“It's hard to punish and save the banks at the same time.” – Henry Paulson
After a frenzied weekend of tense and complex negotiations between senior leaders of the US government and the CEOs of the big Wall Street banks produced no viable alternative path for Lehman Brothers, the company filed for bankruptcy on Monday, September 15, 2008. The filing set off one of the most memorable weeks in the history of finance. Concurrent with the failure of Lehman was the forced sale of Merrill Lynch to Bank of America, a move so rushed and dramatic it’s incredible to think it was the second most important headline on that fateful day.
In a rare public appearance at the White House later that afternoon, then US Treasury Secretary Henry Paulson assured the nation that this crisis would pass, that he never considered bailing out Lehman using public funds, and that Wall Street would have to fix its own problems – there would be no further bailouts. The very next day, the government would bail out American International Group (AIG), an insurance giant with nearly $1 trillion in assets.
What started as an $85 billion loan-for-equity injection eventually ballooned to a total commitment of $182 billion, and while AIG ended up paying the government back in full plus a profit over the next several years, the episode is mired in deep controversy. The bailout of AIG was actually a bailout of the rest of Wall Street, as the company became a vessel through which public funds were used to make AIG’s powerful counterparties whole, thereby stemming the financial crisis. Among the biggest beneficiaries was none other than Goldman Sachs, the investment-bank-turned-bank-holding-company-so-they-too-could-get-a-government-bailout (and Paulson’s prior employer – he left the position of CEO of Goldman to join the Bush administration, perhaps motivated in part by the massive tax loophole he was able to exploit by doing so).
Within days of the AIG bailout, Paulson championed and helped shepherd through Congress the Troubled Assets Relief Program (TARP), a massive $700 billion bazooka full of money designed to inject confidence into the banking system. It was an unthinkably high number for the time. Paulson famously quipped, “If you've got a bazooka, and people know you've got it, you may not have to take it out.”
Conflicts of interests aside, the dangerous precedent was set. Over the next decade, authorities merely postponed a true (and necessary) financial reckoning, blew giant holes in the nation’s fiscal and monetary balance sheets, planted the seeds of the epic bubble currently deflating in the markets for risk, and shattered the belief – however tenuous it might have already been prior to that fateful week – that the American financial system was fair with risks accepted by those that take them. This belief was firmly decimated by the fact that only one top banker went to jail as a result of the global financial crisis of 2008-2009. By the time the 2019 repo crisis unfolded, the Federal Reserve didn't bother with the need for pesky legislation to assume they could bail out Wall Street once again. This time, even the names of which institutions were saved by the funds have largely been kept from the public. Nothing shall stand in the way of socializing Wall Street’s losses. That genie is well and truly out of the bottle.
In parallel to the historic events unfolding in the fall of 2008, a mysterious character known as Satoshi Nakamoto was working on the development of Bitcoin. Motivated by what he and many others believed to be the ongoing collapse of the financial system, Satoshi published his famous Bitcoin white paper less than a month after the TARP legislation was passed. Here’s how the abstract to that paper begins (emphasis added throughout):
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending.”
Fast forward 14 years. An eerily similar and somewhat ironic replay of the global financial crisis is unfolding in the universe of digital currencies. After the total value of all cryptocurrencies reached an apex of just under $3 trillion last November – of which Bitcoin accounted for roughly $1.3 trillion – a rolling crash of epic proportions has wiped out more than two-thirds of that digital wealth. For crypto, however, there is no central bank standing by willing to bailout those who are caught up in the contagion. In many ways, we are observing in real-time what would have occurred on Wall Street if the concept of “too big to fail” hadn’t come to dominate our corrupt political discourse and AIG had been allowed to collapse. How will the crypto crash continue to unfold, when will it be over, and what is to be made of the assets and technologies that survive this crisis? Let’s dig in.