Money Talks: The Synapse Scandal
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Hello and welcome to Money Talks from Slate Money. I'm Felix Salmon of Axios and this is the show where we talk to some of the smartest and most awesome people in the world about money.

Thanks for having me, Felix.

just works. It's one of those things that no one ever needs to worry about. And now suddenly, it's something that people need to worry about. And you have found a whole bunch of people who had money in FDIC insured bank accounts who lost their money. Is that basically the top line here? That's right. Yeah.

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Subject to credit approval. Apple Card issued by Goldman Sachs Bank USA, Salt Lake City branch. Terms and more at applecard.com. So the big picture here, as far as I see it, is that

In the 1930s, a bunch of banks failed and depositors lost their money through no fault of their own. And the government was like, it is ridiculous to expect hardworking Americans to become basically amateur bank analysts before they open a bank account somewhere.

If there is a depository institution, we are going to force that depository institution to pay into an FDIC insurance fund. And then the government will guarantee all of the deposits. And that way, Americans don't need to worry about where their money is. They know that it's safe. And then you don't get bank runs and there's all manner of, you know,

societally optimal outcomes if you have that sort of government backstop. And the whole point here is that you're not putting the onus on Americans to try and work out is their bank safe or is their bank not safe. If they're dealing with a deposit-free institution in, you know, 1957, then that deposit-free institution is FDIC-insured or maybe NCUA-insured, and they don't need to worry about anything.

And then at some point in the past couple of decades, that changed. And a whole bunch of depository institutions sprung up, which were accepting deposits and were not actually themselves FDIC insured. And that, to me, seems like it's a failure of the government and not the failure of the

to sort of like realize that when they put money into an Apple wallet or a PayPal wallet or a Cash App wallet or wherever it is, that they're not getting the FDIC insurance that they would if they put money into a JP Morgan bank account. And the minute that these depository institutions started springing up, the government should have said, look, this is fine. You're depository institutions, but as a depository institution, you need to

pay into the FDIC insurance fund, just like everyone else. And then we will insure deposits up to $250,000, just like we do for everyone else. And they never did that. And so now we're in this situation where you have this two-tiered system and the onus is back on the individual Americans. It's back on the consumers to try and get to the bottom of whether or not their money, if it's sitting at Cash App or whatever, is actually insured or not. And

Making that determination is astonishingly difficult, even if you're a professional financial journalist, as I am. I've tried to do this in the case of something like Cash App. You wind up disappearing down rabbit holes, and it's very, very hard to get a straight answer. That's silly. The whole point of deposit insurance is that you shouldn't have to do that. You shouldn't have to worry. It's just automagically there.

That's been lost. And that is the thing that has to be fixed. I agree with your sentiment. We talk about too big to fail. The Yotta customers are small enough to allow to fail. And so until somebody changes my mind, until the Fed decides to take action, the regulators have made a call that we are okay with allowing failures.

tens of thousands of people. Well, at the beginning of this, there were, call it, between 100,000 and 200,000 fintech customers, Yada and other fintechs called Juno and Copper and Curricup, Yieldstreet, all these obscure companies. They didn't have access to their accounts for, call it, four to six months. They allowed that to occur. And then now at the end of it,

Randomly, some tens of thousands of them have been selected, in a sense, to bear the brunt of a shortfall that existed at the very beginning. And it was avoidable in many ways, but the regulators have allowed this

two-tiered system to occur. Did they do that on purpose, or did they do that just by negligence and not keeping up with technology? More the latter. Depending on the administration, the feeling was certainly that they didn't want to regulate fintechs because they didn't want to be responsible for them. They didn't want to encourage their existence. They were anti-innovation, was the critique.

But they certainly allowed a situation where fintechs could partner with real banks. And then in that case, you have to depend on the regulators to be regulating those real banks.

And they've done so retroactively. So the FDIC says we have got a new proposed rule that, guess what? The onus is on the banks to keep the ledgers and make sure that they know who's got the money. So in the event of failure, at least we know we have a sense of who should be getting the funds in a bankruptcy if a fintech were to fail and the bank was still around. Who knows?

