On the margin: The collapse of Silicon Valley Bank, Silvergate and Signature Bank

Caitlin Long, Nic Carter, Mikel




Alright everyone, welcome back to another episode of On the Margin and today I'm very lucky to be joined by Nic Carter and Caitlin Long. Welcome to the show guys.

NC: Good to be here.

Mikel: It's been a really good calm last couple of weeks.

Caitlin: Hah.

Mikel: Maybe we could just start with the high level and I'd love to get your thoughts about the current status of the US banking. We obviously have had three profile closures in the US here. We have had Silvergate, Silicon Valley Bank and most recently Signature Bank. We are also seeing a lot of signs of stress with Credit Suisse over in Europe. Caitlin, as a legacy banking gal yourself, what's your take at a high level?

Caitlin: Well, look, the traditional banking system has always been insolvent at a systemic level. This has been obvious. That means it's inherently unstable and prone to periodic just major bouts of volatility. I like to point folks to the history. There was a book called "When Money Dies" by Adam Ferguson that explores hyperinflation in Germany and Hungary. What you take away from the history and this always happens in hyperinflationary environments is that the amplitude of the crises increases and the frequency also shrinks. I'm not predicting an end to the US dollar system, although I know a lot of people are. I think that's likely to come during our lifetimes. If you do understand monetary history, then you also understand that fiat currencies don't last forever, and it is the Triffen Dilemma where too much debt gets piled on the balance sheet of the country in aggregate. As a result, the currency ultimately loses its value. A lot of folks would look at this and say well the Austrian have been predicting a collapse of the US dollar since the 1970s and they haven't been right so far and that is true.

Caitlin: The issue is that the balance sheet doesn't matter until it's the only thing that matters. We're witnessing that with the banking sector right now. There's $2.2 trillion of unrealized losses in the bond portfolios of the banking sector. Unless interest rates come down, that insolvency is more than just a liquidity crisis it is actually a solvency crisis. There's two ways to solve it: either interest rates have to come down, or, the other way is that the banking sector is just going to have to raise more fresh equity.

Mikel: Caitlin, one follow on question to that. I think we have all seen the charter that I think was published by the FDIC that shows unrealized loss of all the bond portfolios of these US banks. Now there's one pretty large contingency that says hey wait a sec Bank of America, JP Morgan, this is not like Silicon Valley Bank. They mismanaged their risk and it was wildly irresponsible that they didn't hedge and they deserve what happened to them. Another contingent says that's not how hedging works, and risk gets created and ultimately someone has to sit with that risk. What's your thought on the hedging situation of these banks?

Caitlin: Well, it is true that those banks that are subject to Basel III have to manage their liquidity and do have to hedge their interest rate risk. The community and regional banks that are not subject to Basel III don't have to hedge that risk. That's a fact. The issue is that essentially the community bakns, which is let's face it where a lot of the credit creation in the US economy does take place in certain sectors, a lot of real estate lending, a lot of lending to the heartland like manufacturers and agriculture industry does happen only through commercial banks. There was a political deal. Frankly it's been in place for decades. That the community and regional banks in the US would not be subject to those same requirements. Okay, so what does that mean? It means that the deal that got made was that the smaller banks not the giant ones, but the smaller banks, are allowed to roll the dice. They are encouraged actually by the way that regulations work to borrow short and lend long. What has happened with clarity here is that in an information age the whole concept of borrowing short and lending long as in borrowing short-term and lending long-term... so you take in demand deposit money that can be withdrawn in a short period of time, and you turn around and lend it into a mortgage or auto loan, there is a duration mismatch. In this information age when information moves at the speed of light, banks can't afford to do that to the same degree. If you look at the balance sheets of the banks, virtually none of them are sitting on enough cash to back demand deposits that can be withdrawn at the speed of minutes now. So here's the thing... it used to be that you had to go to a bank branch and fill out some paperwork to make a bank withdrawal. Now you can do it on your phone or through APIs you can do it with software. So the idea of how much time it took to put the instructions in for the payment in the first place is something that has shrunk at the tech forward banks. What's interesting is that the bank regulators for a long time have hated the most tech forward banks. The bank regulators like the concept that everything has to be analog because it slows everything down. However, that is not reality. People are voting with their feet, and using tech, especially there's a generational difference here in addition. There's a lot of people in their 20s who have never set foot in a bank branch. The whole concept that everything needs to stay slow and analog? That's just going to speed up the use of the digital asset industry because it's just a better experience and it's the same thing as taxis and limousine commissions when they were facing Uber. People voted with their feet. It was a better experience driven by tech. These bank regulators that had it out for the tech-forward banks not just the crypto banks but because these banks were using tech-forward APIs and tech-forward online banking tools that give us the ability to access our money faster... boy this bank run is on those very regulators and history will not be kind to them.

