A buzzy new financial player, once thought invincible, nearly collapses due to poor management and reckless bets gone wrong. Congress holds hearings. Regulators offer measures to limit speculation and increase disclosures and oversight. But the industry calls this approach burdensome and harmful to investors. An industry champion makes a case for a lighter touch regulatory approach and succeeds.
This scenario, plucked from the 1990s derivatives industry, has eerie parallels to today, as the House considers cryptocurrency legislation. The Financial Innovation and Technology for the 21st Century Act, the industry claims, will foster innovation while protecting consumers. But we should fear a repeat of the past — a bill that fosters weak regulation for crypto and undermines investor safeguards.
In the 1990s, the firm was Long-Term Capital Management, a hedge fund. In 1998, the firm nearly collapsed due to a series of bad trades that cost it $4.6 billion. To avoid contagion, the New York Fed and private firms stepped in with a cash infusion. Congress then held hearings, a presidential working group studied the issue, and Treasury came up with regulatory ideas for the esoteric financial products that brought down LTCM, known as swaps and over-the-counter derivatives.
But then there was a changing of the guard.
Lawrence Summers, notably, replaced Robert Rubin as Treasury secretary. Suddenly, the word was that derivatives and swaps should be less regulated. Summers argued that “these products have transformed the world of finance” and that “a cloud of legal uncertainty” over the industry could “discourage innovation and growth…driving transactions offshore.”
Soon after, Congress approved his recommendations, and then-President Clinton signed a deregulation bill, the Commodities Futures Modernization Act. As one expert later put it, “Although many factors contributed to the financial meltdown of 2008, it is now almost universally recognized that principal among them was the collapse of the unregulated swaps market.”
The parallels between this old crisis and crypto today are striking. Sam Bankman-Fried courted acclaim from the media, celebrities and Congress right up until his firm FTX collapsed in scandal. Congress then held hearings expressing outrage and calling for reform. Quickly, the crypto industry recalibrated, claimed FTX was an outlier, and insisted that the real problem was onerous regulation and legal uncertainty stemming from the Securities and Exchange Commission, led by Gary Gensler, who was stifling crypto innovation and driving economic opportunities offshore.
Echoing the 1990s, Summers even made a cameo as a paid adviser to crypto firms, touting crypto’s economic potential, despite his past questionable calls.
This crypto bill is the brainchild of the industry’s lobby and its friends in Congress, and it shows. The bill uses a murky definition of crypto’s decentralized technology to legitimize risky industry practices. It gives primary regulatory authority over crypto markets, via a rubber-stamp self-certification process, to the Commodity Futures Trading Commission, an underfunded and understaffed agency that lacks a retail investor protection mandate.
Until the bill’s rules are established, the bill exempts crypto firms from ongoing regulatory enforcement actions. It does all this at the expense of SEC oversight and its more robust investor protections. What little SEC oversight that remains is watered down, such that even online crowdfunding schemes for raising capital would receive more oversight than many crypto firms.
The bill’s worst feature rewrites longstanding securities law for crypto’s benefit by exempting a large set of crypto products from the definition of “security” in the SEC’s authorizing law, even though many crypto products clearly are securities and should be regulated as such. This loophole would erode key protections for crypto buyers and create a roadmap for traditional Wall Street firms to evade existing rules, which could further fuel risky speculation and harm a wider array of investors, even if they never touch crypto.
Will Congress remember the lessons of the 1990s? Some view this vote as mostly about seeking favor from (or avoiding the ire of) crypto super PACs fueled by a few Silicon Valley billionaires who stand to gain, and who are promising to spend tens or even hundreds of millions of dollars this election cycle. Others genuinely want to protect crypto investors but aren’t sure how. Many know little about crypto or financial regulation in general and are being told that this bill is a step forward. But it’s a recipe for trouble.
Policymakers need to take this seriously and stand up for the public interest. There may be a crypto regulatory proposal that strikes the right balance, but this isn’t it. Instead, this bill could sow the seeds of a new financial crisis. If members of Congress don’t want their vote to be the first chapter in the history of that crisis, they should vote against this bill.
Mark Hays is senior policy analyst at Americans for Financial Reform and Demand Progress.
