WBD633 Audio Transcription
Bank Runs, Bailouts & Bitcoin with Caitlin Long
Release date: Friday 17th March
Note: the following is a transcription of my interview with Caitlin Long. I have reviewed the transcription but if you find any mistakes, please feel free to email me. You can listen to the original recording here.
Caitlin Long is the Founder and CEO of Custodia bank. In this interview, we discuss the events that have led to three banking failures within a week, one of which saw the biggest bank run on record. We talk about anti-crypto coordination involving the US government, the inherent instability of the traditional finance system and how this is another signal that the game is up.
“The Fed’s going to end up having to expand its balance sheet again, to proverbially print money, in order to provide the extra cash for the banks to be able to meet the demand deposit withdrawal; the banks should have been sitting on that cash all along.”
— Caitlin Long
Interview Transcription
Peter McCormack: Caitlin, hi, it's been a while.
Caitlin Long: Hey, it's been a while, yeah. We miss you here in Wyoming. You've got the Texas Bull behind you there and I've got the Wyoming Mustang.
Peter McCormack: Yeah, have you got the tattoo yet?
Caitlin Long: No, I was thinking about it though, I swear, I'm thinking about it; I really do want to do it! Just honestly, I've been a little busy.
Peter McCormack: All right, how about in Miami, you and me go and get some tattoos?
Caitlin Long: I might, I'm thinking about it. I want to get the Wyoming Bucking Horse on my ankle, and remember when you came and visited a couple of years ago and I had the sticker on it? I wanted to try it out and I had you fooled for a little bit there, that that sticker tattoo was real!
Peter McCormack: You had me fooled. I'll tell you what, in Miami, if Bitcoin is over $35,000, we go get tattoos.
Caitlin Long: All right. I've got to find somebody in Miami who is good at a Wyoming Bucking Bronco, but you know what, I'll do it.
Peter McCormack: Leave that one to me. Okay, listen, we have got a limited amount of time, we're breaking our rule, you know I always want to see you in person and do this, but everything's gone fucking crazy, Caitlin, and you're my resident expert on the banking sector; I think we had to do an emergency broadcast. What the hell is going on?
Caitlin Long: Well, look, the banking system as we all know has been always inherently unstable because if everybody goes and gets their deposits back at the same time, the system is insolvent and therefore the insolvency gets revealed. It's not like there's anything new that comes to the fore because the insolvency has always been there in aggregate. But the reality is that technology and information and social media allow people to move money faster than they ever have before. As a result, a lot of banks that are tech-forward should have been sitting on 100% cash to back their customers' demand deposits, and instead they got greedy and they were rolling the dice investing in long-term treasuries instead of in cash. As a result, when everybody showed up to get their deposits at the same time, "poof!"
Peter McCormack: Right, let's work through this. There are three specific banks that we want to talk about and they are different scenarios.
Caitlin Long: Great.
Peter McCormack: We've got Silvergate, Silicon Valley and Signature. I am including Silvergate so people listening understand that it is a different scenario what happened with them, but we should at least explain what happened to Silvergate.
Caitlin Long: Yes. Well, I was watching actually both Silvergate and Signature. I'm on the record that I was warning the bank regulators there was bank run risk all over the banks banking this sector and I did it months before the bank runs actually hit, okay. And I think this is interesting because Custodia, my bank, has a 100% reserve non-lending model. Our proposal was to keep 100% of customers' demand deposits on deposit at the Fed and the Fed called that "unsafe and unsound". Yet what has happened is that Fed-regulated banks like Silvergate and Silicon Valley Bank, for example, they were the unsafe and unsound ones because the Fed let them do the following, and I'll quote numbers that I know off the top of my head from the 31 March 2022 Silvergate 10-Q SEC filing.
Silvergate had $13.3 billion of demand deposits that could be withdrawn in the span of literally seconds through the SEN network and through API-based Fedwire transactions. $13.3 billion could be withdrawn like that, and guess what; $1.4 billion of cash on hand. So, when that bank run started, it was pretty fast that the bank unfortunately failed. Now, that was a risk management decision that again the Fed, as the bank regulator, let them take. There is, I know, a bias towards fractional-reserve banking, borrowing short and lending long, and that is literally what Silvergate did. What else did they invest the $13.3 billion of customer deposits in, less the $1.4 billion of cash that they had on hand? Long-term Treasury Bonds and mortgage securities. They were reaching for yield and they did it at the precise moment when interest rates started to rise.
The Fed started raising interest rates almost exactly a year ago, and into an incredibly fast rate-rise environment, these banks invested all the new deposits that were coming in. This is exactly what happened at Silicon Valley and Signature as well; they had a big increase in deposits and they invested in long-term Treasuries. And so, what happens with those long-term Treasuries when interest rates rise is the value of the long-term Treasuries falls, and some of those things are trading, some of the mortgages, in particular long-term mortgage-backed securities, are trading at 60 cents or 70 cents on the dollar right now because of the big increase in interest rates.
Peter McCormack: Right, okay. So, Silvergate themselves, you mentioned they had $1.4 billion in cash?
Caitlin Long: Yeah.
Peter McCormack: In the scenario where there's a run and people were trying to withdraw their deposits, if you're holding your money with the Fed, can you just withdraw as and when you require; you don't actually have to keep it all within your bank?
