Regulations can 
Seem inefficient and strict 
But sometimes they work

“There’s no one really out there making sure good things happen and bad things don’t. $%#@ regulators. They make everything worse. They don’t protect customers at all.”

- Sam Bankman-Fried, Former CEO of FTX

Less than one month ago, Sam Bankman-Fried, known colloquially as SBF, was worth somewhere between $16-24 Billion. Or at least it looked that way on paper.

Today, SBF has a net worth of zero. My fourteen year old daughter, who may or may not be $20 richer this week depending on whether or not she finishes her chores, literally is worth more money than the guy who bought the naming rights to the Miami Heat’s arena in March 2021.

How did this happen? I’m still wrapping my head around all of it, but here’s what I’ve picked up so far:

As the CEO of FTX, SBF became a darling of the tech/crypto/alt-finance/young-billionaire crowd. His exchange quickly amassed a fortune through crypto arbitrage. SBF would buy crypto currency in one market, for example Canada, and then sell it for a substantial profit due to pricing differences in another market, for example Japan.

Bankman-Fried repeated this process over and over until FTX, and SBF himself, were worth billions of dollars.

But then…

Bankman Fried also had a Hedge Fund, called Alameda Research. It turns out FTX was lending money out money to Alameda Research to fund risky financial bets. In addition, some money wired to Alameda had been intended as an investment in FTX. The wire to Alameda was simply a way around regulatory restrictions preventing some people from investing in FTX directly. This was like catching a flight to Havana through Mexico to get around travel restrictions in the USA.

But those wired funds, roughly $8 billion-worth, never ended up in FTX.

FTX succumbed to the same problem that ruined the financial sector in 2008, and in the Great Depression – it was over-leveraged.

To make Alameda look good on paper, FTX invented a coin called FTT, which was really worth nothing. It then stuffed Alameda Research with FTT, making it look like Alameda had healthier financials than it really did.

All of this came to light when Binance, a rival crypto exchange, was examining FTX’s books as part of a buyout offer. Binance pulled out of the deal when it saw the nonsense in FTX’s accounting. When Binance pulled out, FTT investors en masse sold their coins for dollars. They wanted their money back. The trouble was the money wasn’t there. It had been lent out.

Overwhelmed by calls for cash it couldn’t raise, FTX filed for Chapter 11 Bankruptcy and SBF stepped down as CEO. The attorney who has taken over FTX as part of the bankruptcy, John Ray III, was also the lawyer who presided over the Enron bankruptcy. He has called FTX’s financials the worst he has ever seen.

Crypto currency has been hailed as the answer to regulatory over-reach and intractable inefficiencies within our Federal Reserve-based financial system. We all experience these inefficiencies when we have to pay a $25 fee to wire money somewhere, and have that wire take three days to go from your account to where it is going. Crypto gets around that and allows, for example, people in the United States to instantly send millions of dollars’ worth of crypto currency to Ukraine to help in their war effort.

But the price of this lack of regulatory framework is a relatively unrestricted capacity for people – some of whom may have good intentions at one point – to succumb to greedy impulses. Bernie Madoff, for example, was a legitimate and successful investor, until he wasn’t.

It is fascinating to me that, despite the technical leaps forward represented by cryptocurrency, FTX collapsed by the same mechanism that caused 9,000 banks to collapse during the Great Depression: a bank run.

In response to the Great Depression, the United States government created FDIC insurance so that bank customers could more easily trust that their cash was safe at a bank. It also created the Securities Act of 1933, the Securities Exchange Act of 1934 (which created the SEC), and eventually the Investment Company Act of 1940, which gave us mutual funds, and the Investment Advisors Act of 1940, which created rules around how financial professionals interact with customers.

Did all of this stop recessions from happening? No. We have Dodd-Frank now because of the Great Recession of 2008, which cost the global economy $30 trillion.

However, consider the following chart (from a 2019 paper on predicting recessions):

The gray areas indicate periods of recession or depression. Do you notice the difference between pre-1933 America and post-1933 America? The frequency and duration of recessions are both dramatically less.

What does all of this mean for those of who aren’t billionaires? What about people who are managing work and retirement and hoping, in some cases, to leave a legacy behind?

One interpretation, and the one I prefer, is that it means that the US financial system mostly works. Crypto currency and any other unregulated investment may seem appealing because they hold the potential for life-altering wealth creation. However, they can also reduce a healthy balance sheet to ashes. “Move fast and break things” sounds cool, except when the broken thing is you.

This episode also reveals one of the hidden benefits of recessions: they expose overly-risky, empty investments and burn them from the landscape like a wildfire. When was Bernie Madoff exposed? During the 2008 Financial Crisis. 2008 also revealed how many major financial institutions had over-invested in subprime mortgages.

Stocks, bonds, mutual funds, ETFs, annuities, life insurance, and all of the other regulated instruments within the American financial system can seem boring by comparison. But they work, and in some cases – like a CD backed by FDIC insurance or a Series I Bond – have guarantees of safety.

A 20 year-old investor earning a decidedly unsexy average return of 7% in an account where he or she is contributing a modest $500 per month may, over time, see account values that look like this:

Year 10: $86,542.40
Year 20: $260,463.33
Year 30: $609,985.50
Year 40: $1,312,406.70

The above returns might be less fun, and take a lot longer, than buying a new digital currency and watching it skyrocket in price in a matter of days, but for most people, these returns would probably be enough.

If you want to know what instruments within our financial system might help you on your journey to having your version of Enough, or if you want to talk about how find out what your Enough looks like, we’d love to hear from you.