Mikel: I'd love to get your thoughts there as well, Nic. I think the technology component of this can't be ignored. The other thing that I want to draw attention to, Caitlin, completely agree iwth this kind of what you're saying about the community banks. One commentary that resonates with me is that we're creating a two-tier banking system here. Janet Yellen testified in front of congress earlier this week and there was this point where she was asked but basically what are you going to do in response to deposits fleeing from smaller regional banks into larger banks? Janet Yellen did not have a good answer. It was enlightening to watch.

Nic: I think Caitlin makes an excellent point. I was thinking this to myself this morning. I have never gone physically to a bank to send a wire transfer or anything. I don't even know how I would do that. I don't have a check book. I have never written a check in my life. I was just thinking to myself, how is it possible that the banking regulators didn't realize the status quo in banking? Which is that we have desktop mobile banking. How did they not realize this? So they are complaining that people aren't lining up outside banks which would be that throttling effect which would reduces the bandwidth of bank outflows. And yet the obvious reality is that outflows can be basically instantaneous now, which would I think force a re-thinking of liquidity ratios and those sorts of requirements at banks because there's been a structural change with technology making it easier to withdraw deposits. I'm astonished that this hasn't been understood and that bank regulators are still operating in this paradigm of old timey bank runs where people line up on the street outside the bank. If you look at some of the coverage of these bank runs, you had older reporters going to bank branches expecting to find people waiting in line outside. There wasn't anyone. They were asking, where is everyone? Well, they are on their laptop. That's one thing I've been thinking about lately that astonishes me.

Nic: I think Caitlin makes some excellent other points about smaller banks. So credit creation in tihs economy-- small banks lend to small businesses. Large banks lend to large businesses. Just reading the tea leaves here, but if the Treasury and Janet Yellen are suggesting that small banks won't receive the same level of protection as the global systemic institutions then there's no reason to leave deposits at the smaller banks. I can assure you this is happening this week. Everyone in our portfolio is doing this because it's the rational thing to do. You're going to your smaller banks and going and taking your deposits and sending them to the largest banks that you can find. Or you're moving them directly into US treasuries, so the government is now your counterparty. This has a chilling effect on credit creation in the US. There's going to be a lot of sectors underserved because the private sector won't be creating credit anymore. Especially for mom and pop style businesses, which are the ones that community banks typically lend to, and I think that's a weirdly deflationary thing which means there's less credit in the economy and this is an unfortunate consequence of this two-tier system that is now in place.

Caitlin: Oh, and there's more. Just yesterday the Federal Reserve confirmed that FedNow which is the new payments system ultimately replacing FedWire will be coming online in July, and it's a 24/7/365 system. There's a lot of information in the press release about the testing requirements about what the banks rolling it out in July will have to comply with. There was zero acknowledgement that the speed of money movement is going to increase inherently when you get a real-time system installed and running. So earlier we were talking about how long it takes you to put the payment instruction in? Analog vs online banking or API? But now there's also speed-up of settlement once the instruction is received by the bank, and that's going to be real-time. FedNow only limits you to $100,000 at a time but $100k at a time equals increased bank run risk inherently. I was floored that the Federal Reserve said nothing about this in the FedNow press release, about requiring the banks that are going to be offering FedNow to hold more liquidity. It means that the bank regulators don't get it yet.

Nic: Totally agreed. I'll add that a lot of people think that it's suspicious that signet and SEN were basically taken offline a week before that FedNow announcement. I think there's a degree of- I don't think it's a coincidence, but I totally agree that the bandwidth of moving money around has broadened and will continue to broaden. It does bring us into congruence with how banking and payments work in other developed countries around the world. I think it's a technological necessity. But it's also further fragelizing the banking system and there absolutely must be an acknowledgement of that.

Caitlin: But they're not acknowledging that. In fact, they are sweeping it under the rug. Did you guys see the New York Times bombshell that Jay Powell edited out the line in the press release on Sunday regarding Silicon Valley Bank and Signature Bank that criticized the regulatory failure at the Federal Reserve? He's trying to hide it and cover it up. I pointed out that at the very moment that the Silicon Valley Bank run was in full swing and you would have thought that the Federal Reserve's top cop would have known about it, the Vice Chair of Supervision Michael Barr was bragging that Fed supervised banks don't have bank runs. Well guess what? Hello?

