What Gensler role in Long Term Capital Debacle Tells us about his war on crypto

This is the 25th anniversary of the September 1998 collapse of Long-Term Capital Management. That was one of the most stunning events in Wall Street history, as the firm allowed its leverage to grow to more than 100 to 1. But it was shocking beyond the sudden evaporation of $4 billion in value—that was a lot of money 25 years ago— but also because the firm had been put together specifically on the basis of its supposed genius for understanding and managing risk. The firm was dominated not by great traders but by intellectual supermen, including Robert Merton and Myron Scholes. Merton and Scholes had won the Nobel prize just a year earlier for having devised the mathematical formula for pricing options. One of the most beautiful and elegant real-world mathematical proofs in history, at heart, Black-Scholes is basically a way to price risk — an estimate of the likelihood of an event occurring, including a catastrophic event.

The entire tale is indelibly recounted in one of the greatest business books of all time, When Genius Failed. That book sat on my proverbial “read this soon” pile on my nightstand for 20 years until I finally got around to it this week.

It’s actually fascinating to read this gripping and very of the moment tale because anytime a catastrophic event overcomes Wall Street, it involves greed and leverage. That was true in 1929, in 1987, and of course in 2007, and the book painstakingly details how even the smartest humans succumb to the very human temptation to take enormous risks with money that belongs to others.

It’s amazing to see all of these major players in the book tsk-tsking LTCM head John Merriweather with today’s perspective on just how many of their firms were eventually felled by the same hubris that brought down the geniuses of Greenwich.

The final disposition of LTCM occurs in an office at the New York City where my neighbor from Maplewood, NJ, New York Fed head Peter Fisher convenes a bunch of bankers, to figure out how to stop the bleeding. The group included:

• Jon Corzine, head of Goldman Sachs—he later failed to win re-election as Democratic governor of deep blue New Jersey and cratered MF Global in one of the ten priciest bankruptcies in U.S. history.
• David Komansky, the CEO of Merrill Lynch, acquired by Bank of America at gunpoint during the 2007 meltdown.
• Dick Fuld from Lehman brothers, which was allowed to fail in that same meltdown

And one person who played a role was Gary Gensler, now the chairman of the Securities and Exchange Commission. His comprehensive biography on Wikipedia doesn’t even mention Long-Term Capital, which speaks to his long career as a Clinton, Obama, and now Biden appointee, as well as his lengthy academic record.

Nonetheless, it’s worth considering that Gensler was in the room because his behavior on the regulatory front—especially toward crypto, but elsewhere as well—has been so aggressive. As well as remarkably unsuccessful. To a degree we’ve never seen from any prior SEC commissioner, Gensler has inserted himself as not just watchdog, but rulemaker in areas where Congress has simply not given him that authority.

For example, Gensler has taken it upon himself—and his agency—to nudge companies on climate change. The fact that the EPA is already on the job did not dissuade Gensler from approving rules requiring greenhouse gas emissions and other “climate risks” to be disclosed on 10-K forms. The Wall Street Journal criticized Gensler for rules “contrary to SEC history, securities law, and sound regulatory practice.”

Gensler’s behavior toward crypto has been even more overreaching. While it was Gensler’s predecessor at the SEC, Jay Clayton, who sued Ripple in a bizarre last minute maneuver on his literal last day as SEC Chair, it was Gensler who feverishly pursued the clearly flawed suit, pressuring others exchanges to delist XRP. He subsequently sued Coinbase and Binance and his remarks about the industry have seemed bizarrely personal. Miraculously, Gensler did not find reason to pursue Sam Bankman-Fried or shut down FTX, which cost American investors some $9 billion. It’s hard not to wonder if SBF, who met with Gensler a few months before his company collapsed, benefitted from being the second-largest Democratic donor.

After three years and hundreds of millions of dollars, Judge Analisa Torres, appointed by President Obama, definitively sided with Ripple. If you understand the way the deck is stacked in favor of the government, you understand that that was not just a victory for David over Goliath but more like David defeating 10 Goliaths and Hulk Hogan. The SEC spinmeisters have used their extensive press machinery and habitual leaking to favored journalists to suggest that this decision was actually a mixed verdict, but it wasn’t. XRP by law is now the only cryptocurrency in the world that a US court has officially declared is not a security. Even bitcoin, which Clayton had unilaterally declared was not a security, has not had that determination made by a court. In other words, the three-year harassment campaign winded up making Ripple far stronger and left it on much sturdier legal footing.

So, if you look at Gensler‘s contributions to the Long-Term Capital settlement, where the New York Fed intervened to prevent a total collapse of a mega fund that was losing hundreds of millions per day, you see a young regulator who believes in the power of government to prevent financial harm.

In 1998, Gensler was an Assistant Secretary at the Treasury, helping out his former Goldman partner, Treasury Secretary Robert Rubin. Roger Lowenstein describes Gensler as being surprised by how naïve the geniuses of LTCM had been. “Gensler had a related thought: During a crisis, the correlations always go to one. When a quake hits, all markets tremble. Why was Long-Term so surprised by that?” Later, Gensler advises that the group considering putting LTCM into bankruptcy, noting that that Drexel Burnham Lambert declaring bankruptcy in 1990 actually calmed the stormy junk bond market. The geniuses point out that the ultra complex investments of LTCM wouldn’t be wiped out by bankruptcy. “So this is a new paradigm,” says Gensler, who is described as unhappy about the uncomfortable negotiations.

But the most telling part occurs as the talks are breaking down. “The officials went to a side room, and Gensler called the Treasury.” The banks don’t want to throw in billions more to support LTCM, the terminal patient. But Gensler had another concern. “Midterm elections were six weeks off.” With the Monica Lewinsky scandal worsening by the day, “the economy had been the government’s one bright spot. The last thing it wanted was a financial meltdown.”

In other words, 25 years ago, Gensler, who grew up in Maryland had come back to Washington with a wave of Goldman Sachs partners, was keenly aware of the politics of the situation. According to Lowenstein, writing with no ax to grind two decades before Gensler headed the SEC, at a moment of existential crisis, Gensler the bureaucrat cared about politics and how the collapse of LTCM would play in the papers.

The point is young Gary Gensler seems to have understood then that government power was vast and could be made to bring the most powerful people on Wall Street to heel. And yet he seems not to have internalized the idea that those powers have to be granted to an agency by Congress. That’s democracy. Frustration with the glacial pace of lawmaking in America is understandable. The American people need clear rules on crypto just a surely as we deserve updated policy on immigration and others. It is a shame that our elected representatives have struggled to make progress on these complex issues.

The answer, however, is not for unelected heads of agencies simply to harass American business leaders as a way of setting policy by decree. Steering the collapse of Long-Term Capital Management to a relatively peaceful landing was a worthy goal. But they did it then through brutal, weekend-long negotiations. You can’t just make it up while you go.