The writer is chair of the European Risk Management Council
If someone set out to design a rigorous stress test for the financial system, it would be hard to come up with a better one than the scenario emerging from the actions and policies of the current US administration.
When President-elect Donald Trump last year promised a “golden era”, pledging to deregulate businesses and cut taxes, executives at US financial institutions responded with considerable optimism. However, that optimism began to fade as it became increasingly clear that the new administration’s approach was beginning to undermine key pillars of the US financial system.
The stability of the system is a complex and multi-faceted concept. It rests on several pillars, including robust regulation, sound monetary and fiscal policies, efficient markets, a predictable political, economic, and legal environment, and investor confidence. It also relies on effective international co-operation both on a regulatory and a political level.
Each of these pillars is necessary but not sufficient on its own to guarantee financial stability. While undermining one pillar may create stress within the system, the weakening of several simultaneously can result in a “perfect storm”.
‘Liberation day’ wounds
The tariff war initiated by Trump exposed critical shortcomings in his administration’s competence and governance and has placed considerable strain on US financial stability.
Impulsive executive orders — imposing, increasing, pausing, and cancelling tariffs — have repeatedly created confusion and thrown financial markets into turmoil. If this chaos were part of a master plan (which seems unlikely), the plan was fundamentally flawed, scoring an “own goal” by damaging US financial stability without delivering any clear benefits.
However, if this disorder reflects a modus operandi (which appears more probable), the threat to financial stability is even greater. Prolonged uncertainty corrodes investor confidence and is damaging for the entire financial system.
The US administration’s failure to co-operate with international bodies, recognise multilateral processes, honour previous agreements, and treat partners and allies with respect has cast serious doubt on its ability to work effectively with global financial institutions and regulators — another crucial pillar of financial stability.
When the US president posts on social media encouraging investors to buy stocks just before announcing a major tariff move, it severely undermines trust in market integrity. Investors are understandably wary of markets that appear susceptible to manipulation and insider trading.
What the “liberation day” rollercoaster also revealed is a new form of governance. Crucial decision-making within the US administration now appears to be driven entirely by one individual, reflecting his personal worldview, fantasies, and ego.
This style of leadership is not commensurate with how the world’s largest economic power should be governed. Rather, it resembles the governance models more commonly seen in certain authoritarian emerging economies and the behaviour of the US market has started to reflect this.
This helps explain why, when clouds of a global recession began to gather on the horizon, the US dollar fell to a three-year low against other major currencies, and US government long-term bond yields began to rise. These developments signal that the global investor community is losing confidence in American assets and no longer sees them as safe havens.
The US federal executive branch has revealed a level of political culture, competence, governance, and accountability that falls well short of the standards expected from the world’s largest economic and financial power.
The damage done to the country’s reputation as a reliable and responsible international trade partner will be difficult to reverse. Within just 100 days, the administration managed to erode confidence in the overall financial soundness of the US.
Regulation
Some pillars of US financial stability have been less affected so far, but perceptions about the administration’s ability to safeguard these pillars have shifted and the outlook is not bright.
The financial regulatory and supervisory framework is likely the next target for reform. Periodic review of existing financial regulation is of course a positive practice. As the world evolves, certain regulations that were once relevant and effective may become obsolete, unnecessary, or even counter-productive. However, the process of regulatory review and potential deregulation is a delicate endeavour that demands time, expertise, and rigorous analysis.
Given the unprofessional and chaotic manner in which the US administration has handled other reforms, such as government spending and the implementation of “reciprocal” tariffs, it is reasonable to expect that financial deregulation may follow a similar path, marked by equally troubling levels of competence and foresight.
The recent arrival of staff from Elon Musk’s Department of Government Efficiency at the Federal Deposit Insurance Corporation only heightens concerns that we are more likely to witness a sweeping and indiscriminate dismantling of existing financial regulations, rather than a carefully assessed and balanced approach. Impairing the ability of regulators to effectively carry out their oversight functions would be detrimental to the financial system.
In the worst-case scenario, critical regulatory guardrails and risk mitigants — currently in place to prevent financial institutions from becoming overexposed to risky assets, engaging in high-risk transactions, or assuming excessive liabilities — could be removed from regulatory requirements. The consequences for financial stability in such a case could be catastrophic.
Monetary and fiscal policy
One of the most important pillars of financial stability — monetary and fiscal policy — has already been problematic for many years. The US national debt, which now exceeds $36tn, is a major red flag for the long-term stability of the financial system. Despite this, Trump has already announced plans to implement “the largest tax cut in American history”, with the intention of offsetting the revenue loss through increased tariffs.
If this questionable approach to budget rebalancing fails, the federal deficit will grow even further. At this point, any additional increase in government borrowing or debt servicing costs could become the final trigger that pushes the US financial system towards a meltdown.
Markets thrive on stability, predictability, and responsible governance. The speed at which the US administration is currently undermining all of those elements is unprecedented for a developed economy. Trump must recognise that a stable financial system is a public good that must be carefully safeguarded. Without that understanding, financial stability will continue to erode.