Panic!
Second Life Bank Closures Raise Many Questions

by Surfdaddy Orca

The chaotic scene at JT Financial was not unlike the stock market crash of 1929. Following Linden Lab’s January 8th announcement that it would give banks until January 22nd to “settle up on any promises” and “honor valid withdrawals,” harried Second Life avatars scrambled to withdraw deposits.

The scene at SL Capital Exchange was an eery reminder of the 1929 stock market crash

The panic was palpable. Banks across the Second Life grid strained to meet the demand:

“NO FUNDS WILL BE AVAILABLE FOR WITHDRAWAL AT THIS TIME! BANK WIDE LIMITS HAVE BEEN REACHED DUE TO TODAYS ANNOUNCEMENT BY LINDEN LABS! PLEASE COME BACK TOMORROW TO ACCESS YOUR FUNDS.”

“OMG, I GUESS WE DON’T SPEAK ENGLISH! WE CANNOT PAY BECAUSE OUR SERVER IS DOWN AS A CONSEQUENCE OF THE PANIC!”

JT Financial and SL Capital Exchange are only two of many Second Life banks where panic ensued after the Linden Lab announcement. Chairman of JT Financial and SLCapEx, Arbitrage Wise, describes banking policy decisions in a recent interview.

Unlike 1929, when stocks were seen as extremely safe by most economists and investors purchased stock on margin, Second Life’s “Black Tuesday” did not come as a total surprise. Unregulated banking with excessively high interest rates—sometimes as high as 50-60% on an annualized basis—led to some questionable lending practices and in some cases, outright fraud. Earnest Cavalli of wired.com writes, “The decision was widely seen as a necessary step by Linden Labs to avoid governmental intervention. Had the company not banned these unregulated banks, most presumed it was a matter of time before the state government of California (under whose laws Linden Labs operate) stepped in and forced regulations into every financial aspect of the title.”

Coming on the heels of a gambling ban six months ago, and the more recent imposition of a Value-Added Tax (VAT), Second Life residents are reeling from the loss of real US dollars in the form of in-world Linden dollars (L$). As Intlibber Brautigan, CEO of Ancapistan Capital Exchange (ACE) and Founder of the SL Exchange Commission, clarifies during a recent Metanomics forum, only the real-life Federal Reserve can create money. L$ are only treated as “real money” because of the “fiduciary responsibility to investors by SL banks. Real money is gold and silver.” US legal tender laws apply to the US dollar, but not to L$. See the machinima transcript of this fascinating, ground-breaking forum sponsored by Nick Wilson’s Clever Zebra.

Linden Lab reports that since the collapse of Ginko Financial in August 2007, they have received complaints about several in-world banks defaulting on their promises. These banks often promise unusually high rates of L$ return, reaching 20, 40, or even 60 percent annualized. David Talbot of MIT’s Technology Review explains, “Last summer, Ginko restricted withdrawals and eventually vanished. Since Linden dollars can be exchanged for real U.S. dollars, the losses were painfully real.”

In 1924, the New York Times index of the leading twenty-five industrial stocks topped 100 points. By the beginning of 1928, these same stocks had topped 245 points, more than doubling the price. The market continued to soar during 1928 and much of 1929, with these twenty-five leading industrial stocks reaching the 452 point in early September 1929, almost doubling the stocks’ selling price in less than two years.

The initial stock market crash—precipitated by margin calls—occurred on Black Thursday (October 24, 1929), but it was Black Tuesday (October 29, 1929) five days later that precipitated widespread panic and the onset of unprecedented and long-lasting consequences for the United States. The collapse continued for a month and helped trigger the Great Depression of the 1930s.

In the case of the Second Life banks, blogger Prokofy Neva asks, “What’s next?” and compares the ongoing collapse to the subprime mortgage financial crisis of 2007, where there was a sharp rise in home foreclosures. Starting in the US during the fall of 2006, these foreclosures became a global financial crisis within a year. She writes, “The immediate speculation was that the land market would be affected because many people took out loans to get land and homes.”

Are L$ play money? Are in-world loans a reasonable practice? Cornell economist Robert Bloomfield (avatar Beyers Sellers) reports that the Second Life economy is “growing rapidly” with the money supply and land both growing at about 6% per month. This means rapid inflation. But interest rates are even higher, at an average of 2.5% per week. For avatars such as Intlibber Brautigan, a stay-at-home who cares for his ailing father and makes his living online in Second Life, L$ are much more than “play money.” His initial in-world loan enabled him to purchase one half of a Second Life region (sim) and got him started making a real-world living in virtual real estate. He says that he paid off his high interest loan off in two months.

Can Second Life residents self-regulate to control fraud? Should Linden Lab play “God” and regulate the economy? What is the legal jurisdiction of virtual loans and land? Richard Jones, General Counsel at the Federal Reserve, clarified during the Metanomics forum that usery laws (laws that specify the maximum legal interest rate at which loans can be made) “are at the state level, where the bank is.” Interestingly, he had no answer to Beyers Sellers question “In Second Life, what jurisdiction would apply?”

Where can I find a loan, pard?

Perhaps the situation in Second Life (and virtual worlds in general) can be likened to Deadwood (now South Dakota) in 1876, the famous gold-mining town situated in the heart of Sioux territory. Outside the jurisdiction of US states and territories, it became known for its wild and almost lawless reputation. You may not see Wild Bill Hickok or Calamity Jane walking the “streets” of Second Life regions like Tombstone, but you’ll find intense interest on the part of bankers, lawyers, and the Fed.