Yeah, I remember a couple of years ago, the FDIC got very upset at a bunch of crypto companies, including FTX, back when we thought that FTX was a reputable company. And the CEO of FTX US was like, pay your paycheck into FTX and we will...

put your money into an FDIC insured bank account. And then if you want to, you know, convert some of it to crypto or whatever, it's going to be really easy and you can do it all through FDX. And the FDIC got really upset about this. They're like, you only can use our name

if you are the actual institution that's insured. And if the FTX is transferring money into a bank account, they can't use the name FDIC because they are not themselves FDIC insured. And a whole bunch of crypto people and pundits were like, this is really dumb. They're just saying that the bank account is FDIC insured. They're not saying that they are FDIC insured. And the FDIC was like, no, no, no, no, we're clear about this. And now I'm beginning to understand

why the FDIC was so clear about this because it turns out that if you go to a company that says I'm going to put your money into an FDIC insured bank account that company could just

be lying. You don't have any way as a consumer to actually know whether or not they've done it. And that's the issue that's been exposed by this Synapse mess. The companies that use Synapse, so Synapse was middleware. They were the guy standing in between the fintechs. And look, these are pretty obscure fintechs. I only heard about them when this crisis occurred.

The most prominent one in this mess is something called Yotta, which was started by Adam Mollis, who happens to be the son of the Mollis investment banker with the investment bank to his name. And so this was a gamified kind of savings app that promised people a little bit of fun and sizzle to their savings and higher interest rates. And so this was something...

that had a bit of traction, that had more than 100,000 users, and that used Synapse as the middle man, basically keeping a ledger, saying this is how much each individual person has in their Yotta account. And then behind that was another institution, was the actual FDIC bank, a bank called Evolve.

And for you to trust that you actually have the FDIC coverage, which is what Yotta advertised with the express approval of Evolve Bank, you would have to trust that they kept the ledger correctly. So you would have something called pass-through insurance from the FDIC. And in this case, there are a couple of failures. One is when Synapse went under, it turns out that the reminder to everybody in the country is,

FDIC insurance is for banks failing, not for fintech companies failing or for middleware providers failing. So people who thought that they were covered because after all, nobody in the history of the FDIC has ever lost a single penny in an FDIC-backed account. They had that assurance. They thought that applied to them. Turns out it has not applied to them.

So let's just be a little bit clearer about what happened in this case. I put my money into Yotta. Yotta takes my money and gives it to Synapse. Synapse takes my money and puts it into Evolve. And then Evolve, which is an FDIC-insured bank account, takes my money and looks after it and is FDIC-insured.

And that whole chain is a little bit wobbly, especially when there's a company called Synapse in the middle that can go spectacularly kaput. Somehow, with all of this pass-through yada yada, Yotta was allowed to tell its customers that their money was FDIC-insured. It could use the FDIC name, even though it itself was not FDIC-insured. They did. Yeah.

But did they do so? Was the FDIC okay with that? Did they have permission to do that? Or did they just do that kind of fintech-y ask for forgiveness rather than permission and go ahead and do it without permission? The evolution of what's happened in the fintech space was a much bigger player called Chime. I think a couple of years ago actually said, or let people think that they were the FDIC insured entity. When they got wrapped on the knuckles by the FDIC,

they made it clear that Chime is not a bank, but guess what? Bancorp or whoever our bank is, member FDIC. And so it just evolved to a state in which the fintech just points to the underlying bank and says, member FDIC. And the user got to the same place, which is Yotta. Yeah, they're the fintech. They're the wrapper. They're the app. But behind it is a real bank. And so therefore...

my money is as safe as safe can be. If I'm at Chime and then Chime goes bust, but Bancor doesn't, then I still have my account number and routing number at Bancor and I can access my money directly from Bancor. So long as I have that bank account and I know where that bank account is, it should be okay. Should be.

The reality is, and this gets complicated pretty quickly, they've used these huge pooled accounts. They're a gigantic pile of money called an FBO account. And a lot of fintech programs use this. So basically the idea is that 10,000 Yotta customers all put money into Yotta. Yotta gives that umpteen million dollars to Synapse, who gives it to Evolve. And then it's just sitting in a huge Evolve bank account with gazillions of dollars in it.

And the only person with individual records of who is owed what is Synapse, who is this tiny little startup who can go bust overnight. What exactly was the value that Synapse was adding here?

So tons of startups, they want to offer bank-like services. They want to offer checking counts with debit cards that people would put their direct deposit in from their wages or their gigs or whatever. There are a lot of people who are not properly banked in this country, people who don't make enough money or people who've overdrafted out of accounts.

They're now on blacklists. They can't get Chase or B of A accounts. Or they just like the simplicity or they like the higher interest rates, whatever. There is a cohort of fintechs who want to quickly offer up these services without going to the

the work of having a bank charter or buying a bank like Lending Club did or SoFi. On the other side of the equation, you have a whole cohort of banks who are marginal based in places that aren't New York or on the West Coast.