Caitlin Long: Yes.
Peter McCormack: So, if it was a full-reserve bank, like how Custodia would work, you would constantly have access to the full liquidity of customers?
Caitlin Long: During bank hours, so while Fedwire is open, yes. Not 24/7/365, just to be clear. Both Silvergate and Signature offered 24/7/365 debits and credits among customers of the banks. Both customers on the transactions had to be customers of the bank in order to use SEN or Signet, which were the 24/7/365 platform that allowed customers to basically just swap balances. But any money that needed to actually leave the bank has to be done during banking hours, and that of course would apply to Custodia had we been granted a Fed Master Account yet as well.
Peter McCormack: I'm going to come back to Custodia, because Lyn Alden mentioned another bank on twitter yesterday, where she's talked about them not being given a banking licence by the Fed --
Caitlin Long: For five years!
Peter McCormack: -- for five years, because they had a policy similar to yours of being full reserve.
Caitlin Long: Yes.
Peter McCormack: Okay, let's get into Silicon Valley Bank because this has been the big trigger, the largest bank failing since 2008. What was unique about what happened with Silicon Valley Bank?
Caitlin Long: Well, that was an even faster bank run than crypto. I know the White House talking points yesterday were trying to blame all this on crypto. There is an interesting supporting fact related to Signature, I'll come back to Silicon Valley Bank in a moment, but Signature -- Barney Frank of Dodd-Frank fame was a director of Signature and he came out and made an incredible statement yesterday, which is that Signature, they did have $10 billion of withdrawals on Friday but they were still solvent, and the bank regulators moved in to put them in resolution almost, well, he said as an anti-crypto move.
So, I think Signature, something interesting happened there and will be an investigation and it will question the bank regulators whether they pulled the trigger too fast on Signature. But back to the question you asked, that's relevant because the bank runs that were happening at two of the banks that were actively serving the crypto industry, Silvergate and Signature, happened more slowly than the bank run at Silicon Valley Bank. So the White House talking point to say, "Oh, this is all related to crypto", it's just simply not true.
Back to your question. Silicon Valley Bank, in 44 hours, had essentially a 100% withdrawal of demand deposits. In one case, it basically within the span of a few hours, it looked like 25% of their uninsured deposits were withdrawn; $45 billion. Let's step back and ask, how can this happen? First of all, it should have been anticipated by the risk managers of the bank, the management of the bank as a whole, and by the bank regulators. Why? Because we now have API-based banking. So, Silicon Valley Bank didn't do the crypto thing. Silicon Valley Bank had APIs that allowed all of its tech-forward customers to use software to direct payments into and out of those deposit accounts.
APIs are very different than having to go down to the local branch, wait in line, fill out a form by hand, and then have a Fedwire directed to your new bank account at another bank. So naturally, because you have technology, the tech-forward banks are going to have to be -- they have the ability to move money so much faster. It still settles through the Fedwire system within hours, but the initial instruction that came into Silicon Valley Bank happened so much faster than the bank regulators had anticipated. They should have required the tech-forward banks to be sitting 100% in cash to back customer demand deposits should an event like what happened like last Thursday ever occur.
This is not rocket science, Peter. I can't believe that the banks were allowed to do this "borrow short, lend long" strategy, when everyone knew those deposits were volatile and because you can direct the wire transfers from your phone and do it electronically, and by the way you can do it through software using APIs, the whole concept of a bank run sped up. Now, I will also add, it didn't happen yet, but I think the Fed dodged an even bigger bullet because FedNow, which is the Fed's 24/7/365 real-time gross settlement payments system, that's coming online this summer. Now, it's limited to $100,000 dollars, but now all of the sudden you can have a bank run at 11:59pm on a Saturday night, okay, because people are going to be able to move money 24/7/365 in real-time and I have not seen the bank regulators yet acknowledge that the banks are going to need more liquidity.
The impact of all of this is that the Fed needs to require banks, especially the tech-forward banks, to sit on 100% cash to back demand deposits; by the way, almost no banks do that. But the other impact is, the Fed just across the board is going to need to expand its balance sheet. As soon as this happened, I tweeted, "End of QT incoming"; quantitative tightening. The Fed shrinking its balance sheet disproportionately hit the community banks and these are the ones that are having the problems, and the impact of all of that is the Fed is going to end up having to expand its balance sheet again to proverbially print money in order to provide extra cash for the banks to be able to meet the demand deposit withdrawals. The banks should have been sitting on that cash all along.
Peter McCormack: Oh my God, there's so much to get into there. Okay, let me start with Silicon Valley Bank. You mentioned there that the Fed should have required them to hold 100% of deposits in cash.
Caitlin Long: Of their demand deposits, yes.
Peter McCormack: Yeah, to make their demand deposits. Is that a specific different regulation that should have existed for tech-focused banks, and how would they do that; or are you saying that all banks should be doing this?
Caitlin Long: Oh, all banks should be doing this. I just saw an analysis of all the publicly traded banks that looked at their demand deposits relative to their cash, and in this analysis they also added available-for-sale securities. I wouldn't do that because, as we've talked about before, to sell a security it takes you two days to settle a security. For treasuries, it takes you one day. So, if you can have a bank run in the span of 44 hours, I don't think you should be looking at available-for-sale securities as part of a liquidity portfolio. I think you should be looking at good, old-fashioned cash on deposit at the Fed.
