Breaking the Code: Understanding the Complexities, "regulatory capture" of Health and Financial Markets, SVB vs Insulin resistance pandemic (FatDeath)

Greetings! Bonjour! 您好! 

I am Gareth 王, and I am thrilled to welcome you to this edition of the newsletter, where I share my innermost thoughts about latest on Silicon Valley bank demise and it inspired me to write about regulatory capture of finance and food sector.

What are the challenges of regulating financial markets and what is the concept of regulatory capture? How does the complexity of the financial markets compare to the regulation of insulin in the body? What are the risks of fractional banking and how can it be improved? How has fintech failed to disrupt the financial market? What can we learn about finance from the recent receivership of Silicon Valley Bank? How can we better understand financial market developments by humanizing the nuances and drawing parallels to health issues?

These are some of the questions I try to answer in this post.

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This story is deeply personal to me. Over the past 20 years, I've worked tirelessly (but almost given up!) to creates a superior asset class to Treasury bonds. We can easily achieve this by monitoring near-real time cash management (vs liabilities) in well-run mid-market+ companies & using cash like instrument to cover their default risks (this will disrupt and fix the billion & trillion worth "nearly risk-free' asset class that most pension & soverign wealth funds are desperate for).

This post however is to talk about issues relating to moral hazards, regulatory capture & other relating issues. We should recognise that even with good regulations, vigilant monitoring, it is still very difficult to enforce rules as we can observe.

First of all: Fractional banking is a confidence game, and is sadly rather risky, as you would not run your own household with only 20% of equity, right? (majority of banks however has less, as BASELIII accord says CET1 capital ratio of 6% of a bank is considered as well capitalised already, why have more!? !)

With all the talk of disrupting finance in the past 20years (with the boom & almost bust of crypto everything, including biggest Effective altruistic SBF of FTX on VOX👈🏻 good read as this series is sponsored by FTX! ) everyone can also observed that fintech has sadly not changed the financial market one bit (yes we have mobile everything now, but all plumbing the same!) Despite these billion and trillion dollar market of treasury bonds begging to be fixed! I've previously blogged about world need Fixtech rather than a hotchpotch of yet-to-be defined fintech back in 2016.

Although the recent receivership of Silicon Valley Bank (excluding their funds of funds & other businesses at holding company level) may not of interest to most people in the world, my extensive network in the startup, finance, and regulatory worlds closely follows developments (they are engine of the economy and future breakthrough after all).

To aid rest of the world to understand finance easier, let's draw parallel to our health by focusing on insulin, obesity and regulation of ultra processed food that is driver of the majority of population of western world to be overweight (WHO 2021 report). By humanising these nuances, we can help more people understand the impact and significance of these latest financial market development, which hopefully will lead you to given the media/news bombardment as these banking failure story still develops (Credit suisse shored up by government and First republic got $30Bn injections from other banks).

Feel free to skip the introduction to Insulin below, as hopefully you are the 40% of world's population that do not have a weight problem!

So, lets get into the health side of things now and hope by weaving that in the story, it will make financial market's regulations easier for people to understand:

Insulin:

As human beings, we are blessed with an incredibly complex and sophisticated system that monitors and regulates our internal environment to keep us healthy and functioning optimally. One of the key components of this system is the endocrine system, which includes various glands that produce hormones that regulate our metabolism, growth, and development. One of the most important hormones produced by the endocrine system is insulin, which is responsible for regulating our blood glucose levels.

Insulin is produced by the pancreas, an organ located in the abdomen, and is released into the bloodstream in response to high levels of glucose. Glucose is a simple sugar that is the primary source of energy for our cells, but too much of it can be toxic and even life-threatening. When we eat a meal that contains carbohydrates, our digestive system breaks down the carbohydrates into glucose (or worst guzzle down sugary drinks, fizzy to juices), which is absorbed into the bloodstream and transported to our cells. If our blood glucose levels rise too high, insulin is released by the pancreas to help transport the glucose into our cells, where it can be used for energy or stored for later use.  Extra glucose that is not used by the cells will be converted and stored as fat so it can be used to provide energy when glucose levels are too low.

The regulation of glucose levels by insulin is a complex and delicate process that involves many different factors. For example, our body's sensitivity to insulin can be affected by factors such as diet, exercise, stress, and genetics. In addition, our body's ability to produce insulin can also be affected by various factors, such as age, obesity, and certain medical conditions.

