Transcription:
Transcripts are generated using a combination of speech recognition software and human transcribers, and may contain errors. Please check the corresponding audio for the authoritative record.
Penny Crosman (00:03):
Welcome to the American Banker Podcast. I'm Penny Crosman. This week American Banker Reporter Kyle Campbell interviewed Custodia Bank CEO Caitlin Long. Their topic was her bank's legal tussle with the Federal Reserve Bank over its decision to deny Custodia a master account. We hope you enjoy the conversation.
Kyle Campbell (00:23):
Lawsuits between banks and their regulators are rare. Rarer still are cases against the Federal Reserve. And yet until a few weeks ago, there were three active suits against the Fed, all centering on a common issue: The administration of so-called master accounts. A master account, for those who don't know, grants a bank access to the federal payment system and other financial services offered by the central bank. Without one, an institution cannot transact directly with other banks. So, master accounts are critically important and yet until a few years ago, many even in the banking sector did not give them much thought at all. So, how did master accounts go from being a backend technical consideration to fertile ground for multiple legal disputes? That's what we're going to hear about today from one of the key figures in the debate over master account access.
Caitlin Long is the founder and CEO of Custodia Bank, a Cheyenne, Wyoming digital asset bank that first sued the Federal Reserve Board of Governors in Washington as well as the Federal Reserve Bank of Kansas City in June, 2022. Caitlin, thank you for joining us.
Caitlin Long (01:26):
Thanks Kyle. Good to be here.
Kyle Campbell (01:28):
Now not only is Custodia among the small groups of banks that have actually sued the Fed, it is in even more rarefied air. Having taken the issue all the way to a judge's decision, most cases are dismissed or dropped. Before that point, the ruling in question was handed down on Good Friday of this year. It did not go in Custodia's favor. And I want to hear more about that specific decision and the ramifications that you see it having on the banking sector broadly. But first I want to start from a sort of a bigger picture perspective and get your thoughts on what you see as the fundamental issue at hand in this ongoing debate over master account access?
Caitlin Long (02:11):
Well it really does come down to, first of all, what did Congress intend with regard to access to master accounts? And does the Fed have unfettered non judicially reviewable discretion to close existing master accounts? Which is probably what your audience is more interested in than the access question, because it has now come out that there has been a concerted effort to close master accounts, this has not yet fully come public, in Puerto Rico and it's public that six depository institutions lost their master accounts there. It's public that there's one that has sued for loss, but yet if you look at the database of existing access holders, it's still listed as having an account. Yet, it's publicly disclosed that it lost the account. And I just recently learned there are several others of those in that same situation.
Davis Polk's analysis of the cases, I think rightfully, warned that the implication of the fact that the Fed just ignored congressional oversight into this issue and that the judges have handed the Fed unfettered, non judicially reviewable discretion, that should scare the banking industry.
(03:41):
And Davis Polk rightfully said, we're now at the point where the federal regulators will just close master accounts if they don't like the bank serving, say, the oil and gas industry, the LGBTQ plus industry, the pro-life and pro-choice industries, et cetera. And they laid it out. Politics have entered in. I would argue they entered into this whole equation back in 2015 when, you pointed out that it used to be that master accounts were automatically granted. The first evidence that they were not automatically granted to validly chartered depository institutions was the Colorado marijuana bank in 2015.
Kyle Campbell (04:25):
Right, right. And that is an interesting case study and it's been, it's come up in your lawsuit and others as well as sort of being a point of reference. I guess, why is that Four Corners Credit Union case such an important one and what did it mean for these sort of legal precedent around master accounts before your suit?
Caitlin Long (04:53):
Well the district judge looked at the legislative history and looked at the statute and concluded that master accounts are indeed a ministerial function that the regional federal reserve banks must give. And literally the statutory word is "shall." "Shall provide" access to services. And the district court in that case held that credit union was entitled to a master account. It went to appeal and the appeal was what's called a per curiam opinion of three different 10th Circuit judges. Only one of whom reached the decision on the statute and came down on the side of the district court judge in that case, which is exactly how Custodia and the PayServices plaintiffs argued that master accounts are indeed a ministerial function. The legislative history on that is quite clear that the Monetary Control Act of 1980 made it clear a couple of things that this was actually, let me step back.
