In the Adam McKay-directed film ‘The Big Short,’ based on Michael Lewis’s book, hedge fund manager Mark Baum (played by Steve Carell) and Deutsche Bank executive Jared Vennett (played by Ryan Gosling) team up to short the housing market before the subprime crisis. Their conversation about the ratings agencies, banks, and SEC being ‘clueless’ feels uncomfortably relevant today.
Two years ago, a series of banking failures related to crypto shook the financial system, exposing significant risks banks had taken on to cater to the crypto industry. Although the worst was narrowly avoided, the conditions that led to that crisis have not only persisted but worsened due to deregulation and increased political influence by the crypto industry.
In March 2023, three U.S. banks – Silvergate, Silicon Valley, and Signature – collapsed within five days, with First Republic failing in May. These banks held over $400 billion in assets. Research by Steven Kelly and Jonathan Rose for the Federal Reserve Bank of Chicago suggests that their exposure to cryptocurrency and risky bets by venture capital firms were key factors in their collapse.
The crypto industry’s collapse in the previous year, marked by the implosion of FTX and the arrest of hundreds of crypto-related criminals, had not fully resolved its issues. By the time the author testified before the Senate Banking Committee in December 2022, the potential spillover effects on the banking sector were clear. Despite this, the Fed’s guarantee of depositors’ money likely prevented a larger crisis from worsening of the crisis, but it didn’t hold the crypto companies or their investors accountable.
Instead, crypto companies like Coinbase and venture capital firm a16z used their retained cash to influence politicians and regulators on a larger scale than before. Crypto PACs spent $135 million in the 2024 congressional races, resulting in the election of numerous pro-crypto legislators. The industry’s influence also led to the rollback of safeguards, including the disbanding of Joe Biden’s cryptocurrency task force and the FDIC rescinding a rule requiring banks to notify the Fed before engaging in crypto activities.
Legislation on crypto is moving forward, potentially opening the floodgates for more bank exposure to crypto. As the economic recession forecasted for years potentially unfolds, with Trump’s policies boosting the chances of a recession to as high as 70 percent, the stage is set for a potentially larger crisis. A downturn could lead to a massive drop in markets, causing investors to dump risky assets like crypto, resulting in a massive bank run that could affect dozens or hundreds of banks, including the largest ones.
The scenario eerily mirrors the subprime crisis, with crypto as the culprit. Despite lessons supposedly learned, the risk of another catastrophic failure looms, making it seem like a sequel to ‘Dumb and Dumber To’ rather than ‘The Big Short.’
