Dennis Kelleher, who heads the financial watchdog group Better Markets, has long been pushing for tighter Wall Street regulation. In the following conversation with the Institute for New Economic Thinking, he explains why the reckless activities of under-regulated and under-supervised big banks unfairly harm the smaller banks Main Street depends on – leaving regular people to pay the price. A vocal crypto skeptic, Kelleher, whose organization was offered a million-dollar bribe by FTX to help it escape regulatory oversight, warns that the industry has “no legitimate or socially useful purpose” and that people who believe its cheerleaders are at great risk from a “fundamentally predatory business model.”

Lynn Parramore: Do you see the failure of First Republic and the ongoing concerns about several regional banks as signs that the crisis that started with Silicon Valley Bank back in March is more severe than many hoped?

Dennis Kelleher: The problems in the banking system that initially burst into public consciousness when Silicon Valley Bank collapsed really include a number of financial institutions, both on the bank and the non-bank side. Some were hoping that the relatively quiet period after Silicon Valley Bank and Signature Bank were rescued by the FDIC was going to mean that everything was great, but anybody who understands the economic, banking, and financial systems should know that when something happens in one part of the financial system, it almost inevitably reverberates in other parts. As soon as Silicon Valley Bank collapsed, a number of other, similar-sized banks came under deposit flight pressure and revealed some of the weaknesses and fragility that were going to have to be addressed at some point.

LP: Wall Street and Main Street appear to be experiencing this crisis differently. How do you view that difference?

DK: It’s important for people to remember that there are really three broad categories of banks. There are the largest Wall Street banks — JP Morgan Chase, Goldman Sachs, Citi, Morgan Stanley, Wells Fargo, etc. — which tend to do fine because they’re either explicitly or implicitly backed by the federal government — and ultimately taxpayers. Then there are large banks like Silicon Valley Bank and First Republic. Then there are all the other banks.

There are about 5,800 banks in the United States. Only about 35 banks have more than $100 billion in assets. It’s the other 5,765 banks that really are the jet fuel for much of Main Street America. Those are the banks that provide about 40% of all small business loans and somewhere in the same range of commercial and industrial loans, as well as many mortgages. They know their communities. They sponsor the Little League team and finance the local auto dealer, the local hardware store. They finance Main Street families looking to buy a home or to get a student loan to help put their kids through college. And of course, people often use them for investment vehicles to save for retirement.

It’s these banks that we really need to worry about. They are getting unfairly harmed by the large and the largest banks, which are undertaking too much risk. Inevitably, credit is going to become more expensive, not just because of what the Fed is doing by raising rates, but also because banks, in response to what they see happening at Silicon Valley Bank, First Republic, and other banks, get tougher on their underwriting standards and their credit scrutiny.

One of the largest financial institutions in the country estimated that there will be something like half a percent drop in GDP over the next 12 months just because of the tightened lending standards across all banks as a result of the crisis that started with Silicon Valley Bank. Unfortunately, that’s the best case. I don’t even want to think about the worst case.

The so-called Too Big to Fail banks are still too big to fail. Everybody knows they’re going to get bailed out by the government if they get into trouble. The problem is that when depositors worry about other banks that aren’t Too Big to Fail. Unfortunately, like in 2008, Wall Street does well, but Main Street suffers, paying the price for banks taking risks without getting the benefits of the risk-taking that caused the crisis.

LP: People think, uh-oh, this bank is too small to save, so I better get my money out.

DK: Right. The smaller banks don’t pose a threat to the entire financial system, so the government and regulators let them fail. Because of that, depositors take their money out and move them into the biggest Wall Street banks. It’s completely unfair to the entire banking system – doubly unfair because it disproportionately hurts Main Street families and businesses. The thousands and thousands of community banks, which are not Too Big to Fail, actually supply the credit and the lending and the financial services to vast areas of the United States that are not serviced by the Too Big to Fail banks on Wall Street.

