FTX isn’t a 2008 Repeat
Should investors be worried about any parallels between the collapse of Lehman Brothers in 2008, related to toxic real-estate mortgage based securities and the collapse of FTX in 2022? The short answer is no. The prospect of a contagion effect from the collapse of FTX spreading to the real estate market or the broader economy appear small.
In fact even as crypto-related investments continued to sell off, publicly traded real estate investment trusts gained value. Over the last month as Bitcoin fell with the proxy of the Grayscale Bitcon trust (GBTC) down over 25%, the Dow Jones U.S. real estate index ETF (IYR) rose by over 5%.
An important distinction between crypto and commercial real estate is that investment properties generate real income from tenants. Real estate can react to rising inflation by increasing rents. So, far this has been happening in 2022.
Limited Contagion Risk
Banks and financial institutions appear to have actually learned some important lessons from the financial crisis of 2008. Banks appear to have little to no exposure. The exposure of major investment companies like Blackrock and Sequoia Capital have to FTX and crypto appears minimal. Indeed, so far credit markets have shown no visible signs of stress. The spread between high yield junk bonds and government Treasury bonds actually narrowed recently.
The exposure of personalities, like Tom Brady, and politicians, who received millions of dollars in donations, is embarrassing, but not of great economic consequence. The billions of dollars likely lost by individual investors is upsetting. But this is where it looks like the financial losses will be concentrated—to individual investors participating in the crypto space. Right now the contagion effect appears limited to the crypto space.
What Happened at FTX?
Rather than a Lehman Brothers type of event that signaled major problems in the U.S. financial system, real estate markets and economy, what happened at FTX appears, based on news reports, to be more of a fraud type event, like Enron or Bernie Madoff’s investment fund. Although in fairness to Enron, the newly appointed head of FTX who worked at the Enron bankruptcy has commented the financial control at FTX were actually far worse than Enron.
FTX was a crypto exchange holding billions of dollars in customer deposits, based in the Bahamas. FTX also issued its own crypto currency, FTT. Once trading for almost $80 FTT is now worth less than $1.50. In addition to FTX there is Almeda Research, a multi-billion dollar crypto investment hedge fund controlled by the founder CEO.
Facts are still developing at FTX, but if reporting is to be believed what happened wasn’t one act of fraud or misconduct, but many such acts. Allegations include outright theft of customer funds that may be an inside job, raiding customer accounts to fund bad investments made by the hedge fund, fraudulent accounting to attract investments, fraudulent claims and advertising, use of funds for private purchases including houses, allegations of use of funds to buy political influence (CEO was the second largest donor to Democrats during midterms), price manipulation of FTT that was then used as collateral for funding acquisitions and other allegations.
The Real Reason for Caution
The carnage in the crypto space is likely not yet over. Although the collapse of FTX does not appear to have broader ramifications to the U.S. economy there is a related reason for caution. The Federal Reserve setting its benchmark rate as low as zero percent after 2008 helped create the cheap money environment that enabled get-rich-schemes like FTX.
Now that the Fed is raising interest rates and cheap money is no longer driving speculative investments some of these schemes are blowing up. It is becoming more important to prudently model and manage investments, including in real estate. This will be a challenging environment for investors. Savings accounts and treasury bond yields are less than the inflation rate. To not lose purchasing power investors need to take risks. But it’s now increasingly important to take smart risks.