Despite the complexity of this system, most people's healthy body is able to regulate their blood glucose levels efficiently and effectively, with minimal external intervention.

Complexity of Finance

This is in stark contrast to the financial markets, where the complexity and difficulty of monitoring and enforcing regulations often leads to inefficiencies and failures. This was pointed out eloquently 7 years ago by Prof John Kay on his book "other people's money" about The financialisation of the Economy and regulatory capture:

One of the biggest challenges in regulating financial markets is the problem of regulatory capture, where the regulators tasked with overseeing the industry become too closely aligned with the interests of the industry they are supposed to be regulating. This can lead to a situation where the regulators (in reality) are more interested in protecting the interests of the industry than in protecting the public interest. This is a serious problem that has been well-documented in many different industries, including banking, pharmaceuticals, and food.

(Regulatory capture also happens often in health sector, one worst example that led to millions death is Sackler's family's Purdue Pharma who might be able to escape jail time; watch talk about the great book on "empire of pain" with Patrick Radden Keefe).

Back to the latest bank run of Silicon Valley Bank:

Prof Anat Admati 's book and talk below is a must watch, as she pointed out 9yrs ago in Banker's new clothes highlighting inadequacy of equity of banks and regulatory capture, she's finishing the revision of the book, but might need some revision to add in SVB! (brilliant book review by Nobel loreate Roger B. Myerson )

As she pointed out , in the banking industry, regulatory capture has been a persistent problem for many years. Banks are some of the most heavily regulated industries in the world, with regulations that are designed to ensure that they operate in a safe and sound manner and that they do not engage in activities that could pose a risk to the broader financial system.

However, despite these regulations, Prof Adamati argued that much more equity than 6/10% is required, and despite that many banks (like Silicon Valley Bank who is bank of choice for startups and VCs) have been able to lobby and avoid the more stringent version of regulatory oversight (stress test, despite it being 16th biggest bank in US). Some might be exploiting regulatory loopholes or by using their political influence to shape the regulatory environment (Gregory Becker, CEO of SVB was director of San Francisco Fed until recently ).

Food industry

In the food sector, regulatory capture has also been a persistent problem. For many years, the food industry has been heavily influenced by powerful lobbying groups that have sought to shape the regulatory environment to their advantage. One notable example of this is the so-called "Fat & Cholesterol wars," the food industry also successfully convinced regulators and the public that fat was the primary cause of obesity and other health problems.

As a result, many food manufacturers began removing fat from their products and replacing it with margarine (which contains trans fat increases the risk of heart disease, the leading killer of adults). To Make food lower fat content palatable, sugar and salt were added, which all were marketed as healthier "Low FAT" alternatives. (There is more, food industry also successfully sued FDAs based on first amendments to be able to put "health claims" on food labelling to promote eating sugary cereals everyday!)

see fantastic professor Marion Nestle that explained it all on Food politics 10yrs old video here:

However, this strategy eventually led to a new set of health problems, as excessive consumption of trans fat, sugar and salt has been linked to a wide range of health problems, including obesity, diabetes, and heart disease. In response to these new concerns, the food industry has now turned to using artificial sweeteners, which are marketed as "natural" and "healthy," despite the fact that there is little evidence to support these claims. Indeed latest research shown such sweeteners may adversely affect our gut biome which may lead to mood swing and other unintended consequences, must read research by Prof Eran Elinav.

This regulatory capture in the food industry is a clear example of how industry influence can shape the regulatory environment, often to the detriment of public health and safety. It is clear that we need better systems and structures to prevent this kind of capture from happening in any industry, and to ensure that our regulatory systems are working in the best interests of the public. (what questions are raised in your mind now?)

So how can we learn from the way our body regulates glucose to improve our regulatory systems for financial markets and other industries? One key lesson is the importance of simplicity and transparency. The body's endocrine system is able to regulate glucose levels with minimal external intervention because it is a simple and transparent system, with clear cause-and-effect relationships that are easily understood, monitor and solution enforced.

In contrast, the regulatory systems that govern financial markets and other industries are often highly complex, opaque and cross jurisdictions (yes there is something called jurisdiction arbitrage, we need to write another blog post on that!).

Any Solution?

1) KISS (Keep it stupid simple):

All these complexity combined not only to put a veil on the workings of financial firms and line pockets of all the advisors and consultants, ultimately these make it difficult for regulators and the public to understand what is happening and to identify potential problems. Simplifying and streamlining these regulatory systems could make them more effective, while also reducing the potential for regulatory capture and other forms of industry influence.