Community banks are victims of this double standard that the government perpetuates by allowing these gigantic banks to remain Too Big to Fail because they threaten the economy and the financial system. That’s what caused the big crash in ’08. It’s also important to remember that Silicon Valley Bank didn’t collapse because it made a bunch of bad loans.

LP: So why did it collapse?

DK: Silicon Valley Bank collapsed because it engaged in incredibly high-risk, reckless, irresponsible, and maybe even illegal conduct that was mostly done so that executives could juice their bonuses. You have to follow the money. If you see the executives getting inordinate returns — huge pay packages – that’s a red flag because those packages get bigger and bigger based on the size of the risks those executives are willing to take. But the downside of those risks gets stuck on taxpayers and other communities. That’s what we’re seeing now. The FDIC’s loss on Silicon Valley Bank is estimated to be around $20 billion. It will probably end up being a little bit less, but that’s a lot of money – and that’s only the direct cost. The indirect cost is this ripple effect that rips through the rest of the country and impacts Main Street families and Main Street economies in a way that’s just irresponsible and wrong.

LP: The government signals on the one hand that they won’t let banks go bust, but on the other hand, they won’t do 100% deposit insurance because of the moral hazard problem. How do we deal with this conundrum?

DK: The way to deal with it is to regulate and supervise the banks so that they are not a threat to the financial system and the economy – and to do that before you have a crisis. The problem that we’ve had, starting with the Trump administration, is pretty significant deregulation and under-supervision of these large banks. It was a very conscious policy of the Trump administration. He appointed regulators, including Jerome Powell, the chairman of the Fed, and others, with the express intent for them to deregulate the large and largest banks in a way that actually incentivized them to take greater risks.

My organization, Better Markets, engages in the rule-making process and represents the public interest in that process. Throughout the Trump administration, we were at the Fed, which enacted more than 20 rules that deregulated the large and largest U.S. banks. We said at the time, in 2017 through 2020, that the deregulation was going to lead to reckless conduct that would result in bank crashes and crises. What is happening was predictable, foreseen, and talked about in real-time during the Trump administration. We said that the inevitable result of deregulating banks and bankers is that they take more risks and those risks, when they materialize, will threaten the financial system and economy, which leads to these bailouts.

LP: How does the current situation compare to 2008?

DK: It’s not the same as the big crash of 2008, but the drivers of it are very similar, and the consequences, although on a smaller scale, at least thus far, are remarkably similar. None of this is a mystery. If you tell anybody, I don’t care if it’s a 5-year-old kid or a 55-year-old banker, that they can get unbelievably large rewards if they just take risks, and they don’t get the downside, what are these people incentivized to do? To take risks. That’s the situation we now have after four years of the Trump administration deregulating the banks and the financial sector broadly. We have way too much risk in the system, way too little regulation, and not enough supervision — and I’m really talking about the 35 or so banks that have more than $100 billion in assets, since the other 5,765 are regulated pretty well, and conduct their business responsibly for the most part. Yet they’re paying the price once again.

LP: What is the current administration doing to actively address the problem? Are they getting anywhere?

DK: The current administration came into office with the intent to roll back some of the irresponsible actions taken by the Trump administration. But Republicans in Congress, and particularly in the Senate, specialize in obstruction. They have delayed the consideration and confirmation of some very key regulators, including the most senior and important regulator at the Fed apart from the Chair. He didn’t even get confirmed until last August. That position should have been filled more than a year ahead of time, but the Republicans in the Senate — unfortunately with some help from a Democrat or two — prevented it.

On the other hand, there are other appointees, particularly at the SEC, who have done a very good job, working overtime since they got into office in 2021, to address some of the deregulation, risk, and irresponsible conduct in the market. It’s taken too long, but they’re doing it. However, when you have a financial system that was deregulated and you’ve turned the incentives upside down, you really don’t have the luxury of time.

