The Next Financial Crisis Is Imminent, and Federal Officials Are Ignoring the Warning Signs

Art Wilmarth was a member of GW Law's faculty from 1986 to 2020. Prior to joining the faculty, he was a partner in Jones Day's Washington, DC office.

Art's essay is based on remarks he presented at a conference in Washington, DC on September 19th, hosted by Better Markets.

Private-sector credit booms (sometimes referred to as “Minsky cycles”) have been the leading cause of systemic financial crises in major developed nations during the past 150 years. We are currently experiencing an enormous credit boom. Warning signs of an imminent financial meltdown are flashing in markets for crypto-assets, corporate equity and debt securities, and consumer loans. Large financial institutions are highly leveraged and vulnerable to a sudden economic downturn. 

All the ingredients for a major financial crisis are in place, and the spark for that conflagration could come from several different directions. In addition, the U.S. (like other G7 nations) is struggling to cope with a massive debt burden, created in large part by the enormous costs of responding to the global financial crisis of 2007-09 and the pandemic financial crisis of 2020-21. Accordingly, there are growing doubts about the federal government’s capacity to finance bailouts and fiscal stimulus programs that would be necessary to contain the next financial crisis. Attempts to finance a comprehensive rescue program would be likely to precipitate severe problems in the Treasury bond market and undermine the dollar’s primacy in global currency markets. Yet the Trump Administration and Congress have continued to pour gasoline on the bonfire instead of taking urgently needed actions to prepare for the looming crisis and mitigate its impact.

The Crypto Bubble

The Trump Administration and Congress have unleashed a speculative crypto bubble with unrestrained pro-crypto policies. President Trump’s election sparked a prolonged boom in the crypto industry, and the total market capitalization of all crypto-assets reached $4.3 trillion on October 8. The GENIUS Act placed the federal government’s seal of approval on uninsured nonbank stablecoins, causing the stablecoin market to expand beyond $300 billion. 

Huge investments in leveraged crypto derivatives and other speculative crypto investments have driven the crypto boom. Crypto derivatives – including futures, options, and swaps – account for about 75% of all crypto trades, and most crypto derivatives are traded on unregulated foreign exchanges. Perpetual crypto futures contracts – like the credit default swaps that provided fuel for the global meltdown of 2007-09 – allow investors to make highly-leveraged, long-term bets on movements in crypto prices without owning the underlying crypto-assets. 

The Securities and Exchange Commission has endorsed crypto exchange-traded funds, which make leveraged bets on individual and multiple crypto-assets. “Crypto treasury companies” provide additional opportunities for gambling on crypto assets. The foregoing bets on crypto-assets are inflating a “Subprime 2.0” crypto bubble, which resembles the toxic pyramid of credit derivatives and other speculative bets on subprime mortgages during the “Subprime 1.0” credit boom. 

The collapse of the “Subprime 1.0” credit boom unleashed the global financial crisis of 2007-09. The bursting of the “Subprime 2.0” crypto bubble will have comparable devastating effects on our financial system and economy. Indeed, “Subprime 2.0” will probably be worse than “Subprime 1.0” because – unlike subprime mortgages – Bitcoin and other crypto-assets with fluctuating values do not have underlying assets with realizable values and do not produce cash flows beyond the speculative trades occurring on their blockchains. Hence, the crypto bubble is effectively a speculative mania riding on thin air.

On October 10, President Trump announced his intention to impose much higher tariffs on China. That announcement triggered a crypto crash. During the following week, the total market capitalization of all crypto-assets dropped by nearly 15% to $3.7 trillion, while prices for Bitcoin and Ethereum both dropped by over 12%. As analyst Molly White observed, the crypto crash revealed a “lack of circuit breakers [at crypto exchanges], massive leverage, technical fragilities, and overwhelming complexity of interwoven crypto assets . . . . As crypto grows more interconnected with mainstream finance, future crashes will reach far more widely.”

The AI Stock Market Bubble

The U.S. stock market is enjoying a record boom. The sustainability of that boom depends almost entirely on expected profits from huge investments in artificial intelligence (AI). At the end of September, the “Magnificent Seven” technology stocks – Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla – had a combined market capitalization of $20.7 trillion, accounting for 35% of the total value of all S&P 500 stocks. The concentration of so much of the stock market’s total value in so few stocks is unprecedented. According to several measures, U.S. stocks have reached their most lofty valuations since the peak of the dotcom-telecom stock bubble in early 2000. 

