It Takes a GENIUS to Cause a Financial Crisis

Brian Shearer is the Director of Competition and Regulatory Policy at Vanderbilt University's Policy Accelerator for Political Economy and Regulation. Until recently, he served as the Assistant Director for Policy Planning and Strategy at the Consumer Financial Protection Bureau.

Last week, the Senate almost passed the GENIUS Act. Once combined with the House’s STABLE Act through formal conference committee or informal negotiation, the presumably re-named “STABLE-GENIUS Act” would have remade the nature of money and banking in the United States. 

Don’t be fooled. This is not really a crypto bill. The GENIUS Act has little to do with Bitcoin or Ethereum or memecoins. Instead, this is a very significant, and bad, banking reform law. 

I have two fundamental problems with it. First, it allows big tech to open banks without becoming banks. Second, it does not require stablecoins to be backed by fiat currency—they can be backed by other financial instruments too. 

I’m going to walk you through the sci-fi dystopia that could result in three steps. In the short-term, big tech firms could use their market power to force early adoption of their stablecoin “bank” for transactions on their platforms, and they could quickly become the largest banks in the US and make the banking industry much less competitive. Second, these big tech banks will be fragile, and stitched into the fragile fabric of the existing financial system. They will become too big to fail and the Federal government might begin bailing them out. In the longer-term, if they grow big enough and other companies start using their stablecoins off-platform, the country’s big tech companies could become pseudo global central banks. 

This may sound hyperbolic at first blush. But let me explain.

Are stablecoin issuers really just banks? 

Stablecoins are not a particularly novel innovation. At a basic level, the law would allow anyone (bank or otherwise) to register with a state or federal banking regulator to become a “payment stablecoin issuer,” which means they could issue “stablecoins” backed on a one-to-one basis by reserve assets held by the issuer. Stablecoins could be digitally exchanged among people for payment or held like deposits, and anyone could go back to the issuer to redeem the coin for USD. Instead of showing you a digital representation of $1 in your account, it would show you $1 stablecoin, which in good times would be worth $1. You could send that stablecoin “dollar,” and the recipient would get that “dollar” and could convert it into actual USD at any time.

In other words, they are just banks with no deposit insurance and a narrower set of investments (though not narrow enough). The only real difference in function between a stablecoin issuer and a standard bank is the spreadsheet that it uses. In the traditional banking system, when you make a digital payment, banks do not exchange physical cash. Rather, through the payment networks they credit and debit the accounts at the banks on either side of the transaction, and at the end of every day the Federal Reserve adjusts the ledgers for those banks’ Federal Reserve master accounts, which include all official USD in circulation (other than physical cash). Instead of doing that, the reserve assets held by a stablecoin issuer would remain untouched and the record of who owns the stablecoins would be adjusted on the “blockchain,” which is just a different kind of spreadsheet.

What is the problem with the non-fiat reserves? 

The Genius Act does not require 1-to-1 backing in USD. The reserves can also be in Treasury notes and bonds, money market funds, and repo and reverse repo agreements. This is a problem.

To understand why, you need to understand the role of “private money” in the existing banking system. As Professors Morgan Ricks and Lev Menand laid out in “Rebuilding Banking Law: Banks as Public Utilities,” the main reason the country frequently experiences financial crises and bailouts has been the proliferation of “private money” in our banking system. 

By private money, they do not mean crypto. The special thing that banks do is issue a liability we use as money, called deposits. Banks are chartered to do this and are subject to a range of restrictions and obligations because of this government granted privilege. However, over time nonbanks have started to do bank-like things (e.g. investment banks, money market funds) by issuing financial instruments that approximated deposits and had money-like qualities. Banks started creating and holding this kind of “private money” as well, including by using short-term debts (including repurchase or “repo” agreements) between financial institutions (bank or nonbank) as if they were money.

This was a sort of quiet revolution. Since 1980, the country’s monetary supply has shifted from almost entirely USD deposits held by banks, to mostly this form of “private money.” There are several problems with this trend. First, none of this “money” is insured by the FDIC or subject to appropriate safety and soundness supervision. Second, because major banks and nonbank financial institutions are linked to each other in a complicated web of these assets, when a few of them default or even just sell a lot of these assets, the value of this “private money” decreases, which can cause a chain reaction of more defaults or sales, and so on. This is one of the reasons why the Great Recession was so contagious across the banking industry—all of our financial institutions are too entwined with each other. Institutions become too big to fail because, if they do fail, they will cause other institutions to fail.

The GENIUS Act allows issuers to back stablecoins with this kind of “private money.” That means stablecoin issuers’ financial condition will be linked directly to the banks, and banks to the stablecoin issuers. If a bank collapses, and a stablecoin issuer had that bank’s “money” held in reserve (i.e. short-term loans that this bank owes), then the whole stablecoin currency is affected by that one bank’s collapse. The stablecoin might owe repo agreements to other banks, so it could spread in the other direction as well. And if a large stablecoin is backed by Treasuries, and the stablecoin issuer experiences a run, the issuer would need to sell a massive number of Treasuries to cover the redemptions, affecting the Treasuries market. 