(06:00):
There's some interesting history there because the Fed is the institution that at the time begged Congress to require all depository institutions to hold reserves at the Fed so that Volcker could get control of M2. And that was during a period of raging inflation. It was when there were a number of banks that were exiting Fed membership because the Fed was not paying interest on reserves and the opportunity cost of holding those required reserves at the Fed not earning interest when the Fed funds rate went to 22% was too great that you had banks exiting en masse the Fed membership and that made it even harder for Volcker to get control of M2 and therefore get control of inflation. So the Fed was begging Congress and the legislative history is very clear on this point that the deal that was cut was that all depository institutions would hold reserves inside the system. They didn't have to be member banks, but they had to hold reserves inside the system and in exchange for that, all depository institutions got access to Fed services. There's no explicit reference to a master count in that statute nor in the other statute that the Fed is arguing controls.
(07:22):
But the courts have not found that was a distinction that was critical. The courts have held that the account is just the ledger tool for keeping track of access to services, which is what really matters. And that's what the Monetary Control Act changed. And the Monetary Control Act changed the statute that the Fed argues controls as well to make it clear that all depository institutions, by adding the word other depository institutions to the statute make it clear that all depository institutions get access to the services. That was the deal that was cut very clear from the legislative history perspective.
Kyle Campbell (08:04):
And that idea of shall is, that's kind of the linchpin term that is being debated in your case, as well as you mentioned PayServices, which is a group that is based in Idaho suing the San Francisco Fed over on similar grounds that it feels it should have access, be able to access a master account. It seems like the interpretation that the courts have gone with and that others see things as the Fed does say that that "shall" means it's an option that there is discretion and the Fed says, well, if we see something that is going that we deem as risky, we can choose to not grant. Is that a fair assessment of what the other side of the issue looks like from what you're hearing
Caitlin Long (08:55):
It's shall versus may. And the law on this is very unsettled. It typically on a legal question like this does not get decided at district court levels. And as you say, there are three cases, I understand there are others coming, anyone who loses a master account is likely to sue the Banco San Juan had its master account closed and sued for $150 million in damages. So that gives you a sense for what it thinks the master account was worth to it. So somebody actually put a number on what is a master account worth. This is one of those questions that's been out there for a long time. What is a master account worth? We all know that it's public, what the pricing differentials are. And there was a really interesting comment letter that Wise formerly Transfer Wise submitted on the payment system access guidelines that laid out that those that have access to master accounts are paying wholesale prices that can be one 100th of the retail price of an ACH or Fedwire transaction. And so when you start to really look at the volume of transactions, it is volume-based that a user would put through a master account. That's when you can start to quantify what is a master account worth. And we've now had one bank put a number on it.
Kyle Campbell (10:18):
And Banco San Juan, just for those who aren't familiar, is a bank that's based in Puerto Rico. It's chartered under a special charter that is unique to the island and it is for offshore depositors, essentially. And they are suing the New York Fed. And again, as Caitlin mentioned, the New York Fed has or is in the process of removing its master account and has been given the green light to do so by the courts. I want to get back to something you mentioned before about the Fed having unfettered ability to deny a master account. I think that's something that has come up in the debate during the case, of course. And then since the ruling was handed down earlier this spring, and it seems like there's sort of two views, one in which the Fed has unlimited access, unlimited ability to deny or remove an account. And then what some on the other side have argued is that they are saying that you saying that there should be no discretion at all. And I understand these are lawsuits and everyone's painting with stark colors, but is that what this really comes down to, full discretion versus no discretion on the Fed's part? Or do you think that there is some level of say that the Fed should be able to have? Should it be something that is purely just a, are you a depository? Yes, here's your account.