“America’s stock market is largely AI-driven” – a highly disturbing echo of the dotcom-telecom stock boom, which ended with a devastating bust in 2000-02. AI fever has produced “one of the costliest building sprees in world history.” Technology companies and AI developers have spent $750 billion to construct huge data centers with advanced chips during 2024 and 2025, and they plan to spend another $3 trillion by 2029. The current stampede to build AI data centers mimics the construction binge of the late 1990s by telecoms, which spent over $500 billion to install more than 80 million miles of fiber-optic cable networks. 

The performance of AI models has fallen far short of their creators’ promises as well as investors’ expectations. OpenAI’s ChatGPT-5 model, released in August, is widely viewed as a “dud,” and 95% of corporate AI projects are not producing expected profit gains. Experts warn that “simply throwing more computing power at the current models” will not produce AI systems that are equivalent or superior to human intelligence. However, the Trump Administration has thrown its full support behind the AI boom and has dismissed all cautionary warnings about the feasibility and risks of the AI industry’s ambitions.

Technology companies and AI developers are taking on huge debt obligations to build data centers and buy advanced chips. AI-linked companies have issued $1.2 trillion of investment-grade bonds and are receiving large loans from private credit providers. The rapid expansion of AI-related debt poses great dangers to our financial system and economy because technology firms and AI developers do not have any “exit strategy” for satisfying their massive debt obligations if their AI investments fail to produce their projected profits. For example, OpenAI has made about $1 trillion of financial commitments to buy advanced chips and acquire data centers, but OpenAI currently generates only $13 billion of annual revenues and reportedly incurred a net loss of $8 billion during the first half of 2025. 

A bursting of the AI bubble would have devastating effects on our financial markets and economy. The dotcom-telecom bust in 2000-02 destroyed over $5 trillion of shareholder wealth. The technology-heavy Nasdaq Composite index lost over 75% of its value between March 2000 and September 2002 and did not return to its 2000 peak until 15 years later. 

The dotcom-telecom bust was so severe that Alan Greenspan and the Fed cut short-term interest rates to a then-record low of 1% in 2003, seeking to boost housing prices in a desperate effort to make up for the huge losses in stock market wealth. Greenspan’s ultra-low interest rates helped unleash the Subprime 1.0 housing boom, with catastrophic results. Even a 50% drop in the current Nasdaq Composite index – which includes the “Magnificent Seven” technology stocks – would shock financial markets and threaten economic stability by vaporizing more than $11 trillion of shareholder wealth.

Bubbles in Subprime Corporate and Consumer Credit 

Subprime (noninvestment-grade) corporate debts and subprime consumer debts have reached alarming levels. Global private credit – unrated loans provided to business firms by nonbank financial intermediaries (shadow banks) – reached $2 trillion in 2023, with $1.6 trillion owed by U.S. firms. High-yield (junk) bonds and leveraged corporate loans represent an additional $3 trillion of U.S. subprime corporate debt. Thus, more than a third of all U.S. business loans are subprime, with high leverage and very limited creditor protections. Investment-grade corporate bonds, which account for about two-thirds of prime U.S. corporate loans, have exhibited very weak characteristics since 2018. During the past six years, almost half of investment-grade U.S. corporate bonds have been rated at the lowest “BBB” level, and leverage rates for issuers of “BBB” bonds have remained well above historical trends.

Consumer debts have shown significant deterioration during the past year. Delinquencies and defaults are surging on auto loans, credit card loans, and student loans, with combined outstanding balances exceeding $4.5 trillion in June 2025. Vehicle repossessions are at their highest level since 2009, and the percentage of auto loan borrowers with delinquencies beyond 90 days matches previous record highs in 2010 and 2020. In mid-2025, over 10% of outstanding balances on credit card loans and student loans were delinquent beyond 90 days, and almost 30% of student loan balances were delinquent beyond 30 days. Delinquency rates are also rising on FHA and VA mortgages.

