Teetering on the brink of insolvency, Morgan Stanley’s CEO, John Mack, agreed to sell 25% of the bank to Mitsubishi Financial Group on the Sunday before Columbus Day.
“Companies can’t be great unless they’ve almost failed.”
— Bill Taylor
RiskingFailure
Every year, equities traders bemoan the injustice of Columbus Day — it’s a holiday, but only for banks: Markets remain open, so traders have to go to work.
In 2008, that grave injustice threatened to sink the entire financial system.
Teetering on the brink of insolvency, Morgan Stanley’s CEO, John Mack, agreed to sell 25% of the bank to Mitsubishi Financial Group on the Sunday before Columbus Day.
But the money could not be sent by wire until Tuesday, because, due to the holiday, banks were closed Monday.
But not markets! Morgan Stanley stock would open for trading at 9:30 am Monday morning, come what may.
The crisis was so acute, however, that announcing they would receive the Mitsubishi investment on Tuesday — the very next day — was not good enough.
To restore confidence in both Morgan Stanley and the entire global financial system, Mack felt he had to be able to tell the world they were in possession of the money prior to the stock market opening.
He felt that in part because the government told him so: Treasury Secretary Hank Paulson had sternly warned him that, “markets can’t open Monday without a resolution of Morgan Stanley. You need to find a solution.”
The solution turned out to be Mitsubishi writing the largest physical check in history — for $9,000,000,000.
(Largest in amount, not size. It was sadly not presented to Mack in the form of a giant comedy check, like the ones lottery winners get.)
Having fallen 60% the week before, Morgan Stanley shares shot 80% higher Monday morning — all on the news that the bank was in possession of a rectangular piece of paper with a large number on it.
That weekend rescue of TradFi was played out behind closed doors — just as was the case when JP Morgan bought Bear Stearns on a Sunday night and Bank of America bought Merrill Lynch early on a Monday morning.
In DeFi, by contrast, the weekend rescues are played out on Twitter.
The Confidence Game
Banking, be it of the TradFi or DeFi variety, is a game of confidence.
Every bank’s first and most important job is to convince depositors that their money will be there for withdrawal — in full — whenever they ask for it.
In October of ‘08, Morgan Stanley was quickly failing at that job: Despite having just reported a quarterly profit of $1.4 billion, the bank was hemorrhaging tens of billions of dollars in prime brokerage deposits — it was a modern-day bank run.
Morgan Stanley stopped that run with the giant check from Mitsubishi, earned after a long weekend of manic negotiating, that temporarily restored faith in the financial system.
Sometimes it takes longer than a weekend: FDR saved the banking system in 1933 by simply closing every bank in the country for a full week.
DeFi, with its 24/7 markets, does not have that luxury.
Crypto has the advantage of instant settlements: No check-writing required.
But it has the disadvantage of never being closed: No weekends to negotiate confidence-restoring interventions.
A Web3 bank run can start at any time of night, weekday or weekend. And that is what happened Saturday when sales of UST withdrawn from the Anchor protocol caused DeFi’s largest algorithmic stablecoin to fall as much as two cents below its peg, a substantial discount for something that is intended to be a digital dollar.
The response to this run on UST has so far resembled the run on Morgan Stanley in 2008; in both cases, intervention was necessary to restore confidence.
UST was resilient this weekend, in part because of the burn/mint mechanism that is designed to automatically stabilize it, but mostly because of reassuring tweets from Do Kwon and the Luna Foundation Guard (LFG).
And with UST back below 98 cents today, it seems clear that regaining the peg at $1 is contingent primarily on additional confidence-boosting actions by…Do Kwon and the LFG.
This is not a sustainable model: Do Kwon’s sleep schedule cannot be a risk factor forever.
Which is something he is well aware of. By design, the UST airplane is being built mid-flight — it’s just not yet ready to fly on autopilot.
This is UST’s second bank run. The first was in May of last year, when it traded down to 96 cents before regaining its peg a day or two later.
It’s a much bigger test this time around, however, because UST is itself much bigger, with a significant presence on many more chains and exchanges.
Maintaining a stablecoin’s peg across different chains and exchanges is a complex process which has not been entirely worked out as of yet.
And the current run comes just as UST’s yield on Anchor has been cut for the first time and UST’s liquidity on Curve is moving from the 3Pool to the 4Pool.
So it makes sense that intervention is needed at this stage of UST’s development — today is not the day to see if it can stand on its own two feet.
But at some point, UST will have to prove it can absorb large withdrawals strictly with its burn/mint mechanism.
It won’t ever gain the market’s full confidence until it does.
For UST to be great, Do Kwon and LFG will eventually have to let it almost fail.
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