Stablecoins, Money-Market Funds and the S&L Crisis
Lightly regulated new financial instruments can have serious consequences if lawmakers and regulators aren’t careful.
By Thomas P. Vartanian
Photo: dado ruvic/ReutersCelebrations over the recent passage of the Genius Act should be muted.
It institutionalized cryptocurrencies in the U.S. by creating the first comprehensive regulations for stablecoins.
But all too often when Washington lets new financial products on the scene, they aren’t adequately regulated and quickly gain an advantage over existing financial instruments that are more heavily policed.
Market convulsions, economic downturns and bank failures follow.
I watched it happen when money-market funds burst into the market in the 1980s, bringing banks to the brink of insolvency.
Stablecoins could do the same thing.
I was in the room in the 1980s, when Congress and financial regulators struggled to find a way to allow money-market funds to coexist with banks.
Markets didn’t cooperate and Washington acted too slowly to stop disaster.
While the government had long ago capped the interest banks could pay depositors at 5.25%, money-market funds could offer whatever the market demanded.
When interest rates and inflation hit double digits, depositors rightfully shunned banks to earn 12% in a money-market fund.
While the Genius Act prohibits stablecoin issuers from paying interest, it doesn’t explicitly stop crypto exchanges and other intermediaries from doing so.
If Congress and regulators aren’t eagle-eyed, exchanges have plenty of incentive to try.
A report from the Treasury Department in April estimated stablecoins could lure $6.6 trillion in deposit outflows.
That could cause the sort of disaster I witnessed 40 years ago.
Between 1979 and 1989, money-market funds grew more than 20-fold, sucking deposits out of the banking system which would have otherwise been converted into loans for homes, cars and businesses.
The securities firms offering money-market funds benefited from a regulatory ambiguity as similar to the one that now affects stablecoins.
While securities companies weren’t allowed to take deposits, there was no clear rule about money-market funds.
Scrambling to clean up this financial mess, Washington debated whether it was better to even the playing field by capping money-market interest rates or by eliminating depositor interest limits entirely for banks.
Bank regulators chose the latter as a matter of practicality and persuaded the securities, mutual-fund and money-market-fund industries not to oppose legislation—in part by holding over the heads of securities firms the threat of Justice Department criminal prosecution for unlawfully soliciting deposits.
At the Office of the Comptroller of the Currency in 1979, I drafted portions of the law that would eventually become the compromise the banks needed.
While this legislative process played out, the Justice Department issued a letter in 1979 concluding that those who invested in money-market funds could be considered owners of a financial instrument rather than creditors of an institution, as bank depositors were.
Money-market funds got the legal pass they needed, and three months later the Depository Institutions Deregulatory and Monetary Control Act became law, delegating to a newly formed Depository Institutions Deregulation Committee the job of phasing out interest rate caps on banks and savings and loans.
Exactly a year later, when I became general counsel of the Federal Home Loan Bank Board and the Federal Savings and Loan Insurance Corp., my first task was to help implement this new act.
I attended Depository Institutions Deregulation Committee meetings where the heads of the financial agencies argued over various interest rate deregulation plans.
Ultimately, the committee eliminated the interest cap in months because of the relentless deposit drain on the banks.
That only triggered a new crisis.
Some banks could adapt to the dramatic increase in interest they had to pay depositors because business loans were typically short-term with interest rates adjusting according to market conditions.
But the regulatory change immediately locked savings and loans into a death spiral.
They had no option but to borrow short by paying depositors interest of about 12% and lending long through 30-year fixed-rate home loans.
That created an average negative spread of about 5% between what S&Ls earned on their mortgage portfolios and what they paid depositors.
About 1,400 S&Ls collapsed over the next decade, as did the U.S. housing market, which relied almost entirely on S&Ls to finance mortgage loans.
Some 1,600 commercial banks would also fail as the country settled into a deep recession.
As regulators, we made mistakes in the 1980s, and unfortunately the same mistakes are being made again.
We waited too long to act, became infatuated with new products to the detriment of safety and soundness, fought too much among ourselves, and ceded too much control of the economy to the Federal Reserve’s war on inflation.
Frankly, we underestimated how much money-market funds would alter the nation’s flow of liquidity and capital formation.
We were doing a lot of guesswork under great pressure with limited data to assist us.
If we learned anything from the era, it is that Washington must continually adjust regulation on new products to be functionally symmetrical with banks’ limits.
People who create, sponsor or transfer money and investments should be required to meet high standards of integrity and financial knowledge.
The system can’t tolerate any more Sam Bankman-Frieds.
And policymakers must be armed with better resources, artificial intelligence and more-reliable data so that they fully understand how changes in market structures will impact traditional trusted intermediaries and the economy they support.
At some point cheering innovation must give way to a balancing of the benefits with the new financial risks.
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