturally excepted, raised any serious concern about the raison d’etre of financial markets. Instead, they rightly called for stronger rules and enforcement.
Following the bankruptcy of various companies – Enron, World Com, Kodak, Blockbuster, Standard Oil, Woolworth, TWA, Lincoln Savings and Loan, E. F Hutton, Madoff and others – no one declared that the markets on which their shares traded should not exist. Failure in capitalism is ironically a healthy sign, as businesses get left behind and replaced by those better equipped to survive. That’s how Darwin has been interpreted when discussing “survival of the fittest”. Fraud, however, is reprehensible in all its ugly forms.
FTX, the crypto exchange that has just collapsed, looks like a combination of failure and fraud. Its evangelist Sam Bankman-Fried discovered that he couldn’t walk on water and what happened to this ether-based exchange was an old-fashioned bank run. Like the situation facing Northern Rock in the UK before the crash in 2008, there was not enough cash to pay out the creditors when they all demanded their money at once.
It was clearly a failure of governance – and probably a fraud, as it looks like he used clients’ funds from the exchange to prop up his hedge fund, Alameda. My experience of most financial failures that end in fraud is that they don’t start that way. It is rare to find a true crook like Madoff.
Your everyday egomaniac makes a mistake and then covers it up. It ends up with a big hole into which they and their clients’ money is sucked into oblivion. It ends up as a fraud.
But when this has happened in the crypto market, the financial press – especially the FT and The Economist – tend to write rather nasty obituaries of the entire crypto market. But the press and the regulators seem to want to have their cake and eat it too.
After all, the press and almost everyone else has accepted extensive crypto advertising. At the same time, as most central banks were working out how to create their own digital sovereign currency, they have almost universally not allowed any major crypto exchange to come on shore.
It is almost impossible to open a bank account onshore if your company has the word “crypto” in its name. Despite the blathering of the crypto libertines, onshore regulators refuse to agree to allow them onshore and to regulate them, rather than the cry for freedom from political and regulatory control, that is the real issue.
Around 32 years ago, I founded AIMA. The world’s only true alternative investment trade association. My motivation was simple. Back in the 1980s and 1990s, hedge funds were treated as pariahs, much like crypto today. Short selling was regarded by the traditional markets as unethical and ought to be illegal.
Not letting facts get in the way of a good argument, they failed to recognise that hedge funds rarely pursued naked shorts but instead were looking at the relative value of similar companies by buying one and selling the other.
The traditional managers almost always ignored the warning signs that the party was over, as hedge funds got negative on stock. They, and more recently, their unthinking ETFs, ploughed more money into already overpriced stocks creating a series of crashes, reserving the biggest loss to retail investors. More value has been destroyed by crashes caused by blind greed and unsustainable prices at the end of bull markets than was ever caused by shorting.
The problem is, a bit like the internet and online shopping that lives there, nobody likes change. Especially when it may undermine the entire banking system as we know it.
The blockchain structure which underpins the crypto market sometimes referred to as railway lines which carry trains – crypto – is here to stay. Many organisations will, in future, use blockchains to manage their transactions. This will reduce the risk of fraud by using decentralised ledgers and save on the cumbersome bureaucracy and cost that bedevils global banking. If you move your money via a bank, then it’s all kept in one place, putting it at risk from online cyber theft.
To visualise the blockchain, imagine if all your digital information was split into thousands of individual bits and spread out on a vast decentralised ledger. If any section is attacked, it becomes obvious immediately and would be almost impossible to reach every part. It then allows you to do peer-to-peer transactions cutting out the bureaucracy and middlemen involved in most bank transactions. Which is why it’s safer, cheaper and more efficient. And why most banks are trying to adopt it themselves while trying to keep out most others.
The other problem is governments, central banks and treasuries. The US dollar is no longer backed by gold. It came off the Gold Standard in 1971. Since then, what are called fiat currencies, have been just printed with no real backing other than a promise. The main cryptocurrency, bitcoin, is limited in number by design. It’s not exactly liquid gold, but it has a reasonable argument to be seen, despite its volatility, as a store of value.
In comparison, fiat currencies, like the US dollar, the world’s reserve currency, have devalued by 86% in just the last 50 years. As the debt piles up, their purchasing power declines and the printing presses go into overdrive, meaning their day of reckoning cannot be too far away. That is why the authorities hate something as open, transparent and democratic as crypto – the people’s currency.
They can’t control it, and they are trying to shut it down. The answer is not to go away but to emulate exactly what we did after the 2008-9 financial crisis. Engage with the regulators on a global basis. Agree on sensible rules. Make the crypto exchanges declare their liabilities, as well as their assets. Force out the crooks and watch the system go mainstream until a new Darwinian alternative makes us all think again.
In the meantime, I am not only staying involved but increasing my investment, as there is nothing like a crash to create market opportunities.
Ian Morley is chairman of Wentworth Hall Family Office