Unfortunately, things have gotten worse now due to a divided government. With Republicans in charge of the House, they’re back in the business of trumpeting and cheerleading the Wall Street wish list of deregulation. It’s so bad that, notwithstanding the irresponsible and illegal behavior in the crypto industry, they’re even cheerleading the crypto industry!

LP: Let’s talk about crypto. Some have been saying that crypto is dead now, but as you point out, there are lots of people still pushing it, including politicians. Can you explain the relationship between crypto and the banking crisis?

DK: The entire crypto industry is, by choice and design, a largely lawless industry. It’s built on what they want to claim is a financial innovation — but it’s not really an innovation. It’s just a new version of what the financial industry has been doing for decades and decades, which is coming up with different ways to offer and sell financial products that are either securities or commodities.

Yet the crypto industry is claiming, oh, no, we’re not a security and commodity! We’re special, new, and unique, and we want special, new, and unique treatment and laws. What they really want is as few regulations and laws as possible so they can use what is fundamentally a predatory business model to rip people off. One of the reasons we don’t have an even worse financial crash right now is because the banking regulators and other regulators have done a pretty good job of preventing crypto from getting interconnected with the core of the banking system. Up until now, the crypto industry has really been running parallel to the core of the legitimate financial system and it has not been interconnected — certainly not as much as the industry has been attempting to do over the last several years.

The problem is not just a lawless industry, but a lawless industry that’s making a lot of money and using hundreds of millions of dollars in campaign contributions and lobbying to buy elected officials and other allies, like academics, trade groups, and the media. They’re engaged in a massive lobbying campaign to get their special interest put above the public interest. Nothing illustrates that more than the fact that crypto lost around 80- 90% of its value in less than a year, and the marquee names in the industry have turned out to be frauds or criminals. Given that, it should have been consigned to the dustbin of history, but yet you have all these elected officials, almost entirely, but not only Republicans, cheerleading the industry, including, just recently, criticizing regulators for protecting investors, consumers, and the financial system. It’s hard to understand but for the amount of money they have spent to capture Washington, to hijack the agenda, and to elevate their special interests above the public interest.

LP: Why is crypto so dangerous to the public interest, to ordinary investors?

DK: The crypto industry is engaged in the offer and sale of securities and commodities, but they don’t want to follow the rules and laws that apply to every other legitimate business in the United States when they offer to sell securities and commodities – the core investor, consumer, and financial stability protections. So, for example, if you want to be a broker-dealer or a clearing house or an exchange that deals in securities and commodities in the United States, you have to register with the CFTC or the SEC. You have to file periodic reports. They come into your business to make sure that you are doing things like keeping customer assets segregated, that you are not misusing customer assets.

LP: Sam Bankman-Fried didn’t seem to be following these protocols.

DK: Exactly. FTX’s and Sam Bankman-Fried’s criminal enterprise show the rot at the core of the crypto industry. In one business unit, they want to have an exchange, a broker-dealer, a clearing house, a hedge fund, and a prop trading shop offering securities and other services to the public, but without any of the regulations to eliminate, for example, conflicts of interest, or that require them to know their customer and prevent things like money laundering. Every other legitimate financial business in the United States follows these very basic investor and customer protections, and underlying these are very important stability protections. But crypto says, well, don’t want to because we’re special, we’re different.

The only way they’re different is that crypto has been around for 14 years and has no legitimate or socially useful purpose. The only thing it has proved so far that it is good for is ransomware, money laundering, tax evasion, funding narco-terrorists and rogue states, and other illegal activities.

LP: And yet it was billed as the promise of democratizing finance. It was supposed to help regular people achieve financial equality, to allow people of color to climb the economic ladder.

