The FTX and Alameda Research crash, and how midterms affect stocks : The Indicator from Planet Money Crypto? Not doing well right now. But stocks? With elections soon to be behind us, history says they should be on the rise. This week's indicators explain the story behind FTX's bankruptcy and why markets love midterms.

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The midterm effect, and a crypto collapse

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SYLVIE DOUGLAS, BYLINE: NPR.

(SOUNDBITE OF DROP ELECTRIC SONG, "WAKING UP TO THE FIRE")

DARIAN WOODS, HOST:

This is THE INDICATOR FROM PLANET MONEY. I'm Darian Woods. And today I'm joined by one of my favorite people from the wider Planet Money universe, Sarah Gonzalez. Welcome to the show.

SARAH GONZALEZ, BYLINE: You're one of my favorite people, Darian. Thanks.

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UNIDENTIFIED PERSON #1: Yo.

WOODS: And you're here for indicators of the week.

GONZALEZ: I'm feeling it. I'm ready.

WOODS: All right. We've got two indicators today. One is about FTX, a giant cryptocurrency exchange that just filed for bankruptcy.

GONZALEZ: And how the stock market reacts to midterm elections.

WOODS: That's all coming up after the break.

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GONZALEZ: All right, Darian, you're up first with this, like, major crypto exchange that is basically imploding right now. Where do we start?

WOODS: Yeah, so my indicator is $32 billion.

GONZALEZ: Big indicator.

WOODS: I'd say that's huge. It's the amount of value that has disappeared from FTX. Earlier this year, investors were valuing it at 32 billion. And now, one of the venture capital firms that invested is valuing it at $0.

GONZALEZ: Thirty-two billion to $0?

WOODS: Yes.

GONZALEZ: Holy moly. OK, I have to admit, I had not actually ever heard FTX until this week.

WOODS: That might be true. But a lot of people heard about FTX in the Super Bowl.

GONZALEZ: Oh. They had a commercial. Of course.

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UNIDENTIFIED PERSON #2: (As citizen) I call it the wheel.

WOODS: You've got a stone wheel.

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LARRY DAVID: (As leader) What does it do?

UNIDENTIFIED PERSON #2: (As citizen) It rolls.

DAVID: (As leader) Yeah. So does a bagel. OK? A bagel, you can eat.

WOODS: Larry David here, shilling for crypto.

GONZALEZ: It's, like, an expensive commercial.

WOODS: Yeah. I mean, they were riding high at the time. But their fortunes have kind of fallen back to Earth this week. So FTX froze users' withdrawals, and that has shaken up the crypto world, in general. The protagonist is Sam Bankman-Fried, and he goes by SBF.

GONZALEZ: The FTX guy goes by SBF. OK.

WOODS: So anyways, Sam Bankman-Fried - he's a 30-year-old guy with a mop of hair. He wears shorts a lot. He's really earnest, and he's kind of been seen as the good guy in crypto, even though he was worth an estimated $15 billion before this week. He'd go to Washington, D.C., and he'd lobby in support of more regulation of cryptocurrencies. Here he is testifying at a Senate hearing earlier this year.

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SAM BANKMAN-FRIED: ...Agree. I would love to see the CFTC play a more active role in licensing and regulating the digital asset space, and I agree that that will likely...

WOODS: And he's been giving a lot of interviews. He seemed super transparent about what he was doing and - including with NPR's David Gura in June, about how he could even step in when other crypto companies were facing trouble.

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BANKMAN-FRIED: I do feel like we have a responsibility to seriously consider stopping it - even if it's at a loss to ourselves - to spread contagion, and even if we weren't the ones who caused it or were involved in it.

WOODS: And to understand what went wrong this week, you need to know that he has businesses in two separate categories - an exchange and a trading firm. So the exchange is FTX, which at its heart is just meant to be a matchmaker. It matches crypto buyers with crypto sellers, like the stock exchange. And then on the other side, SBF also founded a crypto trading firm. And that is a company called Alameda Research. And Alameda Research borrowed and speculated and tried to make money in crypto. And, in theory, this is still legal.

GONZALEZ: OK. So you have this, like, boring exchange as one company and then the more risky moneymaker on the other side - two separate companies.

WOODS: Yeah. But SBF is heavily involved with both.

GONZALEZ: OK.

WOODS: And it's been reported that several months ago, Alameda Research made some bets that went badly. So it needed to borrow some money. And there has been reports from the Wall Street Journal that it borrowed around $10 billion from FTX.

GONZALEZ: Oh, so he borrowed from his other company.

WOODS: Yes.

GONZALEZ: OK.

WOODS: And that shouldn't have happened the way it did. Where did FTX get that $8 billion from? Well, part of it happened from the accounts of everyday people just using FTX to buy and sell crypto.