Nic: And I'll just add to that, they spent our financial regulators spent the last 2-3 months berating the crypto industry for introducing "safety and soundness risks" into the banking system. But guess what? The risks are coming from inside the house. Not from crypto. The risks are coming from the structure of the banks and from the general lack of oversight. It took private-- who was the first one who noticed the issues in SVB's asset portfolio? I think the first person I saw was a newsletter writer called Bern Kobart. Not the Federal Reserve, not the Office of the Comptroller of the Currency, and not the FDIC. It's remarkable that they put so much energy into attacking crypto banks and the full reserve model like Custodia Bank meanwhile their own house is burning down. It's remarkable.

Caitlin: Just wait until you see what they will be saying about us. I don't know when it will come out but there's something called an Order that comes along with Board actions. They haven't released the order yet, but I guarantee you guys are going to have fun with it when it comes out. Literally, Nic, it's what you just said. They defend a 6% reserve bank as safe-and-sound but attack a 108% reserve bank as unsafe and unsound.

Mikel: Maybe this is a good time to get into the political element to all of this. It seems, and I think people on crypto twitter were already talking about this as soon as there was the collapse of Silvergate and Signature they were already predicting that the political apparatus in the United States would point the finger to crypto. It's crypto's fault. That's exactly what happened. There's also been politicization around the tech industry as well. Let's kind of dig into the whole political element here. Nic, this is where I would call on you. You published a pretty prescient article, now with the benefit of hindsight, where you called it Operation Chokepoint 2.0. Big props to you. Could you describe the original Operation Chokepoint from the Obama era that took place in 2013? What was the purpose? What were the agencies involved? What are we seeing today?

Nic: Yeah, this has been discussed among crypto folks for a while actually. I'm not going to take full credit for the concept. In fact, conversations with Caitlin really informed my thinking. I didn't directly deal with Chokepoint 1.0. A lot of other folks did, though. So really what it was was a kind of covert subtle program to discourage banks from servicing specific disfavored industries. In particular payday lending was one of the targets, firearm manufacturing, ammunition, and the adult industry, etc. Basically the way it would work is that the DOJ and FDIC would make the insinuations and maybe off-the-record comments to the banks themselves and suggest that if they provided services to these "high-risk" industries, with the "risk" being determined by the reputational costs of serving those industries then they would face regulatory investigations and other costs of business rising. So they basically de-banked those industries. This largely ended in 2017 when Congress noticed and saw that federal regulators were basically imposing a de facto new law without authorization from Congress. That largely ended in 2017. Many people of course realized and noticed over the past few months that the pressure has been ratcheting up against banks servicing crypto clients. In particular, the recent banks that "failed", which were crypto-adjacent banks, that is, banks that were servicing crypto related companies with basic bank deposit accounts. Through a variety of mechanisms, one of course being the Fed's denial of new bank charters for crypto focused banks, which was the big red flag for me, but also joint statements from all the joint federal agencies covering these things saying over and over again that providing deposit account services to the crypto industry poses "safety and soundness risks", that crypto introduces "systemic risks" into the banking sector which is of course nonsense. It's the other way around. I was hearing from bankers directly, from startup founders, executives in the crypto industry that were trying to onboard with banks and being told it doesn't work- if you're small, you have to be very big, you have to be a very valuable client or company to get a bank account now to offset the costs that we the bank incur for servicing a crypto firm-- or being met with a total black list on crypto firms. Bankers are now telling me that they have to individually approve with the FDIC each new crypto client that they bring on, which is an insane roadblock to doing business. I called this Chokepoint 2.0. It's not the same as Chokepoint 1.0 but it was the most analogous term. Since I wrote about it in February, the pressure campaign has of course ratched up immensely and turned into bank runs- an insane amount more than I ever expected.

Caitlin: Well, we knew it was happening to us at Custodia Bank because the Federal Reserve leaked to the press two days before it voted Custodia down. What we started hearing, and we didn't know where the leak was coming from at the time, we started to hear from the press that Custodia was about to be voted down. This was presented to us by multiple members of the press, outlets, as a foregone conclusion that was pre-ordained. By the way, this is supposed to be a fair process, okay? It became very clear that both the White House and the Fed were involved in this. One of the reasons we ultimately conclucded that the Fed was involved was because we sent the general counsel of the Federal Reserve a response letter after they had "asked" us to withdraw our application. Within hours, a reporter was recounting the letter back to our PR representative. That did not come from us. Think about the ethics violations and procedural violations that occurred there. But ultimately then it became clear; hopefully there's a SIB in Washington, we had insiders come forward and confirm to us that the White House was involved. It was pretty obvious that day of the Custodia denial because the White House and the Fed coordinated to release their press releases at exactly the same time. The smoking gun is that everyone at the time was speculating about whether there would be another Operation Chokepoint 2.0, and what we have is evidence in email because a reporter revealed to us what the reporter was told. The reporter told us that they were told that within the last 48 hours that all the Fed and OCC bank charter applicants had been asked to withdraw their applications or they would be voted down. So I knew from a very early moment that Operation Chokepoint 2.0 was absolutely underway and absolutely coordinated. Again the interesting question is: wait a minute, there are due process protections for applicants of bank charters.. they are supposed to be reviewed by the agencies on their individual merits. But all of the sudden press links are confirming that the Fed and OCC applicants were being asked to all withdraw at the very same time? Come on, that's not based on merits.