So the Fed's balance sheet effectively should be as big as all the demand deposits in the entire banking system, and it's not, it's a tiny fraction. 95% of the banks on this analysis that I looked at yesterday hold less cash plus available-for-sale securities than their demand deposits, which means if everybody goes and withdraws their money at the same time, the Fed is the backstop and it's going to have to massively expand its balance sheet to create the cash to satisfy the withdrawals.
Peter McCormack: Yeah, I've got it here that Signature had just over 5% of its assets in cash, Silicon Valley had 7%, compared to an industry average of 13%.
Caitlin Long: See, but this is the thing, they had volatile deposits. Those that serve the crypto industry -- this is what Wyoming knew, and you've made trips to Wyoming, you know full well that Wyoming knew that digital assets move at the speed of light. So, anyone serving this industry naturally should have been sitting 100% in cash. The fact that they weren't, it blows my mind. Ultimately, the management teams and the shareholders paid the ultimate price for that because they've been wiped out, as they should be because they made a bad risk management decision.
Peter McCormack: How are these banks making money? What's going on here that's putting themselves at risk? Obviously, they're being greedy, but how should they be making money?
Caitlin Long: Well, here's the thing. This gets into the Wyoming special purpose depository institution (SPDI) approach, and as Lyn Alden tweeted yesterday, The narrow bank approach as well. That is a Connecticut uninsured depository institution, very similar to the Wyoming uninsured special purpose depository institutions, in the sense that they're non-lending banks. If they're not insured, they can't lend, can't take leverage, okay, great. So they are going to sit 100% in cash, which is exactly what the business model of both was.
Now, in the case of the Wyoming SPDIs, they are not permitted to be what's called a narrow bank. The Wyoming SPDIs cannot just literally take deposits and turn around and pay the interest that the Fed pays the bank, turn around and pay that to their depositors; that was the narrow bank's business model. So Wyoming, by law, the special purpose depository institutions have to do something else. What is it that they have to do? They have to provide custody services for digital assets; that's how they make their money.
Traditional banks make money off spread; these uninsured banks make money off fees, and that is how the Wyoming special purpose depository institutions work. A lot of people asked the question, when it all came out, "How is it that Custodia and Kraken Bank and the other -- there are two Wyoming SPDIs and more on the way -- how is it that they would they make money?" The answer is, they're going to charge you fees, and a lot of folks would look at that and say, "I don't want to pay fees to my bank". Well, how is it that you avoid paying fees to your bank? It's because they are taking your money and turning around and taking undue risk with it.
It's the same thing with Robinhood and all these retail trading platforms that don't charge you fees any more to trade your securities. Stop and think about that. If they are not charging you fees, how are they covering their costs? They've got capital requirements, they've got huge technology requirements and they've got huge staffing requirements, so what are they doing with your stocks in order to be able to offer you free trading with no commission? They are taking risk, and you'd better hope that you don't have stocks with those types of firms because if they blow up, guess what, you're not going to get all your money back.
I heard an incredible interview this morning with a biotech firm that had all their cash at Silicon Valley Bank and had to scramble over the weekend to borrow money from the board of directors and piece together, because they owed payroll on Monday morning, and they would have been out of compliance with the law had they not paid payroll on Monday morning; and they were able to do it, but here's the thing. He said, "It was my money, I had my money sitting in a non-interest-bearing account at Silicon Valley Bank. It was the company's money. Your money in your bank account should be yours". And he's right, except that that's not the way the system works right now.
Peter McCormack: Well, I was going to say, because we've got used to free services. But imagine a scenario where you are a company like this and you're opening up an account with someone like a Signature or Silicon Valley and they say, "Listen, you've got two options: we can charge you to custody your money and your money's 100% protected, it's 100% reserve; or, we don't charge you and the other option is we try and invest your money and there's inherent risk with that. This is where we're investing your money, these are the liquidity issues that might come in. You have the choice then". The problem that we seem to have now, and it's something that Troy Cross tweeted out yesterday, these banks are essentially full reserve because the FDIC has backstopped the entire value.
Caitlin Long: The Fed has --
Peter McCormack: The Fed has, sorry, yeah.
Caitlin Long: -- because the FDIC only has $126 billion, I think, of funds in its insurance fund and it can borrow another $100 billion from the US Treasury. But the unrealised losses in the banking system on these long-term bonds were $650 billion. Now you add up $226 billion that the FDIC has access to, that doesn't cover the entire $650 billion balance sheet hole in the aggregate US banking system. So, the Fed has to be the backstop; that's the punchline.
Peter McCormack: So, what's the choice though? Do we move to a system whereby it's fees for custody; or do we maintain this system whereby banks are investing money and taking risk? I'm going to draw out a quote. I read Lyn Alden's -- I don't know if you've read her piece she put out today, I think it was this morning?
Caitlin Long: Not yet.
Peter McCormack: So, her March 2023 newsletter looking at bank solvency, I took out a specific quote, "So, ironically, regulators want banks to be reasonably safe but not 'too safe'. They want all banks to be leveraged bond funds to a certain degree and won't allow safer ones to exist", à la Custodia.