DK: One of the most mendacious things crypto has done is to claim to democratize finance and, in particular, to help minorities, communities of color, and poor people get access to legitimate financial activities. The exact opposite has happened. As we have seen over and over again, for decades, when somebody is claiming to be in the business of democratizing finance, helping communities of color, and helping poor people, it’s almost always the opposite. That’s crypto. Many have lost lots of money that they couldn’t afford to lose – and that money, which adds up to billions and billions of dollars, lines the pockets of these crypto crooks. One study showed that somewhere in the neighborhood of 60 or 70% of crypto transactions are done by people with annual incomes of 50k or below. They’re being sold a marketing ploy of great riches and low risk, which isn’t true.

LP: And yet some crypto pushers are taking advantage of the banking crisis to make it look as if crypto is somehow a safe alternative to the banks, when, as you point out, not only is crypto unsafe, it actually contributes to the instability of the banks.

DK: Indeed. Silicon Valley Bank was the 16th largest bank in the United States at the time it failed, and it got most of the attention for a lot of reasons. But the other two banks, Silvergate and Signature Bank, did an enormous amount of business with the crypto industry. Silvergate did nearly all of its business with the crypto industry when it crashed and failed just days before Silicon Valley Bank. Signature Bank did a significant amount of crypto. In fact, $3.3 billion of Silicon Valley Bank’s uninsured deposits that were ultimately protected by the FDIC, which means backed up by U.S. taxpayers, were deposits from a crypto company. We don’t know everybody who was a depositor at Silicon Valley Bank, but it’s likely there were even more crypto companies than that one.

Every time you look under a predatory rock today, you end up finding some connection to crypto. It is a business that has no socially useful purpose, but it has an incredibly powerful marketing campaign and it has, unfortunately, even more powerful political allies that it’s spending unlimited money on cultivating.

LP: Some have called crypto a libertarian fantasy at its core – the delusion that you can have money without government involvement. What do you think?

DK: It’s worse than a fantasy, it’s a fraud on the public. It’s the responsibility of regulators, policymakers, and elected officials to prevent industries from committing fraud on the public — to lie to them, appeal to their dreams and hopes, and try to overcome their sensible self-protection safeguards. It’s a fundamentally predatory model. It’s really very troubling. At Better Markets, we’ve been crypto skeptics for years. We were the number one opponent of FTX and Sam Bankman-Fried in Washington. It was a very lonely place to be before FTX blew up. Then, all of a sudden, a bunch of people claimed to be against FTX who were not.

FTX bought almost everyone in Washington it thought it needed to get what it wanted. In fact, FTX even offered Better Markets $1 million or more in a bribe to support their attempt to get the CFTC to let them run a special crypto exchange in the commodity markets. We opposed them. We warned that people weren’t paying attention to the details, that crypto was predatory if not fraudulent. We now know, not just fraudulent, but in the case of FTX, criminal, apparently.

FTX and most of these other companies ultimately wanted to eliminate investor, consumer, and financial protections. If your business model is based on eliminating those protections, you are, by definition, a predator, if not a criminal. Unfortunately, people listen to this baloney that Sam Bankman-Fried was telling them about a crypto future where everybody was going to get rich and there was a pot of gold at the end of every crypto rainbow.

LP: He was going to save humanity’s future, too!

DK: Nothing like a good cover story! Sam Bankman-Fried and his team came to Better Markets to convince us to support his multiple proposals. It was in April and May of 2022 when they were really ramping up to get Washington to bend to their requests. Sam Bankman-Fried sat in my office trying to convince me what a great guy he was. We asked him a bunch of tough questions, most of which he did not have very good answers for. I said, look, to be candid, it appears to us that your business model is predatory. You are going to be enriching yourself by what’s called “autoliquidating” a bunch of people who want to invest in crypto. He kept saying, no, no, that’s not what we’re going. And I said, well, explain it to me. Then he would and I would say, well, what you just said proves that it’s a predatory model.

LP: It’s hard to get inside somebody’s head, but I wonder if he had managed to convince himself at that point that what he was saying was true. Or if it was just a straight-up con. I guess we may never know.

