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Published November 11, 2022
Before the 2008 financial crisis, trading firms began to act like shadowbanks packaging subprime mortgages into securities and distributing them throughout the financial system.
One particular trading and brokerage firm, Lehman Brothers, accumulated a risky portfolio of securities derived from home mortgages worth four times more than the company’s equity without regulators having any insight into its business. When the real estate market crashed, and homeowners began defaulting on their mortgages, the securities derived from them collapsed too. The crisis bankrupted Lehman Brothers, threatening much of the rest of the financial sector with insolvency, leading to the foreclosure of 10 million homes and a doubling of unemployment to 10%.
What just happened to FTX this week looks a lot like Lehman’s collapse for the cryptocurrency world. Earlier this week, shadowy business dealings by FTX, a crypto exchange that also acts as a brokerage, lender, and owner of a subsidiary proprietary trading company Alameda Research, came to light. As the price of FTX’s token tanked, FTX received $8 billion in withdrawal requests from panicked depositors. Without assets to back up their holdings, and no one willing to bail them out, the firm teetered on the edge of insolvency. Virtually overnight, the company’s valuation plunged from $32 billion to near zero.
It’s still too early to know if the panic will spread to the rest of the crypto world, but on Nov. 9 JPMorgan analysts wrote in a research note “that a new cascade of margin calls, deleveraging and crypto company/platform failures is starting.”
The core problem with Lehman Brothers and FTX is the same: the secrecy and lack of regulatory oversights required of traditional banks.
It’s all about risk
The financial crisis proved that the problem of banks being “too big to fail” was not about size. It was that financial risk-taking had exceeded regulators’ ability to oversee it, writes economic policy analyst Gregg Gelzinis for the Center for American Progress. In 2008, this new set of roguefinancial actors from General Electric to AIG created novel systematic risks that upended the US economy while leaving average citizens paying the bill.
