Richard Bookstaber writes:

At the start of the 2008 financial crisis, I was at a hedge fund. By its end, I was at the U.S. Treasury. At both, I worked with people only a few years out of college. The drama of 2008 was all they knew about financial markets. “Remember what’s happening,” I told them. “You’ll never see anything like this again.”

Now I’m not so sure. Maybe they’ll see worse.

We have returned to a period of risk, one rife with the sort of pressures that have led to major financial crises. This time, the risks are spread across industries, markets and nations: artificial intelligence, the roughly $2 trillion private credit industry, stock markets, Taiwan and now Iran. These risks are analyzed one by one, news article by news article. We understand them in isolation. Yet they are different entry points into the same underlying structure — a complex and tightly coupled system where the specific source of stress matters less than how quickly that stress can spread.

Signs of systemic strain are emerging.

Let’s start with private credit, which is already showing worrisome signs. Over the past two decades, the retreat of traditional banks after the financial crisis has left many companies increasingly reliant on borrowing from institutional investors. But these loans rarely exchange hands, leaving investors uncertain about what these instruments are really worth or how easily they could be sold if conditions deteriorate.

Now clouding the picture is the fact that many of the borrowers underpinning the lending industry are software and technology companies — the kinds of businesses whose services could be replaced by A.I.

That vulnerability is starting to worry investors. Already uneasy about the way higher interest rates are raising borrowing costs, some have begun withdrawing their money from the private credit funds of well-known companies like Blue Owl, BlackRock and Blackstone. Shares in Blue Owl have fallen sharply. And because the market has no organized exchange and information is inaccessible, investor withdrawals can trigger the kind of wholesale run that in the past turned financial stresses into full-blown crises.

Simultaneously, the A.I. boom is driving extraordinary investment into a small group of dominant technology companies, inflating their valuations to the point that 10 stocks now account for more than a third of the S&P 500’s value. That level of concentration is unprecedented — and dangerous, because it means a shock to any one of these companies can ripple across the entire market rather than be absorbed by it. [Continue reading…]