DK: We may never know. It’s a problem when you dangle riches in front of people, including smart, sophisticated, successful people, like some of the top-tier venture capital firms in California, which not only invested in FTX but publicly talked about what a genius this 31-year-old kid was and how he was going to usher in this unbelievable future of crypto. I don’t know who they met with or who they were listening to, but it wasn’t the guy we met with. Certainly, they didn’t do their due diligence and ask him even the most basic questions. If they did, like us, they would have quickly seen that he wasn’t some type of once-in-a-generation genius, as one of them called him. His business model was fundamentally predatory, and that should be a red flag that there are probably other things wrong under the rock.

LP: There’s been a question about who should be regulating crypto, whether it belongs under the supervision of the CFTC or the SEC. What’s the status of this tussle?

DK: One of the saddest aspects of the entire FTX/Sam Bankman-Fried saga is that they were successful in largely capturing the CFTC, and in particular, its chair, Rostin Behnam, who was basically, with Bankman-Fried, a cheerleader for FTX. He even testified, de facto, on behalf of FTX, on a bill that was written by his former boss, Senator [Debbie] Stabenow, and endorsed by Sam Bankman-Fried. Behnam endorsed and publicly proselytized for it, which was way out of character for somebody who is supposed to be the chairman of an independent financial regulator and whose job it is to protect the public.

So the CFTC has got a lot to answer for, and unfortunately, in our money-soaked Washington environment, they’ll never have to answer for it. In stark contrast, the SEC, which is an investor protection agency, has been very tough on crypto because it has prioritized protecting investors.

However, I think it’s important not to think about this too much as the CFTC v. the SEC. They have parallel missions, but they’re quite distinct. The commodities and derivatives markets in the United States and globally have certain characteristics and important social purposes. The commodity markets are vitally important to every single American because they determine the price and availability of every commodity people need every day, from cereal for breakfast to bread for lunch to gas for their car. The CFTC regulates commodity markets and derivatives, which are completely different from the equity markets and the capital markets that the SEC regulates.

They’re also both underfunded and undermanned when it comes to trying to police the vast, growing, and money-soaked industries they respectively regulate. Each one is really important. I would guess around 10% of their respective markets overlap, but they have quite distinct purposes. Some ask, why do we have so many regulators? We should just combine them. Well, here’s a perfect example where people should say thank goodness we didn’t combine them because the CFTC ended up in the tank to crypto and the SEC was an effective cop on the beat going after the crypto crooks. It’s a good case where you can say that government, even though it may be a little bit inefficient (and I would argue that it’s really not because these agencies have distinct missions) served to work in the public interest this time.

LP: Sounds like there’s reason for optimism in what you say about the SEC when it comes to the dangers of crypto.

DK: I think the public has a lot of reasons to be optimistic. The SEC has withstood enormous pressure and nonetheless has been going after the crypto crooks and predators quite effectively. But they haven’t been alone. The banking regulators have also done a very good job of keeping crypto out of the core of the banking and financial system, although it’s much less visible publicly and it’s even harder to understand in many respects. They really prevented the crypto crash of 2021 from being a huge financial crash. During the crypto crash, roughly from November of 2021 to August of 2022, crypto lost about two-thirds of its value, or somewhere around $2 trillion. If crypto had been interconnected with the banking system, you can be sure that the ripple effects throughout the entire financial system would have been serious, if not grave.

The only reason this disaster didn’t happen is that the banking regulators were very tough and policed the line between crypto and the core of the banking system. It doesn’t mean it was done perfectly, and it doesn’t mean there wasn’t some interconnection – we saw that with Signature Bank, Silvergate Bank, and others, but they really did a very good job and deserve a lot of credit for acting in the public interest. They, too, like the SEC, withstood enormous pressure – political pressure from elected officials and industry pressure. Unless you’re in Washington it’s hard to actually understand the pressure these people come under. But the banking regulators and the SEC really did an outstanding job on behalf of the public and the public interest. That’s something to be optimistic about.