Mikel: I agree with that. For those who may not be quite as familiar with the regulatory apparatus that oversees banking, Caitlin you were mentioning some of the regulatory bodies there. My operation of chokepoint 1.0 was that it was largely a joint effort between the FDIC and the Department of Justice. Caitlin could you describe what- obviously it depends state-by-state but what are the major agencies that oversee banks? And how should the bank application process go? And where did it go off the rails with your knowledge hwne it comes to Custodia Bank?

Caitlin: I'd say it really went off the rails in January. We were making progress up until that point and then suddenly there was a U-turn in January that pretty clearly came from the top brass. And again, we know a lot, more than I can share right now, and it will eventually all come out- but I think there were illegal things done here. Certainly things that massively overstepped the regulatory jurisdiction of the banking agencies. To your point about operation chokepoint 1.0, yes the DoJ was involved but there weren't really criminal charges brought against the banks. It was mostly the FDIC. I shared with Nic as he was preparing the Operation Chokepoint 2.0 blog post that went absolutely viral- how is it that the bank regulators have that much power? They very much do, and yes they can shutdown a bank and seize lawful property even if the bank is solvent. We're going to talk about Signature Bank later but it appears that there are credible allegations that this is exactly what happened with Signature Bank- a taking of private property by the government. But they have, in some cases, at least there's ambiguity, suggesting that the bank regulators do have that kind of power. When you get the FDIC going on a power trip against industries it doesn't like-- and Operation Chokepoint 1.0 covered 30 different industries before Congress started embarrassing them and then they backed down. Now by the way they are starting with crypto this time. Back in Operation Chokepoint 1.0, they started with payday lenders. I think that everyone should expect that the politically out of favor industries are next on the chopping block. It's oil and gas, mining, coal, crypto, firearms, ranching, ammunition, and by the way I just listed the core industries of my homestate Wyoming. Part of the reason why Wyoming created the new special purpose depository institution (SPDI) bank charter back in 2019 is precisely that- there were if you go back and look at the Wyoming legislative records, there were legislators who lost their bank accounts for their businesses. In one case, one of these legislators was a firearms manufacturer or dealer who was almost going out of business- he had a lawful legitimate business and he had to scramble to replace his bank account because the firearms industry was out of favor. So he was interested in having a new type of bank charter where FDIC insurance is entirely optional for precisely that reason.

Caitlin: You asked me whether the bank regulators and how it all works, it's very confusing. The charter authorities- we have something called a dual banking system where the chartering is equal. There is a federal chartering authority at the OCC level and then there are 50 different states and territorities that can charter banks as well. You can either have a state charter or a federal charter. There is a law that went into effect during the Clinton administration called Regal-Oneil that allowed for interstate banking among state chartered banks that makes them equal to national banks. So they are really functionally no different in the grand scheme of things between a nationally chartered bank and a state chartered bank.

Caitlin: And then you have the FDIC and the Federal Reserve (the Fed). Those actually are not chartering authorities but they are supervisors. State chartered banks generally but not always have a federal regulators and the state-chartered banks choose whether the FDIC is their regulator or whether the Fed is their regulator. The FDIC of course is an insurance fund as well, and then on top of that the Fed runs the payment systems. A lot of people think about the Fed as only executing on monetary policy. No. The vast majority of the people who work at the Federal Reserve are in the bank supervision division or in what's called Reserve Banks Operations. That's basically the payment system right there. The Fed is a confusing organization. The Board of Governors is a federal agency subject to administrative federal laws like the Administrative Procedures Act, the Freedom of Information Act (FOIA). The 12 reserve banks are technically privately owned. They live in a state of perpetual ambiguity though because they do take administrative action, and boy there's a lot of grey area there. They exploit that. They sometimes choose oh well we're an agency for this purpose or oh we're not an agency for that purpose. There's a lot of case law around the whole question of those 12 regional reserve banks: are they private organizations or are they government organizations? But that's where all the balance sheet is. So the whole idea of a central bank digital currency (CBDC)? It's not going to be issued by the Board of Governors in DC. It's going to be issued by the 12 regional reserve banks. There has been some thought that one of the reasons why the Fed came down like a ton of bricks on Custodia Bank is because Custodia last July was granted the patent in the United States for tokenization of bank deposits and because those 12 regional reserve banks are quasi-private organizations then they are subject to US patent law. If there was ever going to be a tokenization of bank deposits, then they might need to shove that patent aside. I'll leave it at that. I have no knowledge that it entered into the equation but I will say that we spent a lot of time at Custodia Bank doing a lot of work on our proposed digital dollar "Avit" and the Fed was fully aware of everything we were doing as well as the existence of our patent. If you look at the public press release that came out, it was denying Custodia as an "unsafe and unsound bank". If you read between the lines- well, they said it was because the issuance in part of a token on a public permissionless blockchain. You can start read between the lines what they were very focused on was our proposal to issue that digital dollar.

