An unseen financial threat looms before Trump and his Treasury 

President-elect Trump and Treasury Secretary-Designate Scott Bessent have drawn a difficult hand.

We all know about the country’s bloated national debt, the continuous erosion of the purchasing power of many Americans, and the many other well-chronicled economic challenges the country faces. But it is the threats we don’t see or hear about that often pose the most immediate and significant peril. Principal among these is the country’s antiquated and ineffective financial regulatory system. Its increasing inability to anticipate or avert market anomalies is a direct bridge to the next American financial panic.  

Created in the 1930s, the network of regulatory watchdogs today includes nearly a dozen federal regulators, as well as attorneys general and banking, securities and consumer protection regulators in 50 states and 16 U.S. territories. But in cyberspace, where products are available online and borders mean very little, these nearly 200 overseers are constantly bumping into each other, regulating the same things at the same time.

The country’s bank regulatory infrastructure was built in the wake of the Great Depression, largely to discourage bank runs and protect depositors. As a result, it relies in large part on broad ratios and rules, presuming that if every bank adheres to them, they and the system will be healthy. But as one financial disaster after another has proven, nothing could be further from the truth. 

As the financial landscape has become populated with unsupervised funds, fintechs, crypto companies and a wide range of nonbank intermediaries, high-risk financial activities have naturally gravitated to companies that are beyond the purview of bank regulators. Consider the financial calamities involving FTX, Binance, Synapse and a growing number of other new economy companies that happily flew around regulatory radar and far too close to the Sun. 

As a result, dedicating most of the country’s regulatory resources to ensuring that every bank satisfies applicable capital and liquidity ratios no longer means that the broader financial system will be safe or that banks will not fail when the risk created or assumed by nonregulated companies causes the economy to fall into crisis, as it did in 2008. 

We need to build a smarter regulatory mousetrap that relates to the economy that exists to prevent the next financial crisis. To do so, Donald Trump and Bessent, along with the Congress, should launch four important efforts.

Companies celebrate when their competitors are regulated, and new economy companies are partying hard these days. While banks have become a minority in the new financial services business, they are still the only companies subject to unparalleled cradle-to-grave oversight whose activities, capital, liquidity and leverage are dictated by federal and state law.  

In contrast, the new majority of financial services companies are free to overleverage themselves and stockpile risk without any governmental oversight. Such regulatory imbalances led to financial panics in 1907, 1929, the 1980s and 2008.  

The handwriting is on the wall. An effective system of oversight requires that any company — bank or nonbank — that invests the publics’ funds and whose health may affect financial stability must be regulated.

The new digital economy is creating challenges for federal deposit insurance and its goal of making depositors feel secure. The rapid demise of Silicon Valley Bank underscored how social media can erode confidence in financial institutions instantaneously. And with more than 40 percent of bank deposits uninsured, financial markets have become more volatile, particularly given the increasing uncertainty as to which depositors and companies get bailed out when a financial crisis damages the stability of the system. We need to rethink how much of whose funds held by what kind of fiduciary should be insured in a fast-moving digital economy.

Given the velocity of this economy, any system of financial oversight that is not real-time-based and intelligently predictive is doomed to ineffectiveness. The current system of regulation, which measures where banks have been, has served us well enough in slower moving economic eras. But today, an effective system of regulation must be able to measure real-time risk, predict alternative future scenarios, and model a range of corrective measures for regulators to consider.  

The increasing use of AI technologies by financial companies can only be effectively monitored if regulators have similar technological tools and capacities. They do not. The best way for that to happen is for the regulatory model to be modernized from an adversarial to cooperative-based format where the public and private sectors contribute what they know and do best to the oversight process. 

The cryptocurrency business is a counter-culture darling long past the point where it should have been regulated. Crypto coins and crypto-based derivatives and ETFs, including the leverage created when they are purchased, are approaching $10 trillion. That is approximately 85 percent of the size of the direct U.S. mortgage market represented by random algorithms with no underlying value. Crypto can now affect the stability of the U.S. economy, and it should be regulated as such.

People should have the right to lose their money on speculative ventures like cryptocurrencies. But once an investment doubles as money, it steps into a different world, where confidence and stability are critical. Floating rate cryptocurrencies have no intrinsic value and can be issued, sponsored or moderated by people we may not even be able to find. Even when we know who they are, they are not required, as are others in the financial services business, to demonstrate any expertise, experience or integrity. 

Almost every time in history that a new speculative instrument has experienced an irrational run-up in value, it has been followed by an economic collapse. And crypto’s run-up has been as irrational as it gets.

Cryptocurrencies have become a principle means of financing criminal enterprises, hackers, drug dealers, terrorists, human traffickers, purveyors of child sexual abuse material, and illegal weapons distributors. To make matters worse, hacking cryptocurrencies has now become a principal way that North Korea funds its nuclear program. 

There are many hard economic choices ahead for the president- and secretary-elect. Knowing that they don’t want a financial crisis to occur on their watch, they should appoint people who want to do more than act as stewards for a failing system, and marshal the resources to modernize the country’s outdated system of regulation so it can address the risks of 21st century markets.  

Thomas P. Vartanian has been a bank regulatory official at three different agencies and a practicing financial services lawyer. Currently the executive director of the Financial Technology and Cybersecurity Center, he is the author of “200 Years of American Financial Panics” and “The Unhackable Internet.”