And, you know, they don't have national deposit-taking gathering franchises, and they're hard up for deposits, and they're getting squeezed by the likes of JP Morgan and Jamie Dimon. As a result, this was a lifeline for them. This is a way for them to quickly gather deposits in a way that solved the problem for them. These little banks, they don't have the compliance personnel to deal with this. They never did. And

That's why you've seen a slew of enforcement actions against them. And they're banks based in Tennessee or Arkansas, places like that. They don't have the talent. They don't have the resources to do so. But yet they decided to join this revolution. So basically, we then wind up with this situation where there's a giant pool of money, which belongs to a huge number of people. And...

The only company that knows who's owed what is Synapse. Synapse goes spectacularly bankrupt very quickly. And most of the customers of Yotta got all of their money back. And then a relatively small percentage of customers of Yotta basically got none of their money back. And there doesn't seem to be any rhyme or reason about, except for just sheer luck of the draw, as to which bucket you land in.

I would say that's right. The bankruptcy proceedings, as they began in April, pretty soon after that, the bankruptcy trustee, who happens to be a former FDIC chair, Elena McWilliams, she identified a shortfall of up to $95 million. So the problem wasn't even that the fintech blew up. The real problem was when it blew up,

there was a lot of fucking money missing. When you say a shortfall, the total balance at Yarta was, call it, $500 million, and the total balance at Evolve was $400 million. And then in between, there was like $95 million that was meant to be at Evolve and wasn't, and everyone kind of suspects that Synapse had sort of absconded with it or spent it somewhere along the way. And Felix, it gets even more complicated than that, which is about a year ago,

As Evolve and Synapse were increasingly fighting over shortfalls, what Evolve chose to do was

I'm sorry, what Synapse chose to do was say, we're wed to one bank. It's been our main bank from inception 2017 to 2023. There's a lot of risk to that. We're fighting all the time. There's three other even tinier banks by the names of AMG, Lineage, and American. And they're going to be our suite partners. We're going to sweep all the deposits from Evolve into these three banks, increasing the complexity and the chances that something would break

And so what we know is among these four banks, there should have been something like 265 million, something like that for all these users. And there was anywhere between 65 and 95 million dollars. That was a shortfall that was missing. We have to have a quick ad break, but we'll be back with more about the Synapse shit show.

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It pays to discover. Based on the February 2024 Nielsen Report. Learn more at discover.com slash credit card. So the banks claim that they're not on the hook for the shortfall. Because why? Explain why this isn't their problem. It's a bit of a Mexican standoff at this point. The end of a Tarantino flick, I guess. Evolve says, and by the way, so the day before the elections, I think this is November 4th, was when they chose to let people know

Hey, go to this portal and see what you have coming to you. And like we said, a lot of people were made whole and lots of other people,

some of whom who had $283,000 were told they were getting $582. And do you have any visibility at all into how those determinations were made? Because I thought if Synapse were the only people with the ledger and they weren't telling anyone, how did Evolve come up with a number for anyone at all? Yeah. So, I mean, it's been six months of bankruptcy court processes and court-mediated efforts to try to get their stuff together. And so we all by now agree what people's deposits are.

It should have been. So that number is not controversial. They were able to reconstruct it. They did what's called a reconciliation. What they haven't been able to do is figure out where the missing money went. And if it was synapse,

or these three other newer banks or evolve who should account for that money. It is a mystery. Okay, so this is where I'm going to have to ask about Andresen Horowitz, which I hate doing because we talk about them way too much on this show. But there is a lot of talk out there that if out of the goodness of its heart and out of the billions it has sloshing around, Andresen Horowitz would just spend two or three million dollars to do some kind of a

or the reconciliation thing at Synapse, then that could answer a lot of burning questions. But it sounds to me like

That audity reconciliation thing has already happened and people know how much they're owed. What more could Anderson Horowitz do at this point? Yelena McWilliams, the bankruptcy trustee, has been very clear. They don't have the money to pay for it. And it would cost to begin with two to three million dollars to do an independent third party global reconciliation, which could tell you not just this is what I'm owed, but

but this is where the money is. And that's what's never been done. It's never been done, Felix. So the insane thing is it's not a whole lot of money, actually. You would think that you should be able to get these parties together, knock their heads, force them to all come up with a percentage of it and get it done immediately.

it hasn't happened. Do you think there's a strong sort of just moral case that Anderson Horowitz should, should step up and, and write that check? From where I sit? I mean, it's, yeah. I mean, for starters, there's a lot of,

You could point to a lot of different folks. They're one of them. Is Evolve Bank a relatively rich bank? Like, does it have $2 million lying around that it could use? Presumably, it's already spending a couple of million dollars just on lawyers to extricate itself from all of this. They claim that they've, at their own expense, have done a reconciliation effort.

