If economic theory feels abstruse, why not hear how financial institutions explain today’s increasingly convoluted financial products? Indeed, under the glossy wrapping of innovation, product structures have become more intricate than most investors could ever imagine. Faced with polished sell-side language, investors are often led to accept complexity as the norm, but in markets trillions of dollars in securities transactions each day, technology-driven market-making is giving rise to an entirely new class of financial powerhouses. Armed with intelligence, speed, and technology, these algorithmically-driven players pursue profit maximization with astonishing success, leaving traditional banks far behind and reshaping the global financial landscape.
The recent bankruptcy of U.S. auto-parts supplier First Brands, a company long dependent on private credit, shook Wall Street and triggered massive volatility in U.S. equities. The event has amplified investor concerns about the highly engineered packaging of private credit.
Share prices of the three largest private-equity firms in the US grew even faster than the Magnificent Seven tech giants. Private credit is replacing banks as dominant lenders, life insurers are entering credit markets, and a “Cambrian explosion” of products is being aimed at individual investors.
Risk is inherent to investing, but the rise of innovative trading institutions has magnified disruption in the traditional financial system. In an increasingly complex ecosystem, banks and nonbanks now intersect as clients, counterparties, and competitors. These new champions of financial innovation may prove to be the most worrisome ticking time bomb, amid rising geopolitical tensions. History shows that financial crises are never absent for too long. While past turmoil led to federal oversight and deposit insurance, lessons are swiftly forgotten with each wave of innovation, and regulation is increasingly viewed as an impediment. As a result, new risks exploit the gaps, and new financial behemoths aggressively absorb market liquidity, accelerating the countdown to the next crisis.
A U.S. Senate report following the 1929 market crash warned that greater public participation in securities markets inevitably placed national wealth under the control of financiers. Unfortunately, the world has once again entered an era dominated by financial titans. JPMorgan’s scale may have stemmed from the size of the U.S. economy, but the new generation of financial giants is arising from structural changes deep within the market itself.
Over the past decade, index funds and other forms of passive investing have become unstoppable. This trend has clearly benefited BlackRock and Vanguard, whose low-cost ETFs now dominate public-market passive investment, but private market giants Apollo, Blackstone, and KKR have also quietly expanded their assets under management from USD 570 billion ten years ago to USD 2.6 trillion today, thanks in large part to the explosive growth of private credit. Meanwhile, hedge funds such as Citadel and Millennium have drawn top capital and talent away from Wall Street banks, and trading revenues at firms like Jane Street now rival those of traditional institutions including Morgan Stanley.
These transformational shifts are most evident in the erosion of boundaries across the financial system. First, the line between banks and nonbanks has blurred: since 2020, nonbank lending has doubled to USD 1.3 trillion, accounting for one tenth of total bank loans; at the same time, hedge-fund borrowing from banks’ prime-brokerage divisions has risen from USD 1.4 trillion to USD 2.4 trillion. Second, primary and secondary markets have converged, allowing borrowers, and increasingly asset managers, to move seamlessly between them. Third, retail and institutional investor segments are merging, as individuals now gain access to a broader range of structured products. Asset managers continue to re-engineer ETFs to enable retail participation in high-risk, high-return investments.
Such changes carry inevitable risk. Researchers at the New York Fed and NYU have warned that dismantling the walls between banks and nonbank institutions undermines systemic risk oversight. Bank of England Governor Andrew Bailey noted that structural shifts in market functioning are creating new risks, which have been underestimated. Harvard’s Jeremy Stein put it bluntly: financial innovation resembles a virus, inevitably locating weaknesses within incentive structures and regulatory frameworks. When a trend accelerates rapidly, it often signifies that those weaknesses are being amplified. Complexity, leverage, and short-term funding remain the usual culprits in post-mortem financial analyses.
The critical question increasingly being asked across financial institutions and global central banks is whether a full-scale financial reckoning is approaching. Can private credit withstand an economic downturn? How much hidden risk lies behind the ramp-up in hedge fund leverage?
U.S. President Trump has further intensified the market anxiety. His April 2 tariff announcement triggered intense market swings, pushing volatility to levels last seen during the 2008 crisis and 2020 pandemic. Corporate financing costs soared, and market confidence was severely hit. Today’s combination of surging Treasury yields and a weakening dollar suggests investors are gradually withdrawing from dollar assets in search of higher returns elsewhere.
Moreover, Trump’s cascade of executive actions has served as a series of stress tests for financial markets. Regulatory rollback may increase financial risk: lower supervisory and capital requirements would enable banks to extend more credit to giant asset management firms and hedge funds, accelerating concentration of power.
Such unchecked growth risks masking systemic weaknesses which only become visible during crises. A future shock could originate from within – such as poor underwriting in private credit or sudden volatility in hedge-fund strategies – or from external triggers including fragile regional banks, falling commercial-real-estate valuations, or overheated tech stocks.
Trump, widely seen as a disruptor, may further erode market resilience with his repeated TACO (“Trump Always Chickens Out”) uncertainty cycles. Concerns over the safety of sovereign debt could ignite a Wall Street meltdown at any moment – and contrary to popular belief, other countries will not be spared. America’s persistent current-account deficit is mirrored by growing foreign ownership of U.S. assets, which means that if Wall Street collapses, the pain will be global.
Under Trump, the interaction between this new financial architecture and political volatility is unavoidable. The rule of law and globalization, pillars of Wall Street prosperity, have been treated with disregard. America’s USD 37.9 trillion debt will not shrink magically, and asset prices could deflate amid an investor sell-off.
Even if a crisis does not materialize, America’s diminishing leadership capacity is undeniable; coordinated action would be difficult in a global meltdown. While political turbulence under Trump only widens those fissures, the more basic reality is that financial innovation has reshaped Wall Street as rising asset prices obscure structural cracks. When crisis strikes, the U.S. financial system will sit at the eye of the storm, and no country will remain untouched.
Some may dismiss such warnings as alarmist, but the world today is advancing blindly through fog. The U.S. financial system is undergoing a profound transformation, and the system we see today is no longer what we assumed it to be. Its cracks and eventual rupture may occur in places we do not yet understand. Governments should remember not to overly glorify the profitability of financial innovation, carefully map the interactions between the virtual and real economies, build robust market infrastructure for derivatives, and avoid leaving retail investors exposed to overly engineered, risk-laden structured products.
The author is a Partner at KYMCO Capital and holds a Master’s degree in Financial Economics from Cornell University.