U.S. banks have large and growing exposures to subprime corporate and consumer credit through direct and indirect channels. In addition to their direct loans to businesses and consumers, banks have extended $2.3 trillion of credit commitments to shadow banks. A growing number of life insurers are controlled by private equity firms, and life insurers hold $1.5 trillion of debt obligations issued by subprime business firms. 

The recent bankruptcies of Tricolor Holdings (a subprime auto lender) and First Brands (an auto parts supplier with a checkered history) are harbingers of the risks posed by subprime business and consumer credit. Both bankruptcies reveal (1) the increasingly desperate circumstances of subprime consumers and subprime businesses, (2) rapidly rising default rates on loans made by shadow bank lenders, and (3) growing loss exposures from subprime credit for large banks, life insurers, and other institutional investors from. On October 16, Zions Bank and Western Alliance Bank triggered additional concerns when they disclosed large expected losses from defaulted loans to a bankrupt California commercial real estate development firm. The Trump Administration has ignored the foregoing problems, gutted the Consumer Financial Protection Bureau, and issued a proposal that would weaken safety and soundness oversight of banks.

The U.S. Economy is Not Strong Enough to Withstand a Severe Financial Crisis

The U.S. economy is highly exposed to a financial crisis due to overleveraged borrowers and vulnerable financial institutions. Nonfinancial businesses and households owed a record $42.4 trillion in June 2025. The heavy debt burdens carried by businesses and consumers resemble their debt loads in 2007 and 2019, just before the last two systemic financial crises erupted. In June 2025, total U.S. nonfinancial business debts equaled 72% of U.S. gross domestic product (GDP), matching their level in December 2007 and close to their 77% level in December 2019. Total household debts in June 2025 equaled 67% of GDP, well below their 97% level in 2007 but close to their 73% level in 2019. 

Federal bank regulators have allowed the largest U.S. banks to make excessive shareholder distributions since 2016, resulting in significant declines in their leverage capital ratios. Federal regulators have ignored the lessons of financial crises since 2007, which confirm the urgent need for much higher levels of equity capital at the largest banks. Adding insult to injury, regulators issued a recent proposal that would permit the largest U.S. banks to become severely undercapitalized, as they were in 2007. Thus, federal agencies are recklessly decapitalizing our biggest banks despite the imminent threat of another financial crisis. 

In addition, there are growing concerns about the federal government’s ability to contain the fallout of the next financial crisis. As a result of the staggering costs of responding to the global financial crisis of 2007-09 and the pandemic crisis of 2020-21, the federal government’s total debts more than quadrupled from $8.9 trillion to $36.2 trillion between June 2007 and December 2024. The federal government’s total debts as a percentage of U.S. GDP nearly doubled from 62% to 121% during the same period.

Given the U.S. government’s enormous and unresolved debt problems, there are serious doubts about the federal government’s capacity to finance a comparable rescue program to contain the next financial crisis. Those doubts have grown stronger since April 2025, when President Trump’s tariff announcements triggered a sharp selloff in the stock market, a sudden spike in Treasury bond yields, and a substantial decline in the dollar’s value. Tariffs were the immediate catalyst for April’s market convulsions, but those upheavals reflected much deeper concerns among investors about the federal government’s unsustainable debt burden and failures by both political parties to address that problem. Accordingly, there are substantial reasons to doubt the federal government’s capacity to contain the next financial crisis. If it could not do so, our financial markets, economy, and society would face the prospect of another Great Depression.

The Urgent Need for Immediate Action

The next financial crisis is close at hand, and federal officials must take immediate steps to avoid the worst possible outcomes. Those measures must include: (1) repealing the GENIUS Act and passing legislation requiring all stablecoin providers to be FDIC-insured banks; (2) requiring all providers of crypto-assets with fluctuating values and crypto derivatives to comply fully with the federal securities laws and the rules governing non-digital derivatives; (3) requiring large shadow bank lenders to satisfy reasonable disclosure requirements as well as sensible limits on leverage and risk concentrations; (4) restoring the Consumer Financial Protection Bureau’s ability to protect consumers; and (5) strengthening capital requirements and implementing additional safety and soundness safeguards for systemically important banks, securities broker-dealers, and life insurers. The foregoing reforms are urgently needed to forestall the next financial crisis or at least substantially mitigate its potential adverse effects.

The opinions shared in this article are the author’s own and do not reflect the views of any organization they are affiliated with.

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