Now, in the beginning, they claimed they were going to do a real global reconciliation that would tell you everything. And at a certain point, they pivoted and said, we couldn't do that. We couldn't do that because there's huge remittances that were bulk remittances with unidentified IDs. And

They threw their hands up and said, the most we could tell you is how much we have. And that's why you're getting like, you know, in some cases, pennies. So explain how they determined that. Like they had this giant pool of money, which was for the benefit of a huge number of people. Some large chunk of that giant pool of money got transferred to presumably one of these three other banks, or at least that's what Synapse would say. And they're like, well, now there's less money to go around. What was the mechanism whereby...

Evolve basically said, okay, you who's owed $73,200, you get $73,200, but you who's owed $285,000, you only get 60 bucks. It's a mystery.

And I can say that because as you have sort of the sides kind of forming, AMG, Lineage, and Yotta have both cast aspersions at Evolve saying, we don't know how they came up with these figures. We don't know how they did their reconciliation, and they're not sharing it.

And the sense is, certainly from the judge in this case, the sense is that there's going to be litigation. There already is a ton of litigation. And the rationale for people to actually help each other, for these parties to help, is less and less as the weeks go by. I believe this whole situation can be fairly characterized as somewhere between a shit show and a clusterfuck. Given the risk of that, would it not make sense for your average American punter to just be like,

There's no fucking way I'm going to hand over my money to any shiny neobank which doesn't have its own direct FDIC insurance. Because otherwise, I'm just somewhere in a tech stack and any failure anywhere in that tech stack could end up evaporating my money. It's the takeaway, for sure. It's certainly what the FDIC wants you to believe. And there are tons of people in the tech community who back...

a lot of these startups who feel like it's an unfair takeaway and the regulators are treating the fintech community unfairly. But what's the argument that that's an unfair takeaway? Let me take a step back. Even in the largest of examples of this would be Cash App, would be PayPal, would be the Apple Wallet. So for instance, with the Apple Wallet, they use Green Dot.

you don't necessarily have FDIC coverage there. You actually have to go to Green Dot and specifically opt into it. And the language in the disclosures is then you may qualify for FDIC insurance. My point being, even in the largest and the most protected from disaster type fintechs or fintech services, you're not guaranteed FDIC coverage. And you don't even know that they've done the steps to qualify for FDIC coverage.

The countage to that is that regulators have unfairly not allowed these innovators into their regulatory perimeter. And they've created a walled garden and they want fintechs to die. One of my slogans for a long time was that financial technology or fintech is 1% inspiration and 99% regulatory arbitrage.

And this seems to be like a prime example of that. You get these banks coming along and basically saying, well, we're not really a bank. We're going to be very careful not to use the word bank in our name. And

not to have to deal with all the compliance costs and regulatory overhead involved in actually being a bank, let alone applying to become a bank. And we're just going to, you know, outsource all of that to some other bank and we'll be the whiz-bang front end that lives in an app on your phone. And that makes us very competitive.

asset light and our VC investors will be able to get massive returns on their investment because we're not a bank. And any normal person looking at that just goes, no, that's just regulatory arbitrage. You're not doing anything useful here except for just basically taking money as though you're a depository institution when you don't have the regulatory overhead that all of the other depository institutions have.

have to do. And if you are Jamie Dimon or any normal banker, you can see why the bankers would get upset about that because they have to employ thousands of compliance officers to make sure they tick all of the boxes that the FDIC and everyone else forces them to tick. And then suddenly this new bank comes along and says, hey, guess what? We don't need to do any of that. We'll just sign up

Some company called Synapse, they'll worry about all that. And all we need to do is hire three coders to create an iPhone app. Nothing you say is incorrect in my view. I would point out, though, and certainly after the financial crisis, when the burden seemed to rise for the incumbent bank industry, they would tell you that it's not profitable for them to bank a pretty big cohort of the country.

And as a result, you have a lot of folks who are not well served by banks. And so that's the true service when these fintech guys get high minded, right? You're absolutely right. The flip side of this is that for all the regulators love to rend their clothes and gnash their teeth about the plight of the unbanked and the underbanked, these things are defined

very narrowly. And if you include anyone with a Cash App account, the number of people who are unbanked is actually at all-time lows and really very small. It's so easy now to open up a wallet on your phone with Cash App or with Apple Wallet or with anyone else, and people do. And these wallets come with routing numbers and account numbers, so you can get your paycheck, direct debit in. They really behave like bank accounts in all the important ways.