Caitlin: Just to wrap it up though, Custodia Bank cut that out of our business plan. We re-submitted a much more simple business plan that consisted only of US dollar deposits banking and crypto custody of bitcoin and ethereum. That was also denied. That tells you it was more than just the digital dollar, but no doubt the digital dollar was the thing that the Fed was the most uncomfortable with in Custodia Bank's original business plan. That's what they pointed to as the major issue- we asked them for permission to do this and we told them we wouldn't do it unless we got permission from them, and they just sat for 2.5 years waiting and waiting and waiting and finally we got the answer right at the very end instead of having a dialogue about how to make this work. It gives you some real sense that they wanted to shove the whole thing out because once we cut out the digital dollar and went to a much more simple business plan, one that many banks are already doing like Bank of New York Melon with bitcoin custody? And they still wouldn't approve us? That's just wrong.

Nic: One thing that I haven't seen reported as much is that the FDIC is the absolute center of this. I believe part of the reason Custodia Bank and generally the SPDI construct was attacked was because they would have been potentially exempt from FDIC insurance requirements because the SPDI banks are full-reserve banks with no fractional reserve. This would remove a political lever of control, given the FDIC was the primary instrument of Chokepoint 1.0 here's something else that the current FDIC Chair Martin Groonberg precided over Chokepoint 1.0 he was in office from 2012 to 2018 and then was out and now he's back in. He has direct first-hand experience. He owns that scandal. So they have the institutional knowledge of this, which is now being re-applied in a more aggressive and direct way because it's not insinuations and informal guidance anymore. It's written, it's policy letters, it's written down. They have plausible deniability because they keep saying "crypto is a threat to the safety of banking". They are not explicitly denying banks from giving bank accounts to crypto companies, but they are de facto barring them because through a variety of methods mainly by telling banks that they can't do this because it increases "risk" to their business and also investigations against those banks and also the recent de-capitations of the crypto banks. The person who ultimately was responsible for Operation Chokepoint 1.0 is currently in charge of the FDIC.

Caitlin: Well, also, generally wanted to bring to heel these tech-forward banks that we were talking about early on. He wants to go back to an analog system where you are filling out a paper form and handwriting to be able to move money through Fedwire. This is.. yeah. You're spot on, Nic. Some of the things that we have been told through the insiders that have come forward very much pertains to exactly that.

Nic: After I wrote the article, a bunch of folks reached out to me privately, including bank executives, telling me yeah this is real. Brian Brooks has gone on the record too. He knows this better than anyone, as a former comptroller of the OCC. He stated I think yesterday that chokepoint is real and coordinated.

Caitlin: It is.

Nic: I also have former FDIC officials reach out to me and confirming that this is not a coincidence. It's inter-agency process and it's highly coordinated. I think Caitlin had direct first-hand knowledge of this. The rest of us in the industry were trying to piece this puzzle together. In the months since my blogpost describing Operation Chokepoint 2.0, we certainly have information to know that this is real and it's coordinated.

Mikel: Let's talk a little bit about Signature Bank. How this bank got treated was a huge surprise to me. This was around the furor of Silicon Valley Bank and is the government and the FDIC going to step in or not? And then it was almost a little footnote "oh and by the way, Signature Bank has been seized". It's a bank that has been around for 20 years with $10 billion in equity and $100 billion in assets. And it was just suicided. One of the guys on the board was Barney Frank. If that name sounds familiar to you, then it should. It's right there in the name of the Dodd-Frank Act. It was the banking regulations that swept post GFC. He's now on the record saying...

Caitlin: Oh, from the bombshell New York Magazine article? Yeah.

Mikel: This was a great NY Mag article. She wrote a phenomenal article where Frank directly says they were singled out as the poster child for crypto and he didn't understand why the bank was closed. From my eyes, that just felt very weird to me. Am I missing something? What was your interpretations?