We are already very vulnerable to chain reactions like this. This bill would supercharge that risk. 

If stablecoin issuers are just banks, what’s the point of all of this? 

You might be thinking, we already have thousands of banks. If stablecoin issuers are just banks, what’s the point of all this? As far as I can tell there are two reasons – to avoid transaction fees in the conventional banking system and to allow big tech companies to open international banks. 

First, the noble reason. It seems that some are legitimately trying to build a way around the transaction fees in the current payment system. Transaction fees are a real problem. Monopolistic payment networks and their partnering banks extract an excessive amount of transaction fees off every digital payment. 

But creating unregulated banks just to lower fees is a dramatic overreaction. There is a much simpler fix for that – just cap the fees. Congress capped interchange fees for certain debit transactions in the Dodd-Frank Act. I’m sure some bankers wouldn’t want to cap interchange fees for all debit and credit transactions, but if you are worried about a fee cap, you should be more worried about a stablecoin work-around that eliminates interchange fees entirely by taking payments off the payment networks. 

Second, the scary reason. Big tech wants to open their own banks, which they can’t do under existing bank regulations. We know this is a real threat because Meta has already tried it, and failed, once before. Recently, reporters at Fortune revealed that Meta wants to issue a stablecoin to clear transactions on its platform to lower transaction fees.

When the National Bank Act was passed in 1864, Congress prohibited companies from owning both a bank and other commercial businesses. This “separation” requirement was intended to prevent large conglomerates from creating money to favor their own retail businesses and choke off access to competitors, or conversely, to use their retail business to favor their bank and dominate the economy that way. The separation regime was strengthened in the Bank Holding Company Act of 1956 when big corporate trusts tried to evade it. 

Big tech doesn’t have the lobbying juice to repeal those regulations outright, so instead they are attaching different technology like the blockchain to something that already exists, calling it something “new,” and creating a new legal regime for itself that doesn’t include this separation requirement.

Want to go see the Parade . . . of Horribles?

Once they are allowed to open banks, I would expect big tech to each open a stablecoin bank given that they are already in the business of intermediating large volumes of payments between consumers and third parties. For example, Amazon and Meta run platforms at the center of many retail purchases, Apple and Google have popular payment services linked to physical mobile phones. 

Taking one example, Apple already has quite a bit of power to force adoption of ApplePay by merchants, consumers, and even banks. Right now, Apple only makes a small fee as compared to the interchange fees that banks make on ApplePay purchases. Apple could create a competing stablecoin ‘payment card’ on ApplePay.  Apple could charge less than the traditional bank interchange fees, at first, to get merchants to adopt. Consumers probably wouldn’t revolt because it would be free for them. And banks would have no say in the matter.  But what if eventually Apple forced all ApplePay transactions to be stablecoin purchases using only its issuer subsidiary, cutting out traditional banks entirely? They would have a huge incentive to do that. Apple would have the power to get all of the transaction fee, and once merchants adopt it, there is nothing stopping Apple from increasing the fee. 

It's not a stretch to imagine a scenario where Google, Apple, Amazon, Paypal, Block, and Meta all do something like this, and quickly become the largest payment networks and banks in the world. All consumer transactions on those platforms would use the platform’s stablecoin, and because they would have wide international adoption, other banks and financial institutions could start holding the coins as reserves or denominate transactions in the coin off the platform. Consumers and businesses would still pay significant transaction fees, but now to the big tech companies instead of the banks. They would also pay a complicated series of exchange fees due to the constant need to convert currencies not backed by fiat money. 

Once there are trillions of dollars in a stablecoin, and the coin is being used off a big tech company’s platform, these gig tech companies would effectively become global central banks. They could perform their own monetary policy by deciding how many stablecoins to issue or repurchase, and by toggling what percentage of reserves are USD, Treasuries, MMF, or repo. We would still have monetary policy coming out of the Fed, but it would have to compete or coordinate with international monetary policy performed by a few non-governmental actors. 

In addition, these would not be stable institutions. There would be no deposit insurance. We recently saw how vulnerable banks without deposit insurance can be when the 16^th largest bank, Silicon Valley Bank, collapsed. SVB’s deposits were 90% uninsured and the government had to bail it out to stop the contagion from spreading to other financial institutions. For example, when SVB collapsed, Circle’s stablecoin USDC dropped from being worth $1 to just $0.87, illustrating how all these institutions will become linked, and therefore, vulnerable. 

A Better Answer

The GENIUS Act is not the banking reform we need. It will likely increase financial instability, increase transaction fees, risk creating private world central banks, and undermine our deposit insurance system. Instead, as Ricks and Menand have recently advocated, we need a New National Bank system that breaks the financial-crisis wheel by phasing “private money” out of the banking system, insuring all deposits, and insisting that excessive bank profits be paid back to the public in the form of deposit insurance premiums. If we did that, we would generate billions in revenue to combat the national debt, have a more stable financial system in the long-term, and fairer consumer products too. It’s a win, win, win.

The opinions shared in this article are the author’s own and do not reflect the views of any organization they are affiliated with.

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