And that has been a massive revolution in banking America. These people who never used to have bank accounts now have bank accounts, and that is a vast improvement. And I guess the counter argument is this is good. We have a whole bunch of people who used to be unbanked who are now banked. The only cost to this is that like we've lost a tiny bit of regulatory oversight. And once in a while,

Some customer of Yotta is going to lose a quarter of a million dollars. Oh, well, I guess you can't make an omelet without breaking a few eggs. What do you think the ramifications are going to be? What do you think the effect of this scandal is going to be over the medium term? You could imagine that the fintech nerds and the VCs get their wish and they're allowed into the regulatory perimeter in a way that they aren't today. And while that's tough for

Any new startup, the ones that are big enough that have scale like Chime, which by the way, doesn't use a middleman. They go directly to their banks and they own a lot more of their stack. It's going to be great for the Chimes of the world. So that's one scenario. Another is sort of the status quo, which is we have rules in which the onus on the banks is increased. It seems insane that they were allowed to outsource

the most banky type activity, which is fundamental to banks, which is knowing who has the money, that they were allowed to outsource that to a fintech startup, that that will be essentially taken out of the proposition because the banks now will have to keep the records in a better way than they were before. Something between those two is super likely. One of the least intuitive things about money in the modern world that

Almost no one understands, but it's impossible to understand what a bank is unless you understand it.

is that if you are keeping money in a checking account at a bank, that money in that checking account is not an asset of the bank. That money in that checking account is a liability of the bank. You are lending the bank money, and you are lending the bank money on demand terms, which basically means you can demand it back at any time. In this world, lenders...

you know, charge significant interest for the risk that their debtor won't be able to pay them back. And yet what you find when people open up checking accounts at banks is that people are lending their money to banks at interest rates which are much lower than the risk-free interest rate. You can get risk-free interest

4.5% interest by lending money to the government, but you put your money in your checking account and you're willing to accept 0% in most cases. So it makes no sense why any rational person would lend money to a bank, which is by definition riskier than the government, at a rate much lower than they would be able to get by lending to the government. And that's partly because of the services that the banks provide, but it's also because

ultimately it's not a risky loan. Depositors are not considered unsecured creditors of banks. They're considered very senior creditors of banks who get paid out first and who ultimately have a government guarantee standing behind them. And they can be information insensitive. Full faith and credit of the US government. Yeah. And like that whole regulatory edifice is designed to protect consumers. And

The wonderful situation of the 20th century banking system was that no one needed to understand it. And now with all of these fintechs, we're beginning to enter this world where you kind of do need to understand that. And then I think you're right that the onus is now very much on the regulatory system, on the Fed, and various other bits and pieces, the CFPB and the OCC and the FDIC to get their act together and

and get us back to a place where no one needs to understand this shit because it's complicated and we all have better things to do. And you can kind of see how this came to be. I mean,

A lot of the biggest de facto fintech bank accounts began as money transmitting services, peer-to-peer or whatever. And over time, they evolved into things that looked and acted and felt like bank accounts. It's not shocking that there was a delay in the regulatory regime to respond to it. And sometimes you need people flying through the windshield of a car

to figure out that maybe we should have seatbelts. I really like that analogy. Like, it's true, you know? Like, the Synapse car crash has been very, very damaging to people, but those people, with any luck, will at least cause some Ralph Nader type to come along and make things happen. And by the way, the complexity of the story, I've talked to lots of these victims. They try to explain it to friends and family or local press,

And look, you're a really smart guy. We spend a lot of time just trying to get the story straight. Exactly. And so the complexity of this kills it for people. I try to simplify it in my coverage to be from the perspective of the user. They went into this, they were told, and they had contracts.

saying they had FDIC coverage up for up to 250K. So a lot of these people put in 250K and they were like, I don't want this in the market. I don't want this in crypto. I don't want this in stocks. I want it somewhere safe that offers like a nice interest rate. On the other side, you had people with a lot less money, but that they depended on these accounts to pay their bills, rents, mortgages, things like that. And then been really, really hurt by this.

So from the perspective of the victims here, and I think victims is fair, they did nothing wrong. They did their research. They looked at this and said, all right, member FDIC, Evolve Bank, I'm good. And the fact that they've been allowed to be without their liquidity for six months, and then some smaller cohort to be devastated like this is a scandal. And the complexity of the situation has blunted the recognition of the scandal. I hope that changes.

I hope it changes too. I hope that this podcast does its small part in helping to make it clear what happened. Hugh, thank you so much for coming on. This has been very illuminating. Felix, you know, even just talking with you has...

has been therapeutic and helpful in this process. I'm glad to do what I can. So thanks for listening to Money Talks. Thanks to Jessamyn Mollie for producing. We'll be back on Saturday with a regular Slate Money.

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