An Insider Blows the Whistle on How the Fed Has Allowed Crypto to Invade Federally-Insured Banks

[Gunnar Larson]

https://wallstreetonparade.com/2022/12/an-insider-blows-the-whistle-on-how-the-fed-has-allowed-crypto-to-invade-federally-insured-banks/


By Pam Martens and Russ Martens: December 14, 2022 ~

Federal Reserve Building in Washington, D.C.
Federal Reserve Building in Washington, D.C.

Katie Cox worked for the Federal Reserve for 32 years, the last two decades
of which were spent overseeing complex proposals for bank mergers. She left
the Fed in 2020.

Last Wednesday Katie Cox penned a shocker of a column for American Banker.
She opened with this:

“Suppose you’re a crypto company that wants to own a bank approved to
engage in digital-asset activities. Here’s the fast-track way you might
achieve that, while complying with rules in place since August: Go buy a
bank, any bank. Convert your bank to a Federal Reserve member bank, meaning
that your bank’s federal supervisor will now be the Fed, not the Office of
the Comptroller of the Currency or the Federal Deposit Insurance Corp. Wait
a little bit, maybe six months. Then send the Fed a letter notifying it
that your bank is going to engage in digital-asset activities and that you
have determined the activities your bank will conduct are permissible.
Promise that you will soon establish a risk management framework to manage
this complex new business. If you’re lucky, your bank won’t be examined for
a year or two. By then, you might have cranked up quite a dumpster fire.”

Cox goes on to explain that she’s not recommending this as a strategy, but
simply stating that crypto outfits have found a clever means of engaging in
regulatory arbitrage. It should also be noted that Cox did not write this
column out of an altruistic bent. She is one of a legion of former federal
regulators that now work for crypto outfits. Cox now works as an advisor to
Custodia Bank, a new applicant for Fed membership that wants to engage in
crypto activities. According to Cox, new Fed applicants have a more
difficult time than simply taking over an existing Fed member bank.

The August 16, 2022 rules put in place by the Fed are known as SR 22-6 and,
indeed, leave it up to the bank to notify the Fed and have adequate risk
management systems. But the Fed uses the word “should” do this or that
throughout this rule instead of “must.” Lots of dumpster fires have ensued.

The Fed also makes this statement in rule SR 22-6: “Given the heightened
and novel risks posed by crypto-assets, the Federal Reserve is closely
monitoring related developments and banking organizations’ participation in
crypto-asset-related activities.” Monitoring is, clearly, not the same
thing as policing.

Twelve days after the disgraced and corrupt crypto exchange, FTX, filed for
bankruptcy, the New York Times ran this headline: “Crypto Firm FTX’s
Ownership of a U.S. Bank Raises Questions.” The article explains that a
tiny bank in Washington state, Farmington State Bank (also known as
Moonstone Bank), had received an ownership stake of $11.5 million from
FTX’s sister firm, Alameda Research, which at the time was twice the net
worth of the bank. The Federal Reserve is the primary regulator of
Farmington State Bank according to regulatory filings.

Sam Bankman-Fried, who was indicted on eight criminal counts by the U.S.
Department of Justice yesterday, is the majority owner of both FTX and
Alameda Research, the hedge fund he operated as a personal piggy bank using
customer deposits from FTX. Attorney General Merrick Garland had this to
say about Sam Bankman-Fried yesterday:

“We allege that the defendant conspired to defraud customers by
misappropriating their deposits; to defraud lenders; to commit securities
fraud and money laundering; and to violate campaign finance laws. As this
indictment demonstrates, the U.S. Department of Justice will aggressively
investigate and prosecute alleged criminal wrongdoing in the financial
system and violations of federal elections laws. We will continue to work
to ensure U.S. capital markets operate honestly and with the integrity that
investors, lenders, and the American people are entitled to.”

The American people are the taxpayers that are now picking up the tab for
the Justice Department, the Securities and Exchange Commission, the
Commodity Futures Trading Commission and a multitude of state regulators to
investigate what appears to be a global fraud perpetrated by FTX and its
affiliates. That the alleged kingpin of this fraud, Sam Bankman-Fried, was
so easily able to obtain an ownership stake in a federally-insured bank
means the Fed needs to move beyond “monitoring” the banks it oversees and
into the aggressive role of cop on the beat.

Farmington State Bank is not the only bank whose primary regulator is the
Federal Reserve and that is feeling the fallout from the collapse of FTX.
Silvergate Bank is also primarily supervised by the Fed and experiencing a
mountain of pain. Its publicly-traded parent, Silvergate Capital Corp.
(ticker SI), closed at $148.20 on December 31, 2021. The stock closed
yesterday at $18.73, a decline of 11.9 percent on the day and a plunge of
87 percent year-to-date.

That’s not the kind of performance that breeds confidence in the safety and
soundness of U.S. banks and how they are supervised by the Fed.

Silvergate Capital’s 10-K (annual report) for the year ending Dec 31, 2021
states that “Deposits from digital currency exchanges represent
approximately 58.0% of the Bank’s overall deposits and are held by
approximately 94 exchanges.”

Approximately $1 billion of those deposits at Silvergate Bank came from FTX
– meaning that this federally-insured bank has now brought – at a minimum –
serious reputational damage on itself and its wimpy cop, the Federal
Reserve.

Two Senators who sit on the Senate Banking Committee are taking serious
note of this situation. Senator Elizabeth Warren (D-MA) and Senator Tina
Smith (D-MN) sent a letter last Wednesday to Jerome Powell, Chair of the
Federal Reserve; Martin Gruenberg, Acting Chair of the Federal Deposit
Insurance Corporation; and Michael Hsu, Acting Comptroller of the Office of
the Comptroller of the Currency. The letter seeks answers on just how far
crypto has encroached into the federally-insured banking system.

In the letter to Fed Chairman Powell, the Senators write:

“While the banking system has so far been relatively unscathed by the
latest crypto crash, FTX’s collapse shows that crypto may be more
integrated into the banking system than regulators are aware. To better
understand the scope of the banking system’s exposure to the crypto
industry and how banking regulators currently assess crypto-bank
relationships, we ask for answers to the following questions no later than
December 21, 2022.”

Question number three from the Senators demonstrates just how little
information Congress has been provided about the encroachment of potential
crypto scams into the federally-insured banking system. That question reads
as follows:

Please specify the number and names of banks regulated by your agency which
are currently engaged in the following activities:
a. Providing cryptocurrency custody services.

b. Holding dollar deposits for crypto-related firms. Of those banks, please
specify the number and names of banks that hold dollar deposits as reserves
backing stablecoins.

c. Acting as nodes to verify customer payments.

d. Facilitating stablecoin payment transactions.

e. Providing loans to crypto-related firms. (Of those banks, please specify
the number and names of banks that accept digital assets as collateral for
loans.)

Under the rubric of innovation, Wall Street came close to collapsing the
U.S. financial system in 2008 with its “innovative” synthetic derivatives,
Structured Investment Vehicles (SIVs), and subprime securitizations. Today,
dozens of members of Congress have invoked “innovation” to justify allowing
crypto to run amok in our financial system.

But more than 1,600 of the best scientific and software minds say both
crypto and blockchain are shams. It’s time for Congress and federal
regulators to find a backbone and competently deal with this
confidence-draining mess.
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