The Fed has Created a Haven for Financial Scams
The hunt for high yield and high returns is creating financial scams and claiming many victims.
First off, thank you for the 15 subscribers to my Substack. I also received a lot of praise for my piece on Medium about the coming American retirement crisis. Thanks to this my Medium follower count is up to 250+. I started writing two years ago and the growth of Armchair Banker has been astounding. Thank you all for supporting a beginner writer like myself.
I was watching Breaking Points with Krystal Ball and Saager Enjeti and this was truly a humbling episode. In this episode, Saager discusses how he lost a substantial amount of money due to having his funds in BlockFi. But what Saager was mentioning in the middle of the video caught my attention. He refers to an article on Mother Jones. In this article, the author discusses how regular people also got caught in frauds like FTX and BlockFi. Many young people, especially people aged 25 - 30 (millennials like Saager), were attracted to crypto services/”banks” like BlockFi due to yields. As we have been through ultra-low interest rates and free money the past decade has been a bonanza for speculators. Just go to your local bank and ask for the interest rate for saving your money. You were lucky to get 2% on your savings. It was worse for countries with negative interest rates, where you paid the bank to hold your money. Clearly hard working savers were getting hurt while speculators and people who benefitted from the financialized Western economies (ex: - private equity investors, hedge fund managers, and bankers) benefitted from ultra-low interest rates and easy money. If millennials did not get hurt enough thanks to the 2008 great recession they were about to get hit hard by the Fed’s loose monetary policy. For many young people in America, buying their first home is way out of reach. They have boatloads of student loan debt (which bear in mind have a very high-interest rate and you cannot declare bankruptcy on these loans). After spending money on an expensive college degree, they have to settle for jobs with mediocre wages working in cities where housing is unaffordable. Now, these poor kids have to save their money where their returns are around half a percent (if they are lucky). Now come FinTech frauds like FTX and BlockFi. BlockFi was giving out 9% APY. Obviously, for many young people, this is a deal that they cannot refuse. Instead of putting money in your local bank where you get a measly half percent why not put your money in a BlockFi, FTX, or even Robinhood where you can “earn” a higher yield.
It was not just the average joe who was searching for yield. It was also the so-called “Smart Money”. Thanks to easy money and low-interest rates liquidity was everywhere and hedge funds, private equity investors, and venture capitalists had ample amounts of capital to deploy. So they did what they do best, pump up asset prices. VCs started allocating money to startups knowing that many of these startups are worthless. Not only these startups were worthless, many of these companies like Theranos, BlockFi, and FTX turned out to be straight-up frauds. FTX is a prime example and exposed the so-called “smart money” on Wall Street and Sand Hill Road. Let’s look at institutions that poured money into FTX:
Courtesy: Alfonso Peccatiello (LinkedIn).
As you can see above some of the biggest names in investing poured money into FTX. Some of these names include names like Sequoia, Tiger Global Management, Third Point Ventures (Dan Loeb), and Thoma Bravo. Other investors include macro legend Paul Tudor Jones and hedge fund magnate John Paulson (famous for shorting the housing market in 2008). Also, how can we forget celebrities like Steph Curry, Tom Brady, and Giselle Bundchen investing in FTX and believing in Sam Bankmen-Fried (SBF), thus laundering this scammer’s reputation. But the FTX saga goes beyond investing. Kevin O’Leary is still singing the praise of SBF. Anthony Scaramucci sold 30% of Skybridge Capital to FTX. It was truly remarkable (and I wonder how much due diligence these so-called smart money investors did on FTX). This also shows that with cheap money investing became speculation. Money started pouring into the “it thing” without any due diligence. I mean, FTX was using Quickbooks for their bookkeeping. Did any of these “smart money” asset allocators look at FTX’s books? Every 401(k), institutional investor, and pension fund poured money into NASDAQ, FAANG, and any other stock market ETF which heavily propped up the equity market. With easy money, fundamentals were thrown out of the window.
Two names above that should worry anyone are the Ontario Teachers’ Pension Fund and Temasek (the sovereign wealth fund of Singapore- the organization in charge of managing Singapore’s money). I already wrote about how thanks to low-interest rates and high-risk investments the next retirement crisis is already on its way. We can thank ultra-low interest rates for this coming crisis. Pension funds are used to investing in safe investments like fixed-income securities. Ultra-low interest rates mean low returns for pension funds. Of course, pension funds wanted to chase high-yielding investments. That is why the LDI derivative was created. To put it simply, LDI is a swap agreement where pension funds put their bond holdings as collateral and borrowed heavy amounts of money to engage in high-risk investing. This worked as long as interest rates were super low. But as rates started to rise their collateral lost value. Thus the pension funds had to sell off their bond holdings to pay for their collateral. This aggressive selling of British bonds to cover pension fund collateral is what lead to the UK gilt crisis and the Bank of England reverting back to QE. As I wrote before many US pension plans have engaged in LDI derivative swaps with Wall Street banks and asset managers. So to bail out the financial system, the Fed will have to inflate the currency away or pension funds will suffer.
Chasing higher-yielding investments also meant allocating more money to high-risk alternative strategies like hedge funds, private equity, and venture capital funds. Now, these alternative funds are starting to feel the pain occurring thanks to the era of easy money coming to an end. As the Wall Street Journal reports, Blackstone’s non-traded real estate investment trust posted a letter to investors saying that the fund is limiting investor redemptions. Already, withdrawals from nontraded REITs are up significantly.