Caitlin Long (12:00):
The notion that the Fed not having discretion is dangerous ignores the elephant in the room, which is the state banking regulators, the state banking regulators. I know I've heard some incredible disparagement of the state regulators by these federal regulators in this process. It's been stunning. Washington, DC does not view the state regulators as equal counterparts and that is not what the dual banking system is all about. But that's the point, that the Fed not having discretion ignores the elephant in the room, which is that the states themselves are regulating these banks and are going through open public chartering processes for these banks. So, if you put the polar extremes that the Fed has discretion or the Fed does not have discretion, if the Fed does not have discretion, it's not as though there isn't another gatekeeper. There is. It's the state and territorial chartering authorities and regulators and supervisors.
(13:07):
Remember, they all have, all of the states and chartering territories also have their own banking rules and regulations that all the banks have to adhere to when they're doing business in those states. You have to register to do business in those states, as a corporation. You can't just willy-nilly go in and take deposits in a state. You start with registering with the Secretary of State in every state for example. So that's the point that that ignores, the elephant in the room, which is the states. On the flip side, where we are right now, I would agree, especially in the PayServices case, there is literally nothing standing in the way of the Federal Reserve arbitrarily closing any bank's master account. And is there nothing else to stand in the way? Sorry to interrupt, but there is nothing. We had an argument and you were tagged on this as well with David Zaring, who's a Wharton professor who wrote a law review article to your point saying the Fed is very rarely sued and essentially saying the Fed and federal bank regulators should be sued more because there isn't a lot of oversight.
(14:16):
And when the Fed just ignores congressional oversight as they did in the case of the master accounts, the only oversight comes from the courts. And we just had a court say, well, the San Francisco Fed is not a federal agency. So the Administrative Procedure Act, the due process that's associated with that, does not apply. And so, literally, in the state of Idaho right now, if that court decision stands, any bank can have its master account yanked by the Federal Reserve Bank of San Francisco with no redress. That's where it stands right now.
Kyle Campbell (14:52):
Yeah, and I want to get back to this topic of the overlay with the reserve banks. There is sort of a unique structure at play there, but getting back to the prior question about where does the discretion come in, are you saying that for nationally chartered banks or banks that have prudential oversight at the federal level, so either by the OCC or as Fed member banks, that is one type of discretion whether a bank should be eligible to be a depository on those terms. And then there should be another standard of are you eligible to be a depository based on some sort of state rubric? And then if you are granted a charter, if you are able to be a depository on either of those grounds, then master account access is sort of imbued to you. Is that where the discretion comes in? More at that sort of chartering level as opposed to after you're chartered then there's a discretionary call about a master account?
Caitlin Long (16:01):
Exactly. Kyle, that's exactly what the Monetary Control Act of 1980 recognized. If you are a validly chartered depository institution, whether you have your charter from the OCC or whether it comes from a state doesn't matter, you have automatic access to a master account. That is what the statute literally says. That is what the legislative history backs up. However, what is fascinating, if you go back in the history, what the Fed is trying to do here is become a super chartering authority because it's essentially engineering for itself a veto on the state's chartering decisions. It used to be that ... well it still is today that, as far as I know, the master account application is one page. Why is it one page? Because the state is the one that goes through and frankly the OCC, even for national banks, it's still one page. The Fed doesn't make a distinction.
(16:54):
If you have a valid depository institution charter, it's a one page application. They just need to know, essentially, the names, the signatories, the mailing address, the corporation name, et cetera. Are you validly chartered? That was it. And there's a reason why it was one page because that is historically how it worked. But let's go back even further to the origin of the dual banking system. This is really important. The deal that got cut during the Civil War when the National Bank Act came into place and the OCC was created is that there would be nationally charter banks and there will be state chartered banks and they would be equal. Okay, but right now that's not the case because the Fed has this veto, right, over state charter banks and it doesn't have a veto right over nationally chartered banks. So they are no longer equal according if these district court decisions hold.
(17:47):
Now fast forward to 1930, well fast forward to 1913 when the Fed got created and then 1933 when the FDIC got created, the Fed was operating a payment system. The FDIC is operating an insurance company. Those are utilities that are available to the banking system. It used to be that those utilities were essentially automatically in the case of the FDIC, you automatically got FDIC insurance. And, by the way, all of these charters that are pursuing master accounts are uninsured charters that I'm aware of, with one exception I'll come back to in a moment, we all applied for FDIC insurance and the FDIC didn't grant it. So let's step back here and look at what's really going on. What's really going on is Operation Chokepoint. What's really going on is the FDIC is now picking and choosing who it wants to insure, whereas in the past it regarded the states' chartering authorities decisions with deference.
