Note: This is part 1 in a multi-part series exploring the dangers of rehypothecation and commingling in bitcoin and other cryptocurrency assets that could occur once Wall Street begins offering crypto products. Part 1 is an interview with Caitlin Long and subsequent parts will ask the question, “How did we get to a place that where laws look like this?” Stay tuned for part 2.
Caitlin Long is a 22-year Wall Street veteran with an impressive career inside of and outside of the cryptocurrency space. She started out as an associate at Salomon Brothers (now Citigroup) before becoming a managing director at Credit Suisse and finally heading up Morgan Stanley‘s Pension Solutions Group. As it turns out, Long’s extensive experience on Wall Street (in addition to her Harvard Law degree) give her some unique insight into things that most cryptocurrency investors aren’t going to have top of mind but that institutional investors have been dealing with for years. At the beginning of our conversation, Long says that everyone’s “backgrounds bring them to who they are today and bring them the knowledge base for recognizing trends.” It is Long’s impressive background, combined with a unique recognition of the opportunity to make Wyoming a “crypto haven” and a passion for doing what was necessary to achieve this goal, that put her in the unique position of understanding everything that is wrong with our current system and the opportunity blockchain — and specifically bitcoin — give the financial services industry to ameliorate its past mistakes.
Note: The following has been edited for clarity
CCN Interviews Caitlin Long
CCN: How did you get into cryptocurrencies and how has your background allowed you to enter the space?
CL: Well, like everyone, their backgrounds bring them to who they are today and give them the knowledge base for recognizing trends, and I just happen to have a slightly maybe a typical background because I’m not a technologist but I actually have the legal background as well as having worked on Wall Street for 22 years, most recently running the pension business at Morgan Stanley [where I] really got into the weeds of how assets are custodied, cleared, and settled when they transfer.
The system that we have is very unstable. It’s not fair to investors, and I’ve learned from experience not to trust my brokerage account. My brokerage account itself is not inaccurate, but there’s so much that goes on in these commingled pools of assets behind the scenes that you can’t see. In other words, if you own 100 shares of Apple stock you don’t know that the leveraged institutions of Wall Street haven’t promised those very same 100 shares out to someone else too — and they also show up on that person’s brokerage statement. That kind of stuff really hit me in the gut as just unfair and morally wrong and there’s a lot to be said for pension fiduciaries upping their game and for the investor protection regulation to up its game because frankly, regular investors are the losers from all of these issues in the system.
CCN: Would you talk a little bit about the crypto problem? How the regulations allow that to happen?
CL: Well, there’s fault tolerance in the system. It stems from the fact that trades are not required to be settled instantly, which, for your crypto listeners is going to sound really strange because your trades literally go in the next block. If you’re talking about the bitcoin blockchain, you can see them within minutes, on the ethereum blockchain, your actual trades are right there, and that’s not the way Wall Street works.
Wall Street just settles trades. When I started in 1994, the industry was five days after the trade date [T+5] and now it’s two days after the trade date. We just went from T+3 to T+2 this year, but it’s still two days. Obviously, [delayed settlement is] not a technology problem. It’s long since not been a technology problem anymore. So why is it that Wall Street is stuck with this crazy practice of not settling trades in near real time? The answer is it has to do with the market structures.
Now all these crazy market structures that we’ve let been left with, that were designed to do — to try to help Wall Street settle the increasing trading volumes on the New York Stock Exchange in the 1970s — which essentially said, “Why don’t we immobilize shares, instead of literally running share certificates back and forth across all the brokerage firms?,” which is why if you go down to the New York Stock Exchange in New York, that’s why all the brokerage firms were located right there because they literally were running paper securities back and forth to each other every day. And then they got overwhelmed it and they said, “Why don’t we just immobilize them in a vault somewhere, and everybody will actually own a certificate. That’s a claim against that share.” So instead of owning the real thing, everybody now owns a paper claim against the real thing, and the real thing is immobilized in a vault at a company called the DTC, a big huge company that is the legal owner of 99.9 percent of the securities issued and outstanding in the United States.
Most people don’t realize that if you don’t own the actual paper certificate, you don’t own your securities, the DTC [Depository Trust Company] does. What you own is an IOU, and that IOU is from a leveraged financial institution that might default. So behind the scenes, all of these different institutions that were designed to clear and net settle transactions that gave rise to this settlement delay, those institutions haven’t been done away with, even though the technology problem that created them long ago was solved.