Caitlin Long: Bingo. Yes, correct, she's right.
Peter McCormack: Why?
Caitlin Long: Because that's the way the system works; and, Peter, that's why the bank regulators couldn't get their arms around the concept of a bank that was literally just a money warehouse, just a bank that provided custody services for your money but didn't turn around and lend it. This is the same concept, we have talked about this before, of a bailment. It's an old British common law concept, but we all interact with it all the time. It's the same concept as a parking garage for your car and valet parking, and it's the same concept as a coat check; it's actually the same law. We should go back to that; that's the way banking used to be.
When you park your car at a valet and the valet turns around and goes and parks it in the garage, the valet doesn't have the right to take your car and let an Uber driver go make money with it while you're off having dinner. And then maybe they'll give you the same make and model back; and by the way, they stick you with the risk of a problem with it. That is not how it should work. If you are still legally entitled to your car while it's parked at the garage and the garage goes bankrupt, you can go drive your car away. That exact same approach should apply to money; that is what the Wyoming special purpose depositary institution charters are.
But it was so interesting going through the Fed application process. I'm limited in what I can say, but I will say that not everyone understood this concept. Those that understood it loved it and clearly the folks at the top who ultimately blindsided us after -- we were making a lot of progress, I've said this publicly before, and then they blindsided us in January with this sudden U-turn and it was pretty clear that there was something that was (a) political, coordinated by the White House; but (b) so much bigger than just Custodia. Our application was not allowed to stand on its own. We have due process rights. America is a country of rule of law still and we are pursuing those.
Peter McCormack: So, can we just explain a little bit, for people listening, what actually has happened here with Silicon Valley, specifically in relation to the zero interest rates and how they took the deposits, put them it into bonds, and then with the pivot and the massive interest rates, how that completely screwed these banks?
Caitlin Long: Yeah, so they got whipsawed. In some ways, it's like the retail whipsaw effect that we've all seen with supply chains; there was a shortage of toilet paper, and then all of the sudden the toilet paper is sitting on massive pallets in the middle of the aisles of the grocery stores because they way overproduced and there's not that much demand for it any more! It's called the "whipsaw effect", and that's exactly what happened to the banks, because the system got over-liquified when the Fed expanded its balance sheet, aka printed all the money during COVID, and then cut interest rates as well.
One thing that is confusing to a lot of folks, the Fed does two things to stimulate or retrench the economy: they move interest rates up and down; and, they also move their balance sheet up or down; those are two things. By the way, they might actually not be moving in the same direction. That's where we are right now, where I suspect the Fed's going to keep raising interest rates, but they're also going to be expanding their balance sheet, so they're kind of doing two things that have the opposite effect. But long story short, the whipsaw effect, you saw these huge deposits being deposited in a number of banks including Silicon Valley. You had a tech bubble and you also had a crypto bubble. Those two things were disconnected but they had the same root cause, and that caused these few banks to have a huge influx in deposits and the banks got greedy. They should have just sat with that cash in their Fed Master Account, but they turned around and bought US Treasuries.
The way bank capital requirements work is there's really not a capital penalty for the bank to go buy 10- or 30-year US Treasuries, or to go buy government-guaranteed mortgage-backed securities, which are of course long duration, because mortgages in the US are typically 15-year-plus duration. So, long story short, they're taking in demand deposits that could be withdrawn within the span of minutes, and they're investing in 15-year-ish securities.
It's pretty obvious that they're taking on interest rate risk and the bank capital requirements that apply to the community banks. Ironically, the big banks are immune to this because they're all in the US in compliance with something called Basel III, which is the global capital standards for global systemically important banks. But the community banks in the US were exempt from this. So what they did was take all this unhedged interest rate risk.
Now, if you go back to the consensus a year ago, when the Fed started raising interest rates aggressively, a lot of folks thought that this was going to be a normal tightening cycle; well, it wasn't. Obviously, interest rates went up faster and a lot farther than the talking heads were predicting. So, I think the banks were essentially looking at the interest rate forecasts, including the market's forward expectation of interest rates, and saying, "This isn't going to be terrible, we can afford to take that interest rate risk". Well, they got whipsawed.
Peter McCormack: It seems to me there's a lot of similarities with what's happened here and what happened with BlockFi and their GBTC trade. It's like a duration match initially. I know the BlockFi GBTC trade was a shorter term, they had to hold them to it for six months, but it really was the same risk profile.
Caitlin Long: Similar, yeah, you're absolutely right. Ultimately, everything that happened in crypto lending is just the same thing that happens in TradFi, traditional finance; it's just different manifestations using different financial products, but it's the same problems, and a lot of people had to learn unfortunately very tough lessons. The biggest issue of course is that we're bitcoiners and nobody is making any more than 21 million Bitcoin. There is no lender of last resort, ergo anyone who leveraged it unfortunately had a hard lesson to learn, and there is no lender of last resort, no one to bail them out, in spite of Sam Bankman-Fried's attempts to get a Washington bailout for the crypto industry. I laughed when he called for that last fall!
Peter McCormack: Wasn't Dodd-Frank meant to prevent situations like this happening?