Caitlin: What's interesting about both Silvergate and Signature Bank is that when it's all said and done, there might be positive equity value at both banks. Silvergate stock is still trading at $2. It's not trading like a company that is about to go into Chapter 11 because they are going to avoid Chapter 11 by voluntarily liquidating. The same thing with Signature: if it is indeed true and there are credible allegations there then I think that it will all be said and done that the shareholders actually get money back because it may have been a solvent bank. Barney Frank himself, very knowledgeable, as you point out, author of Dodd-Frank Act, said that this was the first bank in US history that was put in receivership despite being insolvent. I hope there is litigation around that. That was a taking of private property by the government. The ambiguity in the banking regulations that was exploited there very well should be litigated.

Caitlin: The interesting that suggests that just looking at factually from the outside that something different happened there, well when the FDIC takes over a bank they typically go in at 5pm on Friday night. They didn't take over Signature until Sunday night. There were reports that the FDIC was surprised that Signature fell into their lap. Remember how I mentioned that the state-chartered banks choose a federal regulator usually? Signature Bank had been FDIC supervised at the federal level. The other two banks that failed- Silvergate and SVB were Fed regulated at the federal level. These 3 banks were all state-chartered banks. In the case of the 2 that failed, they were San Francisco Federal Reserve banks at the federal level and at Signature's case it was FDIC. This makes it doubly interesting shall we say that the FDIC ended up getting a call from New York and get a bank that it didn't plan to receive because if they did plan on it then they would have been there on Friday night. But they got it on Sunday night. Why?

Nic: I will add there that there's a litany of evidence that something really odd and unusual went on here. Barney Frank's allegations that the bank was solvent, the fact of the timing, the fact that post-SVB collapse on Saturday the sell side was coming out and looking at Signature Bank's financials and saying they aren't facing the same kind of impairments or as in bleak of a position as SVB and they didn't look as badly, and the fact that... and Reuters, this is really interesting, Reuters reported that signet would not be included in an acquisition of the Signature Bank assets which implied that the objective was to furlough signet which was the fiat settlement network they had between their bank customers, a critical piece of fiat infrastructure to the crypto industry. It's very odd. Given if, Silvergate's exchange network SEN collapsed then Signature would be the last remaining one. Clearly there's positive value there, a critical element of their crypto practice, a positive value there in an acquisition and the fact that it wouldn't be included in any potential acquisition indicates that there's an anti-crypto animous in the center of the decisions here. This was later disputed by the FDIC I believe but I don't believe Reuters would have gotten that reporting wrong. I think FDIC saw the backlash and then walked it back a little. But all those things together, and the NYDFS superintendent is on the record as being hostile to crypto, all those things together imply that something deeply unusual and wrong happened to Signature Bank on Sunday night. Remember this is the 3rd biggest US bank failure in US history. Remember, $100 billion dollars in assets. This is not a small bank. It's 5x bigger than Silvergate. To me it looks like a political takedown, an opportunistic takedown during a fog of war to settle a score between DFS and the last major pro-crypto bank. I believe we will get answers about this eventually. But from the information that we have, it looks deeply unusual and it looks like basically emminent domain or exproportion of a private sector entity. At that point the equity value was $7 billion dollars, so the shareholders should be rightfully indignant.

Caitlin: And they will. They are.

Nic: It's not the practice of the United States to seize banks simply because you don't like who their clientele is. That is something that happens in autocratic regimes. That doesn't happen in a free market economy with the rule of law.