(18:49):
Now it's no longer giving deference to the state chartering authorities decisions. And the same thing with the case of the Colorado marijuana bank. It was technically a credit union, Fourth Corner Credit Union. The NCUA refused to insure it. We wouldn't have had any debate if the federal insurance companies had been insuring these institutions. So let's call a spade a spade here. This is not really, at origin, a debate about master accounts. It's a debate about these insurance companies refusing to ensure banks who are different. But then it flipped into the debate over master accounts and who gets access to the payments system. And historically, by the way, the Federal Reserve banks gave non-member banks access to the payment system. They had discretion between 1930, between 1917 and 1980. But everything changed in 1980 for the reasons we just talked about.
Kyle Campbell (19:52):
A couple more really great things to follow up on, but getting back to this idea of the state versus the national charter and the federal payments system, and this is something that I think folks who view this topic differently, they say, well, the payments system is federal and even links internationally as well. So it's not like maybe as things were after the Civil War where banking was done more regionally or maybe done more at the state level, things are going across state lines. There's more interconnectivity and that is something that the Fed seems to come back to quite a bit is just sort of wanting to safeguard the system against what it sees as risks. I guess, how do you square that with your views? Does there need to be some accounting for risk management with the payments system or is that an overblown concern that is sort of being put forth for other reasons?
Caitlin Long (20:59):
Well, first of all, it's not the law. So the Fed wants to make the law. I get that, but it's not the law. The law was again very clear, the Monetary Control Act of 1980, it was the Fed itself that begged Congress for that deal. So yes, that's a really important point, but let's call it spade a spade here. The Fed would love to do away with the state banking agencies and become the super regulator of all of the banks in the United States. And that's the play that it's making here and the courts are supporting it
Kyle Campbell (21:34):
Because there's not an actual law sort of dictating that the Fed has this oversight ability essentially over the payment system. I mean it's asserting that it does. That's correct. And you're saying that there's not statute, but just from a principles based approach, I mean, should there be some sort of oversight for that? And, I guess, is the appropriate place for that just at the chartering level, whether that's the OCC or an individual state agency?
Caitlin Long (22:04):
I'll go back to the Davis Polk analysis of these lawsuits and say that it is dangerous to have that much power centralized in Washington DC because it will start to be used as a political tool if it isn't already. I think it is already in Puerto Rico. But the interesting question, again, I'll go back to Fed history. There was federalism in the Fed. I've been doing a lot of reading in the last several months about the history of the Fed, just to understand how this all fits into the history. I think Carter Glass would be rolling over in his grave if he understood how centralized power became within the Federal Reserve itself originally, if you think back to the deal that was cut at the creation of the Fed, why were there 12 regional reserve banks as opposed to the European model where we had only one entity in the country that allocated credit across the entire country?
(22:59):
Well, the folks in the heartland were very concerned in 1913 about money and credit being dominated by Washington DC and New York interests and that the heartland there would be a value transfer from the heartland to New York and Washington DC and that is exactly what has happened. Again, I think Carter Glass, who's viewed as the father of the Fed, would be rolling over in his grave if he understood that the reserve banks had been knee capped by Washington DC as much as they have been. And that's been a creeping centralization. I have had a lot of back and forth with various academics about the history of all this. It's been a creeping centralization over the subsequent decades and I'm not sure that that's the right answer because again, you start to control this much power in a single entity, it will be abused by both sides of the political aisle. It will be abuse. And where is the due process, again, going back to Idaho, if the Administrative Procedure Act does not apply to a Federal Reserve bank because it's not an agency, there is no redress.
Kyle Campbell (24:08):
If that was going to be the sort of model, how would you like to see that handled differently in terms of oversight and accountability?