CCN: It’s just crazy to think, here we are in 2018, and it’s still taking, two — recently, three — days to settle these trades. So I guess there’s got to be a market advantage to the brokerage firm and I guess they’re lobbying to kind of keep that open?
CL: Well, it’s interesting they did when we went down to T+3. I remember that was in the late 90s from T + 5, the industry fought it tooth and nail. They didn’t fight it as much when we went from T+3 to T+2, but they will fight it tooth and nail if we ever go T+1, and here’s why: because the industry makes a lot of money on securities lending. This is the hypothecation word that I wrote about on Forbes.com, that’s one of those phrases that crypto enthusiasts are going to know and understand just like they know and understand the phrase fiat currency.
Ten years ago it was only the Austrian School economists that were talking about fiat currency; no one ever talks about [U.S.] dollars as a fiat currency. Now everybody talks about it that way to the point that even Fiat — the car company — had this hilarious tweet about two weeks ago that asked why everybody was criticizing their money. It was a play on the name of the company, the Italian car company Fiat. It’s now in the regular vernacular, and I think the word application we have going is going to be in the regular vernacular of industry very soon because that is one of those insidious and subtle things that happen behind the scenes in these in these commingled collateral accounts behind the scenes that you can’t see from your brokerage statement.
For instance, in the MF Global bankruptcy a lot of people, unfortunately, learned what rehypothecation was and learned that it was legal and learn that their brokerage firm got them to agree to it. The remedies to our default are pretty limited if you’ve agreed to it, and it was right there in the fine print. I’ve very publicly been campaigning against this for a while, and it’s not new just because this has been something I wrote about recently. It’s only because it burst on the scene in the crypto sphere due to the entry of Intercontinental Exchange (ICE).
They’re the parent of the New York Stock Exchange, which is one of the largest operators of central clearinghouses and counterparties in the world. So they are a major rehypothecator of collateral. This is one of those things that I love about bitcoin because you actually can own your asset. It’s the same as if you were actually owning that paper stock certificate, except it’s just in digital form and it’s not as easy as paper is to counterfeit or lose. In the case of bitcoin, if you have your private keys and you haven’t lost them and they haven’t been hacked, then you really own your bitcoin. I would love to get back to that in the financial markets as a whole.
CCN: How did the institutional investors let this happen, let the brokerage firms take this amount of power so the pension fund managers and — why [aren’t] all those people kind of lobbying to do away with that old system?
CL: That is a great question and I don’t know the answer — I wish I did. Having better pension fiduciaries and having negotiated some of these agreements ,I knew I was an outlier when we were asking for title collateral terms and one-day collateral posting. We went for intraday collateral posting on our interest rate contracts and nobody would give it to us. When we first started asking, I think it was T+3 collateral posting. You can have a major move in interest rates and the counterparty wouldn’t have to give you any additional collateral for three days.
Well, in the intervening three days, of course, they can go bankrupt. I was pushing for that and it was the experience of the financial crisis that made me learn that I needed to ask for that. Why did many others not? I actually had that conversation with a couple of people in the pension business at a recent Free State Project picnic. So they, like me, are opposed to fractionally reserved assets and fractional reserve banking in general. And I said, “God, why are the fiduciaries not digging into this?,” and they said it’s two things: they think that they’re powerless to change the system, which on an individual basis may be correct, but if they were to work together, I don’t think that’s correct at all.
I think they do have the power to force positive change. Indeed, there’s a terrific speech called The Block Chain Plunger: Using Technology to Clean Up Proxy Plumbing and Take Back the Vote that was given by a Delaware court judge back in 2016, his name is Vice Chancellor Travis Laster. I strongly encourage your listeners to read his speech because it gives a tremendous amount of detail about all the problems in the clearing and settlement system of Wall Street, and he like me, is trying to encourage the fiduciaries to take the reins, take the control back in the markets, because it’s their investors and their clients that are losing as a result of all the issues in the system. Lastly, I’ll add I hope the plaintiffs’ bar starts to come into some of these issues and litigate.
I don’t know the outcome of the Dole Foods situation. I have not seen any FCC enforcement actions in the Dole Food situation, which means somebody lost money there. Why has there not been litigation? Why have there not been enforcement actions? It’s the sort of thing that regular mom and pop investors out there look at this kind of thing and just think the system is rigged against them. And guess what? In a lot of ways it is!