The Blackstone NREIT was specifically marketed for high-net-worth investors. As stocks and bonds performed dismally YTD, also with a looming recession, high net-worth investors are trying to liquidate their investments as fast as possible. This has many NREIT operators like Blackstone and Starwood very worried and are limiting investor redemptions. To cover these liquidations, Blackstone and Starwood have to sell off some of their properties which were bought for high prices during the everything bubble. Keep in mind that these funds are heavily levered in their investments.
The pain in the private markets is not going to end anytime soon. Already private market lenders like Apollo, PIMCO, BlackRock, Ares Management, and Knighthead Capital are working together to prevent any blowback from Carvana’s downfall. Carvana which was a hedge fund darling tech company is now in hot water. The stock’s value is down 97% and the corporate bonds are trading for less than half a Dollar. Low yields meant that many high-risk cash-burning tech “unicorns” like Carvana were able to borrow excessive amounts of money. Easy money meant that private equity and hedge funds had more than enough money to just “give away” to these private tech companies. Hedge funds that you heard about on financial media, a lot like the Tiger Cubs (like Tiger Global and Coatue), and other high-profile investors started piling into private and public technology companies like Carvana and FTX. Now as the market (in particular private and public tech companies) is falling these so-called “hedge” funds are being exposed. Tiger Global, a hedge fund notorious for outbidding every other VC fund to invest in illiquid high-risk tech startups, is now losing $185 million per trading day! Many of the high-profile hedge funds and institutional investors were invested in FTX. Anthony Scaramucci who runs a fund-to-funds investor Skybridge Capital sold 30% of his company to FTX and SBF. One would think how much due diligence Anthony and his team usually conduct when investing client money into these “hedge” funds. Let’s also not forget that many public and private pension plans, foundations, and university endowments are heavily invested in these alternative investments. The Ontario Teacher’s Pension Plan had to write off $95 million while Temasek (investment fund run by the Singaporean government) lost $275 million thanks to SBF and FTX. No doubt there are some very angry teachers in Ontario and citizens in Singapore.
But the low-interest rate environment not only affect Wall Street and corporate America. Countries like Sri Lanka thought they can just borrow money without any consequences. Thanks to this high borrowing and many more macro policy errors countries like Sri Lanka are suffering from food and energy shortages, thus creating massive societal chaos.
We are also seeing the deep flaws of financial media. Of course, anyone who has been reading Armchair Banker this is no surprise at all. We all saw how financial media was quick to defend the exchanges and Citadel during the GameStop saga only to go after the traders attacking their belove hedge fund buddies. So is there any surprise that financial media’s covering of SBF and FTX is nothing short of disgust? Let’s also not forget that FTX was one of the largest donors to Democrat and Republican politicians. Rep. Waters from the US House Financial Services Committee is already praising SBF.
One of the saddest parts of this long bull market era is the fact that this era, alongside the rise of Robinhood, FinTwit, and influencers, has given us a wide array from grifters, liars, pump and dumpers, to outright scam artists. Shameless hucksters like Kevin O’Leary (paid spokesperson for FTX), Anthony Pompliano or Pomp, and Chamath Palihapitiya (SPAC booster) have a lot of explaining to do. Everyone is buzzing about the Liver King and how he has been exposed as being a fraud. The guy who tells the world that his physique is from eating beef liver is now exposed to taking steroids. These financial influencers are just as bad as the liver king (I call them the liver king of finance).
My final warning to any crypto holders is to get your coins away from centralized exchanges and put them all into a Wallet. Preferably a physical wallet where you can find all your crypto offline. I still believe in the power of Bitcoin and crypto and I do not want crypto analysts and investors to confuse this new technology with the SBF’s fraud and brazen thievery. FTX was a centralized exchange doing old-school fraud. Please do not confuse SBF’s behavior with crypto. FTX is the MF Global and Enron of crypto.
Finally, we live in a sick society where people like Julian Assange, Edward Snowden, Chelsea Manning, and Daniel Hale are either rotting in high-security prisons or being persecuted for exposing the truth while Bankman-Fried is still living in his sky-high penthouse in the Bahamas, getting to enjoy thanksgiving with his family, and get to be featured on panel talks hosted by the New York Times.* Let’s also not forget the thousands of people in US prisons for non-violent crimes.
The era of low-interest rates and cheap money made Wall Street, Silicon Valley, Washington, and the rent-seekers ultra-rich while hard-working people suffered. Hardworking savers, pension funds, and endowments chased higher yields and parked money in crypto FinTech frauds, high-risk tech investments, and alternative investment strategies. Now as the party is over, the fed raises rates, and the everything bubble collapses, expect more pain. The wealthy will do fine while the ordinary investor and laborer are going to feel the pain from this bubble’s pop, inflation, and economic downturn.
I was writing this article before SBF’s arrest by the authorities.
What I write here is not investment advice. Please consult a professional and do your own research before investing. I still believe in the power of crypto and hold some investments in crypto tokens. Investing in crypto is very risky. As Buffett has said, do not invest in anything you know nothing about. I write for educational purposes only.
Please check out some of the articles I recently wrote:
The Coming American Retirement Crisis: This article was one of my most-read articles. The Fed and Wall Street have created a retirement ticking time bomb that is about to blow out. If you are concerned about your future, this article is a must-read.
Time to Look North?: As we enter a new macro and geopolitical era where commodities are going to take center stage (especially nuclear), now may be a good time to look for investments listed in Toronto.
China is Winning the Russia - Ukraine Crisis: China is gaining a geopolitical footprint in the ongoing Russia - Ukraine crisis and follow-up economic downturn.
The Start-up That's Disrupting Music: A brief write-up on Audius and how it affects Solana (written before the downfall of FTX).
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As always live well, stay healthy, and prosper!!!