Caitlin Long (24:16):
Well, yeah, I'm not going to give any policy arguments for how this might change because I think the congressional history is very clear that Congress did respect the states and did not intend to give power to the Fed to become a super chartering authority to veto states decisions. Let's step back and flip the script a little bit and look at the history of banking. Again, your audience is going to be a lot of bankers who understand where did payment innovations come from? They came from the private sector and a lot of these payment innovations were done without permission. The banks just did them and then they bubbled up and got turned into clearing houses like ACH or turned into the big networks that were spun off from the banks like Visa and MasterCard. Do you think that the Federal Reserve, which has nothing in its charter requiring it to do innovation at all, do you think that any of those innovations would've been allowed if the Federal Reserve had been a super chartering authority?
(25:31):
The states have innovation in their remit. Every state banking authority has safety and soundness and economic growth in their remit. It is the Fed that does not have economic growth or innovation in its remit. And so if it actually has super chartering authority and veto authority and can close any bank it doesn't like for any reason with no redress, then what do you think is going to happen to innovation in this country? And I'll pause by asking a rhetorical question. Stable coins are quite the innovation. We're recording this podcast on the morning when the Lummis-Gillibrand bill has been released. This would allow depository institutions and state chartered trust companies to issue stablecoins. State chartered trust companies can only go up to $10 billion. The state chartered, well, any depository institution, regardless of whether it's state chartered or nationally chartered, can issue. These are special purpose. They've actually gone in a different direction than the president's working group special purpose depository institutions. That's what a Wyoming special purpose depository institution is. And they would be overseen by the Fed but not chartered by the Fed. So I went on a little tangent about stablecoins there. Back to the rhetorical question, do you think the Fed would've approved the creation of stable coins as an innovation? I think the obvious answer is no. Right?
Kyle Campbell (27:04):
Sure. Yeah. I mean that's definitely a fair point to make. They've been going at a very, very deliberate pace, I guess we'll say, in putting out policies around stablecoins. So that's fair enough to say as a fact. So, I mean, the other side of that innovation is the Fed could find itself in a world of having to deal with more explicit political issues if it did relinquish discretion to any chartering entity. If there were a state that maybe wanted to allow certain types of green finance entities that were not traditional banks to have a master account, or if another state maybe wanted to allow some kind of gun manufacturing entity to engage in a master account because, and there were charters set up along those lines, which these seem outlandish, but we have seen some sort of outlandish red versus blue state policymaking in recent years. If there was no sort of mitigating ability or power for the Fed that it could sort of give rise to highly politicized entities being chartered and getting this sort of access, what is your level of concern about something like that actually happening and what do you make of that point raised by the other side in this issue?
Caitlin Long (28:40):
Yeah. Well, actually we got the opposite, which is the Fed now has complete unfettered, non judicially reviewable, non congressionally oversight discretion to close the accounts of politically targeted banks. So pick your poison from that perspective. One of the most important pieces is the separation of banking and commerce. The states respect that. So the examples that you just gave, would a firearms manufacturer or a green energy company start its own bank? They wouldn't be permitted to in the states, but I get where you're going. There is a very, very big piece that unless you're a bank, you don't understand the extent to which the Fed both has to operate within the law and its own credit policies which are published, which is that the master account, it's in 12 USC 248a, that the Fed shall provide services with the proviso that the depository institution holds sufficient clearing balance in the account.
(29:49):
Okay, so that is in the statute. It is absolutely within the Fed's power to restrict to the account holder to a sufficient clearing balance in the account. That is a very important distinction. There's another very important distinction, which is the eligibility. The account holder has to be a depository institution and it has to be engaging outside of the Federal Reserve Act. It has to be engaging in permissible activities. So that's clear from the court, you have to be engaged in legally permissible activities. That was one of the things that came out of the Fourth Corner case, for example, it was no longer requesting the ability to serve the cannabis industry. It was just going to serve those that were not violating the Controlled Substances Act like the trade associations and ancillary businesses that were not actually touching a controlled substance, that's legally permissible. There's no question about that.