Caitlin Long: Yes, absolutely, and again that's what's so ironic. I've actually talked to Representative Barney Frank, who's on the board of Signature Bank. He actually, I think at the time, maybe about seven or eight years ago, was on the board of the World Wildlife Foundation. I don't know if he still is; wonderful man. We had a great conversation about Dodd-Frank, and he wanted to know -- no, actually, you know now I'm thinking about, it was actually Chris Dodd, never mind. But anyway, it was Dodd of Dodd-Frank, so I don't think I have ever met Barney Frank, but I had a big, long conversation with Chris Dodd about Dodd-Frank and he wanted to know, as somebody who was a financial practitioner, but also somebody who's interested in bitcoin, this was probably 2015, what my thoughts were.
I laid out, look, financial regulation should be actually pretty simple. Is the financial institution solvent? In the questions you were asking early on, you asked some really astute questions about, if there are demand deposits, why are the banks turning around and basically, to use the analogy of a parking garage, that when you park your car, they'll go off and rent it to an Uber driver and pocket all the money and stick you with all the risk, that's what the bank is doing with your money? It's like the old Bart Simpson episode that's a take on It's a Wonderful Life, and Bart figures out that he can't get his money back from his bank, and there's the Jimmy Stewart. It's in Joe's house and then Bart goes and smacks Joe! It's hilarious because it just captures the moment.
Peter McCormack: It was Moe. It was Moe from the tavern who punched Joe!
Caitlin Long: Okay, that's funny! But you get the point, right?
Peter McCormack: Yeah.
Caitlin Long: People don't realise that's how the system works. But if the bank regulations were requiring banks to hold 100% cash on their Fed Master Account for all their demand deposits, we would have a stable system, much more stable than we have today. Now some would say, and this is where you were asking the question about demand deposits, there is a difference in the bank between demand deposits and time deposits.
Time deposits are basically CDs or savings accounts where if you read the fine print, the bank can gate you, they can prevent you from withdrawing your deposits on demand. Those are not demand deposits; you have agreed to lend that money to the bank. What most people don't realise, including this biotech CEO who had $25 million of cash and had to scramble to make payroll on Monday over the weekend, he didn't realise that he lent that $25 million to Silicon Valley Bank. That is legally how a bank deposit works. Your money is not yours; you're lending it to the bank.
Now, it's even more acute when you lend it to the bank in a time deposit where the bank can say, "I won't give you your money back, you don't have a right to it". But most of us think when we put money in a bank, it's our money; it really is not, unless you have a 100% reserve bank that cannot lend. Again, the polarity of what happened with the Fed telling Custodia that our business model was unsafe and unsound, while they're saying that all these other banks are safe and sound, and then these other banks implode without the Fed even knowing?
One of the most hilarious comments, one of the worst-timed comments ever by a regulator was Thursday morning, when the Fed Vice Chair for Supervision, Michael Barr, who by the way sits over all the bank regulators at the Fed, made an anti-crypto speech and he said, "Fed-regulated banks don't have bank runs because they're subject to prudential supervision"; I'm paraphrasing. But long story short, the guy in charge, the guy who's supposed to be minding the store, the guy who by the way, his group, his division labelled Custodia's business model "unsafe and unsound", he said that just as Silicon Valley Bank's bank run was taking place. And, by the way, he has been appointed by Jay Powell to lead the investigation into what went wrong at the Fed.
Elizabeth Warren came out this morning and blasted the Fed for being the fox that's guarding the henhouse, doing the investigation on their own. She got it almost right though. She blasted Jay Powell and said, "You need to recuse yourself". But she then said, "The Vice Chair for Supervision, Barr, he should be independent and do his own work", and I just came over the top and said, "He's conflicted as well, he's the one who made the statement that Fed-supervised banks don't have bank runs, as the biggest bank run in 110 years was taking place". Who's really minding the store? Mark Cuban asked that question over the weekend. Where were the regulators?
Of course, the answer is what we were just talking about here. They intuitively think these leveraged, fractional reserve, "borrow short and lend long" business models are safe. They need to re-examine their biases, because they are not safe in this day and age where information moves that quickly, and banks have technology to be able to close your account from your phone in the span of the speed of light. The world has changed, banks need to sit on a lot more cash, the Fed's going to have to expand its balance sheet substantially before this is all over.
Peter McCormack: I'm going to ask you about the expansion of the balance sheet, but I do want to just raise something there with Elizabeth Warren because you've brought her up. She seems in conflict with Barney Frank, in that Barney joined Signature Bank, he has, I don't want to say "lobbied", but essentially he's lobbied for a loosening of the regulations that he was part of creating similar to how Trump pushed for it. We've seen Elizabeth Warren come out and blame Trump for an attempt to loosen these regulations, these Dodd-Frank regulations.
Where do you sit within this, because I think some people like the idea of tighter regulations as stress tests on the bank to prevent these kinds of bank runs? But to see Barney Frank to come out, I wonder if he's conflicted now that he's on the payroll, or was on the payroll of Signature? It's a tricky one.
Caitlin Long: It is, but so here's the thing. I'm all for far tighter regulation on the banks, it's just not the regulations that they're talking about. The far tighter regulation is very simple: banks should back 100% of their demand deposits with good, old-fashioned cash. That way, if everybody lines up, all those demand depositors want to get their money out immediately, they can have it. That would make the system far, far more stable. That's not the regulation they're talking about, but I'm absolutely for that regulation. That's what Custodia Bank is, right. It's an acknowledgement that money is moving faster, period, and banks are going to have to sit on a lot more liquidity.
