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.
What appear to be separate developments — a new kind of lending market and technological dislocation on one hand, stock market exuberance on the other — are in fact the same network of money and expectations, approached from different directions.
Of course, private credit isn’t only financing those companies vulnerable to A.I. It is also a critical source of financing for the infrastructure that drives A.I. — the data centers and semiconductor chips. This infrastructure is largely being built by the handful of companies like Google and Microsoft that dominate our stock market. In this tightly connected system, the weakening of private credit strains the A.I. investments of the tech Goliaths, which in turn threatens the stock portfolios, the retirements and the pensions of tens of millions of people.
In addition, the A.I. boom is placing new strains on the physical infrastructure it depends on. It drives enormous electricity consumption and has a ravenous appetite for advanced semiconductors. These carry geopolitical weight.
Take Iran. An energy shock from the conflict that raises the cost of power or constrains its supply directly affects data centers and A.I. production, raising costs for the A.I. Goliaths, which then transfer those pressures to our private credit and stock markets.
Then there’s Taiwan. If China were to invade or blockade it, America’s access to semiconductors would be severely limited. That would immediately slow deployment of A.I., weakening the companies driving the A.I. boom, with the inevitable knock-on effects.
Our current financial system fails not because any one thing goes wrong. It fails because different shocks propagate through the same structure and in ways that are hard to anticipate. When something eventually goes wrong, it spreads faster than it can be contained.
It is critical that our policymakers realize that private credit is not just a parallel risk sitting alongside the A.I. boom. A.I.’s data centers, chips and infrastructure have been built largely on private loans. Investors in those loans cannot easily sell their positions. So if there is any quake in the system and they find they need to raise cash, they will do what investors do when they can’t sell what they want to sell: They sell what they can. And what they can sell easily are the large, publicly traded technology stocks that dominate the major indexes.
This is not the first time we have built a system like this. The crisis of 2008 is often remembered as a story of homeowners gorging on excessive debt, a housing bubble fueled by speculation and millions of mortgages going bad. But the housing bubble itself was not the reason the crunch became so destructive. The accelerant that pushed the crisis to such depths was the financial system that had been constructed around the housing market. Novel and complex financial instruments obscured the risk, intertwined balance sheets across the financial system and eliminated the buffers that once absorbed shocks. When the housing market tanked, these instruments nearly took our entire financial system down with it.
This time, the danger isn’t financial engineering. It’s that our financial system has attached itself to the vulnerabilities of our physical world — power grids, water, land, supply chains — and created hazards that markets have no framework to analyze. Our models for detecting risk look at prices, volatility and correlations. They have no instruments for reading a grid failure, a drought or a severed supply chain. By the time warning signs show up in market data, the damage will already have been done.
The physical risks of Iran, Taiwan and the A.I. boom are supplanting the types of financial risks that preceded 2008. I’d take financial risk any day. Financial risk moves just prices. Physical risk moves the world.
Richard Bookstaber is the author of “A Demon of Our Own Design,” which in 2007 warned of the 2008 financial crisis. His forthcoming book is “A Risk Manifesto: Decisions in the Face of Material Events.”
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