FTX crash is eerily similar to the Bernie Madoff scandal, ex-regulator Sheila Bair says

By Matt Egan, CNN BusinessUpdated: Tue, 15 Nov 2022 11:34:27 GMTSource: CNN BusinessIn the span of just three years, Sam Bankman-Fried built FTX into a massive crypto exchange backed by marquee invest

By Matt Egan, CNN Business

Updated: Tue, 15 Nov 2022 11:34:27 GMT

Source: CNN Business

In the span of just three years, Sam Bankman-Fried built FTX into a massive crypto exchange backed by marquee investors and valued at $32 billion. It took mere days for all of that to implode in a sprawling bankruptcy filing.

Sheila Bair, a top regulator during the 2008 financial crisis, told CNN there are eerie similarities between the dramatic rise and fall of Bankman-Fried and FTX and that of infamous Ponzi scheme mastermind Bernie Madoff.

Bair notes that 30-year-old Bankman-Fried, like Madoff, proved adept at using his pedigree and connections to seduce sophisticated investors and regulators into missing "red flags" hiding in plain sight.

"Charming regulators and investors can distract [them] from digging in and seeing what's really going on," Bair, who chaired the Federal Deposit Insurance Corp. from 2006 to 2011, said in a phone interview on Monday. "It felt very Bernie Madoff-like in that way."

FTX filed for bankruptcy on Friday, throwing the cryptocurrency industry into chaos and raising the specter of vast losses for customers of the crypto exchange.

'It all feeds on itself'

Long before his Ponzi scheme collapsed, Madoff was known as a wizard on Wall Street. He was the former chairman of the Nasdaq Stock Market, served on Securities and Exchange Commission advisory panels and managed money for the rich and the famous.

For his part, Bankman-Fried was a top campaign contributor to Democrats in the 2022 election cycle. He hired multiple former US regulators to serve in senior positions at FTX, and his parents are both professors at Stanford Law School. Up until the bankruptcy filing, FTX even had an application pending with federal regulators to clear derivatives, The Wall Street Journal reported.

Better Markets CEO Dennis Kelleher said in a statement on Monday that FTX had a strategy of "revolving door hires" from the Commodities Futures Trading Commission (CFTC) and elsewhere "to use their knowledge, influence and access at the agency and in Washington to move FTX's agenda."

"People feel duped," Brian Armstrong, the CEO of rival crypto exchange Coinbase, told CNN in a phone interview on Friday. "On the surface, FTX was able to garner a lot of attention. But as people looked into it, the fundamentals were not there."

FTX garnered its $32 billion valuation with the blessing of investments from BlackRock, SoftBank, Sequoia and other top investors.

"You get this herd mentality where if all your peers and marquee names in venture capital are investing, you've got to, too. And that adds credibility with Washington policymakers. It all feeds on itself," said Bair, who sits on the board of directors at Paxos, a blockchain infrastructure company (Bair said she was speaking for herself, not Paxos).

Now, authorities in the Bahamas are investigating potential criminal misconduct surrounding the FTX explosion.

Neither FTX nor a lawyer representing Bankman-Fried responded to requests for comment.

If it sounds too good to be true...

Madoff offered investors marvelous returns that were remarkably consistent and an improbable track record that later proved to be made possible by an elaborate scheme that involved repaying existing clients with new client deposits.

Given the speed of its demise and media reports, serious questions have been raised about the accuracy and strength of FTX's balance sheet. FTX's bankruptcy filing indicates it had liabilities of $10 billion to $50 billion at the time of the filing.

Bankman-Fried secretly transferred about $10 billion of customer funds from FTX to his trading firm Alameda Research and used a "backdoor" to avoid triggering accounting red flags, sources told Reuters.

Bankman-Fried denied to Reuters secretly transferring funds, blaming instead "confusing internal labeling."

Bair urged investors to use caution and be skeptical. "If it sounds too good to be true, it probably is," she said.

Calls for regulation

The good news is the former FDIC chair is not worried about the FTX implosion threatening the entire financial system the way Lehman Brothers did in 2008. Crypto is still a relatively small part of the broader economy and financial market.

"There is no systemic impact to the real economy," Bair said, adding that this is all just "funny money in the ether with speculation."

But the bad news is the crypto market remains largely unregulated, making it the Wild Wild West of the financial world. And that leaves investors vulnerable when something breaks.

"It's time to settle on a regulatory regime for crypto and sort out who is regulating what," Bair said, "because people are getting hurt."

— If you are an FTX customer and want to discuss how you have been impacted by the bankruptcy, please reach out to [email protected]