What's that going to do? It's going to make the cost of providing banking services go up for everybody. People hate paying fees, now we're back to what we were talking about earlier, but banks have high capital requirements, and high technology and people costs. They're going to have to cover those costs somehow, they're going to have to charge you higher fees, but the system's going to be far more stable. I bet you if you explained to most people, they would make that choice, as opposed to rolling the dice with their money.
Peter McCormack: Well, listen, It's a new lens for me this last couple of days, Caitlin, because in the UK we have something similar to the FDIC, and our bank deposits are covered up to about £80,000. I never have £80,000 in the bank, why would you? It's melting away. You put it in Bitcoin, you put it in housing, you put it in gold, you put it in whatever, anything else that appreciates in value or can earn you some kind of interest, but I don't have that. But in terms of my business, I do, because I have seven full-time employees and you know how cashflow works. I've always got to be three, four, five months in advance.
I've now just seen a situation where there was a run on a bank and there are people, owners of businesses, who are saying, "I'm not sure I can make payroll this week".
Caitlin Long: Correct, scary.
Peter McCormack: That is a situation that could affect me. If there was a run on my bank, I could be in a situation where I can't make payroll and now I'm like, "Do I need to have, I don't know, ten corporate accounts, each with up to £80,000 in; do I need to do that; is that what I need to do?"
Caitlin Long: Yes. So, there are a lot of people -- I'm sympathetic. Like the CEO who's interview I heard this morning, the $25 million biotech who had corporate cash sitting uninsured in Silicon Valley's account. $250,000 of the $25 million in his case was insured, that's it. Okay, now here's the thing. Whoever runs finances at that company should have been paying attention to this.
I spent a lot of time with the corporate treasurers, when I was working at Morgan Stanley, understanding the pain points of corporate treasury, you know, big companies. General Electric has 10,000 bank accounts around the world. They probably have 1,000 people in their corporate treasury staff whose job it is to reconcile all those things, to move the cash around. But here's the thing: those treasury analysts are also understanding the counterparty risks of their banks, because they understand that only $250,000 of their bank deposit is insured.
One of the interesting questions is, should that CEO of the biotech company have had his finance person analysing the counterparty credit risk of Silicon Valley Bank? Yes. So, when he said, "Oh, that money's mine", that's the way it should be, but that's not the way it is. He should have had his finance person analysing that. One big lesson for every business, yourself as a small business owner, all the way up to the GE's of the world that have 10,000 accounts, everybody needs to understand you're lending money to your bank and your bank might default on you, and you need to understand the impact of that.
So, what does it mean? Should you go get ten different bank accounts? I'm not going to give advice for that in particular, but I remember back in 2008, that is exactly what everyone around me at Morgan Stanley went out and did. They ran out and opened up bunch of bank accounts and put $250,000 in each of them just to spread it around. That is what rational people who understand this risk might do, or alternatively a sweep account where you take anything above the $250,000 and put into US Treasuries. I'm sure something like that works in the UK as well.
Peter McCormack: Yeah, but Caitlin, if I wanted to use something like Custodia, what kind of rates would you charge to custody the money? It sounds like an advert, but shill me; what would it be?
Caitlin Long: We're not operating.
Peter McCormack: But if you were? Is it something that may be like 1% of your deposits; that would cover --
Caitlin Long: No, no.
Peter McCormack: Much higher?
Caitlin Long: No, no, it won't be that high. I've got to be really careful here. It also all depends, because if all you're going to do is deposit your money and just have it sit there, so here's the way the maths works. For a bank that does nothing other than the narrow bank's business model, they would have to hold 5% capital after their first three years of operating, which they have to hold 8% capital. So, you've seen that Custodia proposed to hold 108 cents for every $1 in our Fed Master Account. That extra 8 cents was our shareholders' capital during the first three years and thereafter, it would be 5%; that would be the requirement. That's the basic business model. So, the customer has to basically cover the bank's cost of capital otherwise the bank loses money on the relationship.
The other way to handle that is the way the big banks handle it, to look at the customer holistically and say, if this customer is also depositing Bitcoin for custody and they are just using the US dollar piece as an ancillary product, that ancillary product has to cover its costs, it has to stand on its own. But this is one of the reasons why it's so important for banks not to be the narrow bank. Again, the Wyoming SPDI banks cannot by law just take customer deposits and turn around and pay interest on them and basically be a pass-through to the Fed, they have to provide other services.
If you look at Custodia's business model, it's Bitcoin custody; if you look at Kraken's business model, Kraken Bank, they were going to provide debit cards services, they were going to provide custody services, they were going to provide prime services, as Custodia planned to provide as well. So, there are whole bunch of services around digital assets that diversify the product exposure.
Now, come back to the question, how do these banks make money? It should be pretty obvious. It's the same way that Bank of New York or State Street or Northern Trust make money; it's mostly on their services, mostly in their cases custody. Those banks don't make money off spread, they make money off fees; big difference, and it's a successful business model.
Peter McCormack: But I don't need to buy custody service for Bitcoin, I'm a bitcoiner, I know how to self-custody, I've got my Casa.
