The new masters of the universe
Financial giants are transforming Wall Street
Thomas Bennett hails their innovation and dynamism, but warns against hubris
Finance is an industry moulded by disaster.
It took a civil war to bring America’s banks under federal supervision, a banking panic to create the Federal Reserve and a Great Depression for the government to insure deposits.
Yet the reformist urge that burns hot in the moment of catastrophe has a tendency to fade.
Lessons are forgotten, innovations happen and regulations become regarded as a nuisance.
New risks emerge—as do new titans, who defend their successor system vigorously and convincingly.
The conclusion of one crisis begins the countdown to the next.
Regulators can choose whom to target but have less control over the firms that succeed in their place
Wall Street has never failed as spectacularly as it did in 2008.
Its executives fuelled a dramatic increase in borrowing which helped inflate a housing bubble.
The complexity of its financial instruments had made the system’s fragility invisible even to insiders.
After the subprime-mortgage market faltered, liquidity vanished across the financial system.
Lehman Brothers was one of hundreds of banks to fail.
Had the state not bailed out the biggest lenders, things would have got much worse.
Reform crystallised in measures such as the Dodd-Frank Act of 2010, which subjected banks to a vast compliance bureaucracy.
Lenders have been forced to hold more capital and to rein in their traders.
Regulators can choose whom to target but have less control over the firms that succeed in their place.
In 2008 Charles Goodhart, an economist, described the “boundary problem” in finance.
Setting and policing the boundary between regulated and unregulated institutions is hard, he argued, partly because risk-takers inevitably respond to regulation by shifting their activities into areas that are watched less closely.
That is exactly what happened.
Since the crisis, and especially in the past few years, a handful of American asset managers have thrived, often in areas that were the province of banks.
Their lending activities, often called private credit, have grown rapidly, in part because banks are hemmed in by regulators.
Hedge funds dominate trading activities where banks once held sway.
Loose monetary policy helped.
So did voracious global demand for American assets—these firms are beneficiaries of American exceptionalism.
Executives at these firms believe their success confirms the wisdom of the new financial order (see chart).
The collapse of Silicon Valley Bank, which recklessly borrowed from uninsured depositors who then ran for the exit in 2023, confirmed their view of banks as poorly run and intrinsically vulnerable.
But is a reckoning coming?
How would loans made by private-credit funds perform in a recession?
How risky is the growth in borrowing by hedge funds?
Versions of these questions are being asked in every major financial institution and central bank.
Donald Trump’s chaotic presidency is making these questions more urgent.
On April 2nd Mr Trump “liberated” America’s economy by announcing massive and arbitrary tariffs.
Financial markets promptly went on a vertiginous ride, their volatility reaching levels surpassed only in 2008, at the height of the financial crisis, and in March 2020, at the beginning of the pandemic.
Stocks had their fifth-worst two-day decline since the second world war.
Companies’ cost of capital soared.
Confidence among consumers and executives has been badly shaken.
The self-inflicted trade crisis at times looked like it might precipitate a full-on financial crisis.
Yields on America’s government debt surged while the value of the dollar plummeted, suggesting investors were fleeing American assets despite higher returns—a troubling dynamic typically reserved for emerging markets in turmoil, not the global financial hegemon.
Calm, or its semblance, has returned.
Some executives see a real-world “stress test” completed—or even defeated, given how quickly Mr Trump bent to markets and paused the full implementation of his tariffs.
Share prices in the big private-markets asset managers are still down a quarter of their value since their post-election peak in November, but markets have stabilised.
Some contend only the pride of the Wall Street bosses who supported Mr Trump has been damaged.
Pride goeth before a fall
But to be sanguine is to be naive.
Even if Mr Trump manages to refrain from smashing up global trade, the contrast between America’s fine-tuned financial system and the chaotic condition of its politics is too stark to ignore.
Wall Street thrives on the rule of law and globalisation, both things which Mr Trump spurns.
Many of the conditions of a financial meltdown are in place.
The national debt sits at $36trn, close to a record relative to the size of the economy.
Asset prices are inflated—and could easily be deflated if foreign investors decided to sell.
As this special report shows, financial innovation has transformed Wall Street.
As in eras past, surging asset values have concealed cracks in the new financial order.
Whatever dangers are lurking, Mr Trump’s presidency will make them more dangerous still.
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