There is a huge market opportunity (rather than short term valuation/exit play) for a firm to truly bridge the trust and confidence gap in finance/asset management across jurisdictions.

2) Diversification

Another key lesson from the way our body regulates glucose is the importance of diversity and redundancy. The body has multiple mechanisms for regulating glucose levels, including insulin, glucagon, and other hormones, as well as feedback loops that help to maintain a stable balance. This diversity and redundancy helps to ensure that the system is robust and resilient, even in the face of changing conditions or unexpected challenges. In finance, despite it is finance 101, have multiple banking relationships and back to basic is key, namely manage cash flow! I'm happy to see how 'cash management' is now being pushed by many VCs to their portfolio companies to do the basic better.

In contrast, our regulatory systems for financial markets and other industries often rely heavily on a single set of rules or principles, which can be vulnerable to manipulation or exploitation. Building greater diversity and redundancy into these systems could make them more resilient and better able to withstand unexpected challenges or attempts at manipulation.

3.) review and adapt

Finally, we need a feedback loop to continuously improve and measured against a universal moral bipartisan value (if we can find one!).

How do we review? must be based on facts, measuring against pre-defined metrics (not using consultants or audit firms who has no skin in the game! unless they will put up substantial amount of money and assets behind their opinion!).

Furthermore we need to guide them via moral yardstick, what I called Corporate parenthood. Goal should be simple, namely raise responsible and value adding firms (like kids and adults) that add rather than subtract value to the world. or are you a firm (child) trafficker that just wanted to create firms for quick sales for a profit?

How to truly fix Finance

This is ofcourse only a blog post, I don't propose a solution to everything of the world, although I do have a solution to fix finance, which is going back to basics. If likes of Garry Tan and Reid Hoffman and other soverign wealth funds want to join forces, we can easily create such new longer term equitable asset class within 9-12 months. It's not rocket science and we can solve and devise a better simpler and more viable version of ESG (corporate parenthood for mid market firms).

In conclusion, the regulation of financial markets and other industries is a complex and challenging task that requires careful attention to detail, transparency, and the avoidance of regulatory capture. By learning from the way our body regulates glucose, we can identify new strategies and approaches for improving our regulatory systems and making them more effective, efficient, and equitable. With the right structures and systems in place, we can ensure that our economy and our society continue to thrive, while also protecting the health and well-being of all our citizens.

Bailing out rich depositors this time (vs banks that had bad debts in 2008) can still create long term moral hazards by incentivising risky behavior, as others UHNWs may feel that they will always be rescued by the government. we will have to see how these all play out.

(Interesting regulatory capture development below on democracy now that showed the stringent Dodd-Frank rule that was watered down by senate/past president, and Frank who was on board of Signature bank when it went down!)

Some of you might want to know what I really think about this SVB Saga, I would have given you full load down if we were in a chatham house CXO lunch, and the story is still developing as we speak, I aim to if schedule allow organise a chat with Prof Anat Admati & John Kay others about this as they are the real expert!

But in brief, depositors money is generally safe (if there is no bank run), but there maybe some nefarious tech, fintech politicking going on, where combination of factors from bad risk management, bad communications, to opportunistic tweets for small group of crypto friendly bro's to create such 'bank run'.. Because now and no doubt in months ahead there will be push from the DeFi world saying they need to and can fix the financial system? (sadly the answer is no, not at Trillion level).

The Fed, US & UK governments stepped in to quell the fear was the right thing to do, but it is mostly to protect the uninsured losses (namely VCs and LPs) so read what you will, there should be strings attached to such help as we must learn from history, as TARP & other bail out back in 2008 has not changed the industry a bit sadly, partly also is because our present ultra-financialised economies worldwide and competing for the top line GDP growth is the only game in town. don't forget GPD is not such a great metric neither! see Prof Diane Coyle's video below:

In the end, it's crucial to remember the basics of finance (Finance 101!) - keeping a close eye on your cash flow. This is something that even ultra-high net worth individuals need to do, as some can still struggle with cash flow issues. It may seem daunting, but it's not difficult and you don't necessarily need an advanced financial education, like a two-year MBA, to grasp this concept (although, unfortunately, I did!).

Worth a read the below report on an older report in 2020 idea of "Wealth Economy".

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warmest regards,

Gareth 王