Caitlin Long: Understood, yeah.
Peter McCormack: But right now, if you turned round to me and said, "Look, you can take your £80,000 insurance risk, or you could pay 1%", I would happily pay for custody of my pounds in my bank account for my business knowing it was 100% backed, because I cannot have the risk that I cannot make payroll.
Caitlin Long: Right, because that's catastrophic for you, of course. So, what's interesting is the Fed has blocked you from having that choice, were you a US company, by prohibiting the Wyoming SPDI banks from getting access to Fed Master Accounts. It is far from over yet, we're in a big fight and it's going to take some time, but I didn't walk into this anticipating that that fight was how this was going to end. I didn't want to be here, our board didn't want to be here, however it's where the Fed has forced us and here we are and we are fighting like hell.
Peter McCormack: Why is the Fed doing this, though? Look, I saw in the Lyn Alden article, she said the reason that they're against this is because if you have a full-reserve bank, that will suck up the liquidity from the rest of the sector, because everyone would put their money there.
Caitlin Long: I don't think so, and I'll tell you why, because Custodia, our business plan was not to pay interest on deposits at all. Traditional banks can pay interests on deposits. How? They can afford to because they are making money on loans, so they share some of the profits with the customers by paying interest. My reaction to that argument, which we heard at the Wyoming Legislature before the Charter got enacted in Wyoming back in 2018, my response was, if the traditional banks are so afraid of competition from a bank that's not going to be paying interest, then you really shouldn't be coddled by the regulation.
Let competition happen, let people choose whether the certainty of keeping a deposit in a full-reserve bank is worth it to them, relative to the interest rate that they could be using by lending their deposit to a bank pays them interest. It's a simple calculation and not everybody's going to make the same decision. The markets work.
Peter McCormack: What, so is there a problem here that the big banks are not independent enough from the Fed?
Caitlin Long: Well, of course they're not independent from the Fed.
Peter McCormack: But independent enough? Is that one of the issues; should there be a line drawn between the Fed and the banks, complete independence?
Caitlin Long: Well, you can't and I'll tell you why. If you go back in the history of the Fed, and by the way, all central banks work this way, not all of them but most of them, the regional Federal Reserve banks are owned by the banks. They are quasi-private entities, although when they do do administrative functions, there is definitely ambiguity and they like to claim that they're private entities when they want to claim they're private entities, and they like to say, "No, we're doing government functions", when it's in their interest, and there's a hot potato back and forth where they pass the, "Hey, we're public; no, we're really private".
But ownership-wise, it is true that they are owned by the banks. The way the Fed works is there's a government agency that sits on top, the Federal Reserve Board of Governors, that is subject to all the government agency requirements, and then the 12 regional Federal Reserve banks are legally owned by banks. They are legally owned as private institutions by their members, so you cannot segregate the two because the shares of the regional Federal Reserve banks, which is where the balance sheets of the Fed are -- people talk about the Fed's balance sheet, it's actually an amalgamation of the 12 regional Federal Reserve banks' balance sheets. Those entities historically were formed by private commercial banks. And then of course when the Fed was formed in 1913, they basically created what is effectively, what became ultimately, the Board of Governors, which is a federal agency.
Again, it was the creature from Jekyll Island, it was a corrupt bargain back in 1913, during ironically the progressive era. So, what's interesting is you now have progressives that have in the United States obtained positions of real power. You asked earlier about Bernie Sanders versus Elizabeth Warren; they're both progressives.
Peter McCormack: Sorry, Barney Frank versus Elizabeth Warren.
Caitlin Long: Barney Frank. Well, Barney Frank was on the board of Signature; Elizabeth Warren is a progressive Senator. The progressives really tried to nationalise banking back then, and I do think that there's a real push to try to nationalise banking right now. And we know a lot. I've hinted, there's a lot that's going to come out about the Custodia situation that is going to stun people about exactly how much coordination and politicisation of a lawful applicant to a federal agency occurred. And, like I said, at this point we are fighting. Something untoward happened to Custodia, and in fact I'm making a trip to Washington, DC because Congress wants to know exactly what happened to Custodia, and we do have evidence and I'm going to be sharing all that evidence.
Peter McCormack: Well, I'm pretty sure Cynthia Lummis will be very interested in what you're doing and probably has your back, and I would have thought there are a few other senators out there who probably have got your back in terms of this. Look, I want to know and I'm sure you'll come and tell me at the time you can tell me. I'm conscious of our time; we've got nine minutes. I do want to cover two subjects so we can finish out. Very quickly, I just want to cover Signature, because it seems like the FDIC took over them whilst they were still solvent, so very quickly tough on that; and then talk about QE to Infinity.
Caitlin Long: So, Barney Frank, who's on the board of Signature, again Frank of Dodd-Frank, the Wall Street Reform Act that happened right after the Financial Crisis of 2008, 15 years ago, he did tell both CNBC and Bloomberg yesterday, I saw two different interviews quoting him as saying, "This was a solvent bank. Yes, there were big withdrawals on Friday, but this was a solvent bank. Had we opened on Monday, we would have been a going concern". That is a staggering statement. There have been shareholders who have come out and said, "Something untoward happened here"; notice the theme? Custodia had the same thing happen to us, a politicisation and it was designed as part of a hit, a coordinated hit, between the White House, the Federal Reserve, the FDIC in their case, and Congress on a bank that was favourable to the digital effort industry.
