The Next Financial Collapse
The signs are increasing that the economy will experience a severe financial crisis, very likely sometime this year. Containing such a crisis would depend heavily on the actions of two people: Fed chair-designate Kevin Warsh (should he be confirmed) and Treasury Secretary Scott Bessent.
How would the two perform? Based on their past actions, as well as President Trump’s penchant for using a crisis to reward cronies and punish enemies, the signs are not auspicious. More on that in a moment. First, let’s review why a crisis is likely.
For starters, financial markets are overvalued. The Dow broke 50,000 last Friday. But more importantly, several key sectors are over-leveraged and undercapitalized. A lot of investment is speculative, energized by cheap money and weak regulation.
In a severe downturn, insolvencies cascade into the broad financial market and the banking system, wiping out the capital that undergirds the leverage. That’s what happened in the financial collapse of 2008.
Today, this risk describes three key sectors that have been driving the financial boom: crypto, private credit, and AI. Like the opaque financial inventions that drove the 2008 collapse, these sectors are heavily leveraged and under-regulated.
Crypto is in one of its periodic crashes, and this could be the big one. Bitcoin peaked at about $125,000; at this writing, it is trading at under $70,000. Total crypto market capitalization, while significant at about $2.7 trillion, is also down about 40 percent from its peak.
Crypto serves no useful purpose except for money laundering, fraud, insider trading, and other illegal transactions. Its value is set only by the expectation of speculators that other speculators will keep bidding it up. When the market turns, there’s nothing real to sustain its worth. And today, there are other speculative bets, like sports gambling and prediction markets, to take up people’s time. Dumb money isn’t flowing as heavily into crypto anymore.
Enactment of the industry-written GENIUS Act last July, formalizing but weakening crypto regulation, gave crypto a nominal government seal of approval, and helped juice valuations. But more critical pro-crypto legislation, which would change the entire regulatory market structure, is now stalled.
In a severe downturn, insolvencies cascade into the broad financial market and the banking system, wiping out capital.
For a time, Trump’s massive profiteering in crypto reassured investors. Last October, when crypto was booming, Paul Krugman wrote that “crypto has become a Trump trade.” But the Trump halo is wearing thin: The value of Bitcoin is below what it was when Trump took office in 2025.
Another danger signal: More and more investment in crypto is via companies like Strategy and BitMine that issue stock and debt and use the proceeds to buy crypto. A steep decline in valuations wipes them out and adds to the panic selling. If we need one more reason for alarm, major banking houses have sponsored crypto funds, putting bank capital at risk. Unlike the 2022 crypto crash, when Gary Gensler was in charge of the SEC and made sure to keep crypto separated from the broader financial system, now the damage can cascade into the banks.
That’s just crypto. A second troubled sector is private credit. The $3 trillion private credit sector allows risky borrowers to tap a totally unregulated capital market. The major players include Goldman Sachs, KKR, Apollo, and Blackstone, and the sector has been active in providing loans for the data center build-out.
The Wall Street Journal recently reported that investors in private credit have been cashing out “in droves,” as risks have increased and expected yields have not materialized. The stock of Blue Owl Capital, the largest private credit firm and a major data center investor, fell more than 50 percent over the past year, and investors have been pulling money from funds that the firm manages, according to The New York Times.
How heavily leveraged are these loans? We don’t know, because the sector is totally unregulated. Basically, these investment banking operations are borrowing money to relend it. It is banking in everything but name. In a major downturn, a lot of these loans would go bad, creating cascading effects.
An AI crash is related to private credit, since many private credit loans are related to the AI build-out. But other AI risks are unique, and more alarming. One is the risk of a so-called flash crash. AI has been driving a lot of the broader stock market boom. It remains to be seen just how much the massive investments in AI will pay off, or what kind of shakeout will occur. If investors turn negative, automated trading systems can react in the same direction, magnifying the downturn. Flash crashes happened before AI. They are more of a risk now, as bots have been calling the shots for more and more investments.