Caitlin: You know what's interesting is that I read in American Banker 2 days ago that every time a bank is received, the FDIC inspector general reviews the process. These inspector generals are independent. They are CPOs- commissioned police officers. They are law enforcement officers with arrest authority and with subpoena power. From what I understand, some actually do carry firearms. They are full-fledged internal audit officers with police powers of these organizations. Now the agencies have them including the FDIC, the Federal Reserve and the OCC. According to practice, every time a bank is received, the FDIC Inspector General reviews it. I assume the Inspector General will be asked about this at some point. I expect it could be up to a year from now, to Nic's point, but this is one of the things- one of these sort of- internal auditors with police powers can and will review these situations. I found it fascinating that the Federal Reserve put in charge of their internal review of Silicon Valley Bank's collapse not their Inspector General but the guy who was in charge of the bank examiners who missed the collapse in the first place. They put the fox in charge of the hen's house, literally. It was the vice chair of supervision and his division missed Silicon Valley bank and Silvergate. By the way, I have gone on the record warning bank regulators that there was bank run risk in the banking sector that were serving the crypto industry. The fact that one of the top cops Michael Sue the acting comptroller of the OCC which is the federal bank chartering authority picked it up and actually cited me in a footnote of his April 8th, 2022 speech warning about the liquidity risk among the banks that were banking the stablecoin issuers. I know that my warnings were received because of that. I've been warning since 2020 that there was bank run risk in these banks, and privately behind the scenes I was warning bank regulators (plural) that there was bank run risk in these banks. Nothing got done about it. It's interesting because Senator Warren came out and criticized the Fed for using their own staff to do the internal review instead of using their Inspector General or maybe bringing in the GOA the government accountability office which is effectively the external auditor of the government... in fact actually, Warren's tweet and NY Times Op Ed was to let Vice Chair for Supervision Michael Barr do his job-- well what, wait a minute, that was the division that was responsible and missed this problem in the first place. Moreover, I said that as the Silicon Valley Bank bank run was in full swing, Barr made an anti-crypto speech saying that Fed supervised banks don't have the bank run risk because they are subject to Fed supervision. So this literally is the fox guarding the hen's house. I tweeted at Senator Warren that I almost agree with you, it's definitely something that Jay Powell himself should not be involved in, but when she said let's let Vice Chair Barr do his job she should have said no let's have an independent review whether it's the internal auditor eg the Inspector General or an external auditor like the GOA. One of the things that this industry should be actively calling for is a GOA investigation of the agency coordination and the exploitation or the extra-jurisdictional authority, or exploitation of grey area, that these bank regulators have grabbed here. In particular, it's the FDIC and I would add the Federal Reserve. The OCC hasn't so far been involved but the Fed and the FDIC have absolutely done things that I do not believe are legal. They have expanded beyond their statutory authority. It's not just a question of exploiting grey areas. I'll give an example. That statement that the Federal Reserve released on January 27th, at exactly the same time as the White House released its anti-crypto statement, and Custodia Bank's denial of membership application, was publicly released, those three things came out at exactly the same time and again this was in coordination. But here's the punchline. That January 27th policy was not properly vetted-- under the administrative procedure act, something that is a sweeping policy change must be put out for public comment. It was not put out for a public comment. It was put out in the Federal Register on February 7th as final, and I do not believe that is lawful.

Nic: I think a few folks in Congress picked that up as well. I think recently our industry had a whole bunch of FOIAs go out to try to get to the bottom of this.

Caitlin: It's not going to work though. Either the Inspector General has to review it- again the internal auditors of the agencies- or the GOA the external auditor will have to review it.

Nic: Obviously, we have a bank run. Three banks are either "voluntarily" liquidated or going into receivership. All 3 had a crypto banking practice where they would give deposit accounts to companies in the crypto industry. SVB had the smallest share in terms of the crypto market customers activity but infamously they were Coinbase's banker back in the day so they were what allowed Coinbase to stay in business in 2014 and 2015. At the time they were servicing USDC at the time. Those three ended up being closed down and then the Fed comes in with this BTFP facility providing liquidity to banks basically insuring the banks aren't going to fail at least imminently and not face these runs- so throughout this crisis these are 3 banks shutdown and they happen to be the 3 that are focused on crypto company customers. You have other banks that are impaired with the exact same hold to maturity issue like First Republic Bank is now facing serious issues. Yesterday there was some sort of brokered injection of $30 billion of capital into First Republic Bank. They will survive. It's oddly convenient for regulators that have an anti-crypto perspective that the 3 banks and none others that failed were the ones servicing crypto and in particular Silvergate and Signature which maintained critical fiat infrastructure which allowed the crypto companies to exist in particular signet and SEN. Now that those don't work any more, crypto liquidity is impaired and it's very hard to move fiat around to match the settlement speed of blockchains. So that's going to cause issues for exchanges and stablecoins etc. I find that extremely "convenient" that throughout this crisis 3 institutions go down and 2 of them are the major banks servicing the crypto industry. No other banks that didn't have a crypto practice failed. So for me the general takeaway-- and Silvergate, we- there are still open questions for me regarding the withdrawal of the Federal Home Loan Facility that they were taking advantage of- what caused Silvergate to repay that loan? What did they hear? Was that a political pressure campaign against the FHLB? We don't know what the real story was there. I think that was the immediate trigger or catalyst for Silvergate's dissolution. Not as clear a smoking gun as the issues we see with Signature's closure but still concerning and an open question that we deserve answers to.

Caitlin: Right, a "voluntary" early repayment.

Nic: Right, and if the repayment is the thing that plunges you into insolvency, then why would you do that?

Caitlin: It wasn't insolvent, though.

Nic: Right. So why would you commit suicide like that as a bank?