This is going to be interesting, because the truth will be told, okay. The facts ultimately will come out. This is why an independent investigation needs to happen and Congress needs to take this on. This is why again, when Elizabeth Warren said she didn't think the Fed should be investigating itself, she's right. She didn't want Jay Powell to be leading the investigation, she wanted someone else at the Fed. Again, I'm back saying, "No, a bipartisan coalition needs to look into this, the Government Accountability Office, the GAO in the United States, needs to look at this".
There were some corrupt things that happened here in the move against the digital asset industry, in particular against the digital asset banks. I've said this before: federal agencies have far outreached their statutory authority. How do you deal with that? The Government Accountability Office can look into it, Congress can look into it, reporters can and will and are looking into it, and then of course, you've got the Judicial Branch, which is an equal branch of government where litigation is a remedy for agency overstepping, and we have seen it.
Now, what's interesting In Signature's case is that it does look like the state's banking authority, New York in their case, stepped in before the FDIC did, and it's come out that the FDIC was surprised that they were handed Signature Bank on Sunday, because they didn't think that it was a bank that would have normally gone into receivership. When the FDIC takes over a bank, they typically bring their examiners in at 5.00pm and then essentially receive the bank and have it frankly usually sold to a buyer by Monday morning.
Well wait a minute, what happened here? The FDIC didn't even get involved with Signature until Sunday afternoon? That tells you something, something odd happened there. There are allegations that illegal things happened there and there were threats to sue over it, and boy I sure hope that people who were wronged in that situation, if indeed that's the case, do pursue their legal remedies in the judicial system, because that is the way for folks who are victims of agency overreach to have their rights restored.
Peter McCormack: Okay, wow! God, there's a lot to go on that then. Okay, let's finish on the end of QT, QE to Infinity. I fear, and this is something you and I discussed back in 2019 with Saifedean, we actually talked about what was going on. You said they were running out of bullets. I fear now there is a yo-yoing towards very high inflation. I spoke to Lyn Alden, she said inflation is going to be the big topic of the next decade. They've tried to reduce inflation and what we've seen is they've failed, so now we're seeing liquidity coming back which may drive inflation again. Are we potentially yo-yoing towards, well I don't want to say hyperinflation, but very high inflation?
Caitlin Long: Well, yes, because the system's stability is so low as we just witnessed. I mean, last week, you had Jay Powell testifying before both the House and the Senate in the United States, and he said, "The system is stable". And then two days later, all of a sudden, the worst bank run in the United States! And, the guy who was minding the store, the Vice Chair for Supervision was saying, "Federal Reserve supervised banks don't have bank runs", as the biggest bank run in 110 years was happening! I mean, those things speak for themselves, res ipsa loquitur, those things speak for themselves. So, that tells you something, they didn't see it coming.
So, what's the impact? I would encourage folks who are interested in the historical context to go read the book, When Money Dies, by Adam Ferguson. He's a British historian who wrote that book in the 1970s about the hyperinflations in Germany and Hungary. What you learn as you read that book is that the amplitude of the crises increases and the frequency of the crises increase as the money is dying. We know the traditional financial system is inherently unstable; by the way, we've known that for decades. That doesn't mean that it collapses tomorrow. It could, but it could also still go for decades.
I've been critical of the broken-clock economists who have been, "The dollar is going to crash!" They've been saying that since Nixon closed the gold window in 1971 and they've been wrong. The more interesting question is, why have they been so wrong, because I do believe they will ultimately be right? The answer is that the US has had the balance sheet to keep doing what we've been doing. We will ultimately hit a wall, in which case they will be right, I just don't know when. It feels like it's likely to be during our lifetimes. That's why, plan accordingly. Bitcoin's up 30% since this bank run started on Thursday! I'm sure those who wanted to kill it are mad as hell that Bitcoin is up 30% in their face!
Needless to say, the system is fundamentally unstable, and you and I have talked about this before. Bitcoin's price is volatile, but the system is stable, very stable. The US dollar may not be volatile but the system inherently is unstable, and I'll close with a Nassim Taleb argument that basically, "If you constantly put out forest fires, when the conflagration finally comes, it burns the whole thing, and it might burn so hot that it kills the bacteria in the soil, and it will take decades for the forest to re-forest itself".
That's what I worry about, that by basically saying the US can't have a recession because the Fed will constantly ease into that, all we're doing is drawing down that remaining balance sheet capacity to support the additional debt that is being issued; and there will come a day when the balance sheet is the only thing that matters. Right now, the Keynesians and the modern monetary theorists are in control of economic policy and they don't think the balance sheet matters, and I think the balance sheet is the only thing that matters when it comes to that point. We just don't know when it is.
Peter McCormack: That's one for Paul Krugman and Stephanie Kelton. Look, Caitlin, thank you so much. I know you've got to go, I appreciate this. I will see you in Miami, we will go and get tattoos and we'll have a proper catch-up.
Caitlin Long: Love it! Thanks, Peter, appreciate it.
Peter McCormack: Take care, bye.
Caitlin Long: You too, take care.