GONZALEZ: Oh, OK.

WOODS: You know, in the everyday banking world, this kind of thing would not be allowed. But to make matters worse, there was this problem with the collateral that Alameda Research used to borrow the money. So, you know, collateral, you often use when you borrow money - like, maybe a house if you're getting a home loan.

GONZALEZ: Right. So the bank can just, like, take your house if you don't pay back your loan, right?

WOODS: Yeah. And in this case, Alameda Research's collateral was a token issued by FTX. So the whole thing was just kind of a snake eating its tail. It wasn't very useful collateral whatsoever.

GONZALEZ: It keeps getting sketchier and sketchier.

WOODS: Exactly. So it was all just based on confidence. And then once that confidence started to, you know, disappear a little bit, then everything kind of collapsed. And so SBF called out for help from his former mentor, Changpeng Zhao, or he actually likes to be called CZ, and he is the CEO of the largest crypto exchange, Binance. And these two people don't always get along. Like, for one thing, he is not a fan of more crypto regulation, like SBF is.

GONZALEZ: OK.

WOODS: And on Tuesday, SBF announced that CZ's company, Binance, was looking into bailing out FTX. But then, the next day, on Wednesday, CZ backed out of the deal. He said, quote, "the issues are beyond our control or ability to help."

GONZALEZ: Wow. Brutal.

WOODS: Pretty honest. And that day, it was reported the Securities and Exchange Commission and the Department of Justice were investigating FTX, not to mention more overseas investigations. And this morning, FTX and Alameda Research were filing for bankruptcy. And SBF resigned as FTX's CEO.

GONZALEZ: Oh, my gosh. It just keeps getting worse.

WOODS: So overall, looking at this, it's been pretty fascinating to watch this $32 billion go up in flames, and this huge fall from grace for SBF. And - big picture - I mean, this could be the spark for what SBF was kind of asking for all along.

GONZALEZ: Stronger regulation of crypto - yeah.

WOODS: Exactly. Yes. Yes. So it could look more like regular financial markets in the future. And regular financial markets are what you're going to discuss. Take us away.

GONZALEZ: OK, yeah. I want to focus on the standard stock market, especially after a midterm election. So my indicator - I'm playing a little fast and loose with it here, but it is four, as in the midterm elections, which happen every four years.

WOODS: Got it.

GONZALEZ: A little bit of a stretch, but the midterms and the stock market have this, like, pretty consistent, serious, long-term relationship going on.

WOODS: OK. Is a ring involved?

GONZALEZ: So usually after a midterm election, the market goes up. This is pretty well documented. It's pretty consistent, since the year 1950. After every single midterm election, the market does a lot better - no matter which party wins, no matter which party is in power.

WOODS: So is there, like, a rational reason for this?

GONZALEZ: Yes. So the midterms, generally, are when there's, like, a big shift in who controls the House and the Senate, right? So typically, whoever is president during a midterm election - their party does really poorly, right? The other party ends up taking control of one or both houses or keeping control if they already had it. So there is this split government. So, for example, like, if the House and Senate are both controlled by Republicans but the president is Democrat, that's a split government. Or if the House and Senate are split, that's considered a split Congress. And the stock market, apparently, really loves a split government.

WOODS: Wow. Maybe the only part of society that loves a Congress that can't get anything done.

GONZALEZ: Yeah. Right? And it is because the stock market sort of gets, like, reassured that no big policy changes, no big spending is going to go through in the next two years because, basically, nothing happens when there's a split...

WOODS: Right.

GONZALEZ: ...Government - right? - when there's gridlock.

WOODS: It's a bit of a breather.

GONZALEZ: Yeah. When there's gridlock, no one can pass any laws. And so there's a lot less uncertainty, which, of course, the market loves.

WOODS: And - OK - that's starting to make sense. Now, at the moment, we still don't know the final results.

GONZALEZ: Right. It's still too close to call. But I do want to say that all of this is just kind of, like, historically speaking - right? - all of this might not actually mean a whole, whole lot this year, just because there's so much going on right now. We had historic spending because of the pandemic, high inflation, high interest rates that the Federal Reserve says needs to stay high. People are worried about a recession. There's Russia's war in Ukraine. All of this will affect the stock market, though. So, like, who knows? An interesting thing is that, like, a certain split is apparently more market friendly. And it is when there is a Republican Congress under a Democrat president. That is apparently the best environment for stocks.

WOODS: Thank you so much for joining indicators of the week, Sarah.

GONZALEZ: Yeah, of course. Thanks, Darian.

WOODS: This episode was produced by senior producer Viet Le, with engineering from Robert Rodriguez. Dylan Sloan checked the facts. Kate Concannon edits the show, and THE INDICATOR is a production of NPR.

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