Caitlin: Well, that's the point. The stock is still trading at $2 which the market is saying there's some positive equity value there. Let's see when it's all liquidated whether the shareholders get anything back. That's the point though. It's entirely plausible that shareholders get some money back both in Silvergate and Siganture. It's crystal clear that shareholders will not get anything back in Silicon Valley Bank because just this morning they filed for chapter 11 bankruptcy protections.

Mikel: Just to underscore the point that both of you are making- it's been telling how these 2 situations were handled. Silvergate and Signature- a lot of the deposits were crypto-based and SVB was concentrated in the tech sector. Just the way these were treated compared to First Republic Bank and Signature gets closed with no explanation? Reuters and reported that the suitor the acquirer of Signature would have to divest any and all crypto activities, which I thought was very interesting. FDIC came out and denied this or walked it back of course.

Nic: It's intensely suspicious. Did Reuters get that wrong? I don't think so. They are a pretty credible organization. What I think is more likely is that the FDIC saw the backlash and walked it back. Will they really let some acquiring bank let them re-create Signature's crypto practice? I would be shocked if they did.

Mikel: I'd like to end on something more positive. It's been fun to watch the reaction that bitcoin has had throughout all this. If you look at the market's expectations of- it has been a whipsaw this last few weeks. We saw a facility and the opening of the discount window there has been $300 billion added back to the bank's balance sheet so maybe we found our liquidity floor in terms of QT and maybe that's what bitcoin is responding to.

Caitlin: Well, QT is definitely over. That's clear. The Fed's balance sheet is expanding again, last week by $300 billion. The interesting thing- I don't usually comment on bitcoin's price because it does its thing on its own but I think in this case the divergence between bitcoin and the just the risk assets is very interesting. Those of us who have been bitcoiners for a long time have always expected at some point it would start to behave as the true insurance asset against systemic collapse. I don't know if this incident is the "big one", it's plausible that the "big one" happens tomorrow or 20 years from now we don't really know. But it's clear that the underlying traditional financial system is unstable and it has a huge maturity mismatch and the Fed is stepping in to make up for the difference with its balance sheet. QT is over, QE is back, it's potentially going to be very big. The more banks fail, the more the small banks fail, the bigger the balance sheet at the Fed is going to have to be. The fact that bitcoin is up 30% this week alone is awesome because it's flying in the face of what bank regulators are trying to do which is to try to kill crypto and it's only making bitcoin stronger. Nic and I have seen this before in the previous de-banking wave in 2017-2018. That was the time when tether took off; necessity was the mother of innovation. It was a real innovation in terms of a new US dollar payment rail. It's pretty clear that the Fed doesn't like it and took aim at all the private stablecoin issuers. They haven't yet taken aim at tether and maybe tether gets the last laugh for trying to deliberately stay off shore. I don't know, let's see what happens.

Nic: I think my big takeaway from this of course Arthur Hayes came out with an article this morning saying this new facility proposes up to $4 trillion dollars from the Federal Reserve which is larger than the total COVID stimulus so obviously massive change in the positioning there. It's clear that QT is over and the Fed is in a stance now where they realize they have to provide liquidity or else the banking system will utterly collapse. So the safety of the US banking system has been called into questions and depositors are now doing the estimation and analysis: are these liabilities mine or are they someone else's? Moving to the neww regime from the old regime- is it someone's liability or is it genuine money unto itself like gold or bitcoin? The interesting thing for me is bitcoin's divergence from the rest of the crypto market. It's a true most sound monetary protocol and it's ripping. The rest of the market is doing okay but lagging. Stablecoins as well. Previously crypto folks thought that stablecoins were awesome collateral but ultimately they were someone's liability and it depends on what's happening at the underlying banks. Stablecoins as good as they are, they are not that ultimate "no one's liability" asset. Bitcoin with all its warts and issues and this regime where we enter a global full blown banking crisis is one of those ultimate assets and arguably the best one because gold is still typically custodied with a third party. People are now revising their views around where they are storing their wealth. Bitcoin as a wealth store has done extraordinarily well in this environment and the price action has been very validating for what bitcoin is and what it aims to be.

Mikel: We all have been de-sensitized when it comes to large numbers coming out of the Federal Reserve. $300 billion dollars- this is a quote from a chief economist at JP Morgan- this was about half of what was extended to banks during the GFC (great financial crisis). So only one week in and we just did about half of what we did in the GFC. Just something to consider as we end this interview. This has been eye opening for me and I'm sure for the listeners as well.

Caitlin: I am on twitter and linkedin and nostr, working at Custodia Bank.

Nic: Everything for my corpus is at niccarter.info. Thank you.