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Dr. Daniel Sutter: Lessons from the FTX collapse

Cryptocurrency exchange FTX imploded in November.  The company and its founder Sam Bankman-Fried (SBF) attained incredible notoriety in a short time and a $32 billion valuation before the bankruptcy.

Does the collapse demonstrate problems with markets or government regulation of markets?

Details continue to emerge.  I will assume that FTX was basically a scam, based on a statement by the court appointed supervisor, John Ray, who has supervised numerous bankruptcies including Enron: “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy information.”

How did the fraud occur?  Reportedly two main channels.  First, investors’ deposits with FTX were lent to Alameda Research, another SBF company, without customer knowledge or approval.  Second, FTX also issued its own cryptocurrency, called FTT, which they mostly held but purchased a small quantity at a very high price.  Based on these purchases, FTX claimed the FTT were worth billions and then borrowed against them.

Is this just the most recent incarnation of the evils of greedy capitalism?  Greed appears an inaccurate culprit here, given SBF’s advocacy of “Effective Altruism” and hundreds of millions of dollars of donations to charitable causes favored by the political left and Democratic campaigns and PACS.  Perhaps then FTX represents the evils of “woke” capitalism.

This appears like another example of a person exploiting others.  I do not consider this a “market failure,” but rather a moral failure of a specific human being.  Life would be better if con artists, swindlers, and grifters did not exist.

Swindlers create two costs: the injustice and hardship of those cheated, and the costs others must incur (including opportunities passed up) to avoid scams.  What matters is whether swindlers harm society more with regulated or unregulated markets.

Markets are voluntary; no one had to invest in SBF or his companies.  Voluntariness lets us protect ourselves.  If you have reservations about someone, invest elsewhere.  You can avoid a company even if other investors do not share your concerns.

We cannot always exhibit similar caution with government decisions.  In a representative democracy our representatives decide for us.  Our preferred candidate may not win election.  Our representative, even if quite cautious, may be on the losing side in the legislature.  And unelected bureaucrats write most financial regulations.

Furthermore, a law, regulation, or executive order does not automatically make the desired action happen (or prevent something undesirable).  Regulators must act on allegations of misconduct.  The SEC and Commodity Futures Trading Commission have both now initiated investigations into FTX; timely investigation might have prevented the swindle.

Bureaucrats ultimately are accountable to our elected representatives.  Consequently, political factors always receive consideration.  Recall SBF’s massive contributions to Democrats.  Politicians will protect their benefactors when possible.  This is not a slam against Democrats; I would expect Republicans to do the same.

Government oversight produces a lulling effect.  If people know the SEC and other agencies supposedly shut down fraudulent investments, we reasonably infer that non-shuttered companies are not frauds.  We are not as vigilant when we think someone is watching out for us.

Several House and Senate committees will hold hearings on FTX.  Can new regulations prevent a repeat?  Before FTX blew up, SBF advocated extensive government regulation of cryptocurrencies.  His proposal reportedly would have entrenched FTX in the market.

We reasonably fear being taken advantage of smart people without consciences, persons who would swindle grandmothers out of their homes and not lose any sleep.  Yet such individuals often end up writing laws and regulations.  Their swindles become loopholes or special provisions buried deep within the rules and legal.  Unregulated markets let the SBFs of the world hatch their schemes but let us not do business with him.

Good luck when SBF writes the rules we must live by.

No one deserves to be swindled.  Wicked and wickedly smart individuals may catch us in elaborate scams.  Yet their scams are more harmful when aided and abetted by government rules, including rules intended to keep miscreants in check.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision.  The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.

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