(30:52):
So I've just given you some of the restrictions that the Fed has. It's not like it's unfettered access. But I do want to go back to the legal eligibility. This is such an important point, Kyle, because I don't understand why the banks aren't screaming about how many facially ineligible master account holders are listed on the Fed's master account database. The most obvious one is the Texas Comptroller of Accounts, I think is the name of it. It's the state of Texas's Treasurer, the tax collector in the state of Texas. They have a master account. I did a back of the envelope calculation of what that master account is worth because if they're using it to run ACH and Fedwire payments through as opposed to running the ACH and Fedwire payments through a retail bank and paying retail prices on those, then I think that's worth at least $10 million a year in savings to the state of Texas.
(31:46):
Just on my back of the envelope math, why does one state have a master account and the other 49 not, or if you are the Texas banks, why is the state of Texas allowed to circumvent you and go straight to the Fed instead of having to work with you? A Texas bank? There are also dozens of trust companies. What is a trust company? It is a corporation that in most cases is legally prohibited from accepting deposits. So now let's go back to the legal eligibility point. The institutions that are legally eligible for Fed master accounts are depository institutions. The statute specifically says it has to be an insured depository institution or a depository institution eligible to apply for insurance. So now let's go back. The FDIC is refusing to insure certain institutions. So several of us, there are 33 of us that have pending applications for master accounts as uninsured entities. We are all eligible for as depository institutions for Fed master accounts. Why are all these trust companies holders of Fed master accounts? There are several state chartered trust companies, Fidelity Fiduciary Management. There's a company called State Trust of Tennessee. These are state chartered entities. Raymond James, also state chartered entity, not federally, not OCC, state trust companies. How are they eligible now? The OCC, there are a couple dozen OCC. Big names BlackRock, Wellington, Chilton, ADP. How are they eligible? They're not depository institutions. Why are the banks not screaming about this?
Kyle Campbell (33:35):
Yeah, I mean, these are all great questions. Things that are now able to be known because of a recent policy change to require the Fed to disclose master accounts holders, applicants, and those who've sought to become holders who've been either their requests are pending or denied. That does sort of feed in to one of the questions raised in the decision regarding your case with the Fed. Obviously there's a small provision in the law that actually required the Fed to do that, that was interpreted as essentially giving the Fed the green light to deny requests, the specific issues cited by the court in the decision against Custodia. What are your concerns about precedent that's being set from your case in particular, and how do you see that rippling through the banking system beyond what we've sort of discussed already?
Caitlin Long (34:39):
Stay tuned. I can't speak about the Custodia case. I will say that in all of these district court decisions, those are district court decisions. There's one in New York that's Banco San Juan, Second Circuit. There's one in Idaho that's PayServices Ninth Circuit, and then there's one in Wyoming that's 10th circuit, Custodia. That's not typically where law is made. And there are conflicting decisions. And when you get conflicting decisions at the district court level, it tends to go to the appellate court level where the law is made. And if you get conflicting decisions at the appellate court level, it can go to the Supreme Court where the ultimate law is made. The last time the Fed faced a lawsuit, challenging the boundaries of its regulatory authority was the Dimension Financial case. This is the case over the Bank Holding Company Act. It's almost exactly. Actually, I think it was exactly 40 years ago. It was 1984 and the Fed lost at the Supreme Court. So stay tuned.
Kyle Campbell (35:44):
Got it. So should we be looking for an appeal filing in the coming weeks and months?
Caitlin Long (35:49):
Stay tuned. Stay tuned.
Kyle Campbell (35:51):
Well, Caitlin, thanks so much for taking the time. Again, really enjoyed being able to go deep on this topic. There's so many levels to it, so much more that we could have discussed and maybe more to discuss down the road, but we'll certainly be following and watching how things develop from here. So thanks again for taking the time and sharing your insights.
Caitlin Long (36:13):
Thanks Kyle. And I really appreciate the work that you've done on this topic. You've done a good job reporting it, being fair on both sides. It's far from over and I suspect that we will continue to talk in the years to come.
Penny Crosman (36:26):
Thank you for listening to the American Banker Podcast. Kyle Campbell produced this episode with audio production by Kelly Malone Yee. Special thanks this week to Caitlin Long at Custodia Bank. Rate us, review us and subscribe to our content at