It may be hard to believe, but not long ago, a leading debate in US politics was over how best to regulate reckless financial activity. Until the 2016 Democratic primaries, financial regulation was a major issue, with the two major candidates displaying starkly different approaches to dealing with Wall Street.

This attention was the natural consequence of the massive financial crisis of 2008, which led to millions of layoffs and millions of foreclosures. Problems such as too-big-to-fail banks, excessive securitization, and proprietary trading with other people’s money were seen as among the biggest problems facing the nation. But memories fade, thoughts shift to other priorities, and the pendulum begins to swing from strict financial regulation to lax financial regulation.

It all started in 2018, when Congress passed the largest bipartisan bill of the Trump era large regional banks deregulated in a way that helped lead to the collapse of Silicon Valley Bank and a Federal Reserve-led bailout for its depositors last year. Tightening capital requirements to make banks safer, which was supposed to take effect under President Biden, worked blocked amid an epic backlash from the industry and its ilk allies in civil rights groups. The cryptocurrency industry has essentially he bought himself a Congress and is working to install a regulatory structure without interventions for his house of cards.

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In this period of deregulation and abandonment of finance, approximately 200,000 customers of fintech “neobanks” have been cut off from their deposit accounts, even as the level of public outrage has barely risen above a whisper. Finance has become so invisible that even financial abuses that amount to separating people from their money don’t spark much discussion.

In this case, the desperation of these fintech customers was entirely predictable and even expressed in a Treasury Department report almost two years ago. The fact that the risks were known at the highest levels and not taken into account reveals how inattention to the dangers of finance can feed on itself. Without public awareness of the inner workings of finance, catastrophes can happen before our eyes.

THE chaos at Synapse, a bankrupt and defunct intermediary that enabled neobanks to offer app-based deposit accounts, seems beyond repair at this point. Jelena McWilliams, former chair of the Federal Deposit Insurance Corporation (FDIC) under Donald Trump, who has been appointed Chapter 11 receiver for the company, declared in a judicial document last week that Synapse partner banks are holding between $65 million and $96 million less than the fintech firms say customers are owed. This is a potentially greater deficit than the estimate provided the week before.

What’s worse, McWilliams said in the report, “a full, last-dollar reconciliation with the Synapse ledger and Fintech Partner ledgers may not be possible.” The trustee does not even believe he has the authority to direct funds from partner banks to clients. That means the stalemate will continue unless the bankruptcy judge intervenes.

Fintechs have no capital or liquidity requirements, as we are now seeing in real time.

The reasons for this failure to ensure the integrity of depositors are murky and complex. This could be anything from Synapse mixing customer money with operating funds, as has been statedor a banking partner who withdraws more client funds from joint accounts than they were entitled to, as has also been stated from the former CEO (who, in another case of upward failure, just got $10 million in seed funding start a robotics company).

Either way, regulators find themselves hamstrung by the controversy. Since Synapse is not a bank, there was no bank failure, so the FDIC cannot intervene. The banks in question are small, which removes them from the direct oversight of the Consumer Financial Protection Bureau. Last Friday the Federal Reserve, the main regulator of Evolve Bank & Trust, the partner bank most involved in the chaos issued an executive order against Evolve for failing to put in place an effective risk management program to manage fintech partnerships, as well as deficient compliance programs for anti-money laundering and consumer protection. But the Fed went out of its way to say that the enforcement action was “independent of the bankruptcy proceedings involving Synapse Financial Technologies.” While Evolve can’t pay dividends or raise its debt without Fed approval, that doesn’t get end users any closer to their money.

Despite this paralysis, at least one corner of the federal regulatory apparatus anticipated this. On November 16, 2022, the Treasury Department issued a report at the White House Competition Council on the entry of non-banks into the consumer banking space. The summary makes clear that while neobanks have succeeded in increasing competition for deposits, with potential benefits for consumers, there was a problem: “They are generally not subject to the same oversight for safety and soundness or protection of consumers… which raises various public policy considerations.”

Instead of becoming banks themselves, a costly practice that would confer all these regulatory compliance burdens, fintechs partner with banks that (supposedly) offer consumers deposit insurance protections. This creates a situation where banks are “both direct competitors and collaborators,” but more importantly, it creates regulatory gaps.

Fintechs have no capital or liquidity requirements, as we are now seeing in real time. There is no continuous supervision of their activities. They are subject to CFPB consumer protection laws and potentially state licensing regimes, but it’s a patchwork that doesn’t address core banking practices. Partner banks are supervised, as the Fed-sanctioned Evolve Bank makes clear. But, the Treasury report concludes, “if the fintech firm… provides the services to consumers, then the federal banking regulator’s ability to regulate and examine the services related to consumer banking provided by the third-party fintech company could be more limited”.

This is exactly what happened here. Synapse has proven to be an unreliable partner for its fintech partners. No one on the fintech side or the banks was prepared for the disorganized collapse of the intermediary that held them together, and no one on the regulatory side was monitoring Synapse, which sat between the banks and the fintechs, for safety and soundness. And now around 200,000 customers, according to the most credible estimate, are paying the price of being excluded from their deposits.

“If conducted responsibly, bank-fintech relationships can be beneficial to competition and consumers,” the report highlights. “However, the increasing variety and complexity of these relationships highlights the need for a clear and consistently applied supervisory framework to strengthen the banking regulatory perimeter and protect consumers.”

The report recommends coordinated and strengthened oversight for bank-fintech partnerships: “Regulators should thoroughly supervise bank-fintech lending relationships for compliance with consumer protection laws and their impact on consumers’ financial well-being.” What followed, however, was anything but robust. Last year, major banking regulators guidance issued on how banks should interact with fintechs and other third parties, but they were quick to add that the guidance “does not impose any new requirements on banking organisations” and is more of a useful piece of advice for managing a relationship with third parties.

Although the guidelines stated that banks were ultimately responsible for any shortcomings in dealing with third parties, regulators left it up to partner banks to decide whether to do business with fintechs and how those banks could add compliance practices and risk management in any situation. contractual agreements. The type of oversight you would see at a regular depository institution is not present with fintechs.

There are still diligent financial regulators working to rein in finance. The Consumer Financial Protection Bureau is at the height of its power, so much so that big banks are accepting its rules, such as limit late fees on credit cards, even while they are still before the courts. The FDIC simply failed Citigroup on his living will, which is supposed to provide a roadmap for the liquidation of complex financial institutions and, if found wanting, could be used as a pretext to break up big banks.

But finance is a multi-headed hydra, always moving and maneuvering to evade oversight and maximize profits. The depressing thing about this particular strand of financial innovation is that the dangers of the fintech business model were completely visible to the diligent regulators themselves. The problem was that no one else really bothered to implement the recommendations until it was too late.

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