To the extent that AI lives up to its billing, one of the things AI does well is to replicate and customize what the big and hugely profitable software companies do, for a lot less money. A lot of software is glorified and enshittified recordkeeping, something that AI can accomplish more simply and cheaply. As our friend Matt Stoller explains, the profitability and market valuation of companies like Adobe, Zoom, Salesforce, Workday, ServiceNow, LegalZoom, Thomson Reuters, and even Microsoft are at risk. Reuters has just reported that software stocks have underperformed the S&P 500 over the past quarter by 24 percent.
And the potential for serial crises is linked. The recent sell-off in private credit purveyors has been driven by not just concerns about data center loans, but the fact that about 20 percent of private credit loans are to software companies at risk from AI.
ANY OR ALL OF THESE SECTORS could trigger a financial crash, which would then spread to other sectors. And here’s where the record of Kevin Warsh, the Fed chair-designate, is so troubling.
Warsh was a Fed governor during the 2008 collapse. Unlike chair Ben Bernanke, an academic economist, and vice chair Don Kohn, whose entire career was at the Fed, Warsh had come directly from a Wall Street hedge fund.
Prior to the September 2008 collapse, whenever the Fed acted to rescue failing firms, it extracted a price. In the 1998 collapse of Long-Term Capital Management, a hedge fund that had secretly borrowed so much from money-center banks that it threatened to take down the entire banking system, New York Fed chair Bill McDonough called all the leading bankers into a room, locked the doors, and successfully demanded that they pony up enough money to make the system whole.
Similarly, when Bear Stearns went broke in March 2008, then-Treasury Secretary Hank Paulson brokered what was criticized as a sweetheart deal for JPMorgan Chase and CEO Jamie Dimon to acquire Bear at pennies on the dollar. But Morgan had to put money into the deal, and Dimon later complained that it was a money-loser.
However, in September 2008, when Merrill Lynch and then AIG were collapsing, the advice of Warsh to chair Ben Bernanke was for a pure bailout with no costs to Wall Street. That advice was taken, again and again, and it became the essence of the policy of the Fed and the Treasury throughout the crisis.
Though Warsh later became a critic of the Fed’s bond purchases, at the time he was a big supporter of ad hoc Fed inventions of “special facilities” to support bailouts. Bond purchases were the core of this strategy, backed by Obama Treasury Secretary Tim Geithner, former president of the New York Fed.
So what would Warsh do in a new crisis? For starters, Warsh and the Fed can’t act alone. Under the terms of the 2010 Dodd-Frank Act, the Treasury secretary has to concur with emergency actions by the Fed.
A complication is Donald Trump’s habit of using government to reward friends and punish enemies. In his recent $5 billion lawsuit against JPMorgan Chase and Dimon, and a similar suit from last year against Capital One, Trump claims that he had been “debanked” in 2021 due to “political and social motivations.” He has made similar claims against Bank of America.
In a crisis, would Trump instruct Bessent to refuse help to these huge financial players? That would be hugely dumb, but hugely dumb has never stopped Trump. “In a financial crisis,” says a close student of past crises, “you don’t try to pick winners or you end up the loser.”
Would Warsh forget his past criticisms of the Fed’s huge bond purchases, and do what was necessary? The man is nothing if not an opportunist. But more troubling is the likelihood that Warsh and Bessent would just use public money to bail out everyone on Wall Street, repeating the cycle that began in 2008, when very cheap money and little regulation led to gross financialization and a more concentrated oligarchy.
Beginning in March 2020 during COVID, the Fed balance sheet was increased by some $3 trillion in 90 days. That cheap money, coupled with few limits on its use, is at the root of the last round of economic concentration, enriching Wall Street at the expense of everyone else.
Bernanke and the current Fed chair, Jay Powell, share responsibility for that pattern. By contrast, Warsh’s views of Fed policies have been all over the map, with no internal consistency.
All of this needs to be probed in his confirmation hearing. At least one Republican on the committee, Sen. Thom Tillis of North Carolina, whose vote is required to move the nomination to the floor, has been scathingly critical of other Trump appointees and of his vendetta against Chair Powell.
Kevin Warsh is far from who you’d want leading the Fed in a crisis. The alternatives are likely to be even worse.
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