‘The Economist’: Much about the risks of the superstar firms will become clear only when trouble strikes

Pic.: enfrasys.com

More and more alarming articles about possible financial collapse are appearing in the professional Western press. One of the most recent is from ‘The Economist’.

Always a haven in dangerous times, America has itself become a source of instability. American finance, always unique, is now uniquely dangerous. The list of anxieties is long. Government debt is rising at an alarming pace. Trade policy is beset by legal conflicts and uncertainties. Donald Trump is attacking the country’s institutions. Foreign investors are skittish and the dollar has tumbled. Yet, astonishingly, one big danger lurks unnoticed still.

The financial revolution is now encountering the maga revolution. Mr Trump is hastening the next financial crisis by playing havoc with trade, upending America’s global commitments and, most of all, by prolonging the government’s borrowing binge. America’s financial system has long been dominant, but the world has never been as exposed to it. Everyone should worry about its fragility.

The new firms are a magnet for financial talent. They also enjoy regulatory advantages, because governments forced banks to hold more capital and rein in their traders after the financial crisis of 2007-09. That combination has led to a spate of innovation, supercharging the firms’ growth and propelling them into every corner of finance.

Three big private-markets firms, Apollo, Blackstone and kkr, have amassed $2.6trn in assets, almost five times as much as a decade ago. In that time the assets of large banks grew by just 50% to $14trn. In the search for stable funding, the upstarts have turned to insurance; Apollo, which made its name in private equity and merged with its insurance arm in 2022, now issues more annuities than any other American insurer.

There is much to like about this new financial system. It has been highly profitable.

Unfortunately, the new finance also contains risks. And they are poorly understood. Indeed, because they are novel and untested by a crisis, they have never been quantified.

One lot of worries come from within the system. The new giants are still bank-like in surprising ways. Although it is costly to redeem a life-insurance policy early, a run is still possible should policy holders and other lenders fear that the alternative is to get back nothing. And although the banks are safer, depositors are still exposed to the new firms’ risk-taking. Bank loans to non-bank financial outfits have doubled since 2020, to $1.3trn. Likewise, the leverage supplied to hedge funds by banks has ballooned from $1.4trn in 2020 to $2.4trn today.

The new system is also dauntingly opaque. Whereas listed assets are priced almost in real time, private assets are highly illiquid. Mispriced risks can be masked until assets are suddenly revalued, forcing end investors to scramble to cover their losses.

Much about the risks of the superstar firms, and their linkages to the wider financial system and the real economy, will become clear only when trouble strikes. New emergency-lending schemes would be needed. Rescuing banks last time was politically toxic. Saving billionaire investors would be an altogether harder task. And yet if the biggest of these giant firms were left to fail, it could lead to a global credit crunch.

Nobody knows when disaster will strike. But when it does, investors will suddenly wake up to the fact that they are dealing with a financial system they do not recognise.

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