Psychologist James Reason’s ‘Swiss cheese model’ holds that major disasters in complex systems are the result of the accumulation and alignment of multiple failures—the ‘eyes’ or holes in some kinds of cheese. Today, several risks—overvaluation, high debt, cash flow shortfalls, volatility, rising interest rates, interconnections, financial games, poor safeguards—are creating the perfect conditions for a financial crash.
Valuations are stretched. Cyclically adjusted 10-year US price-to-earnings (CAPE) ratios are at their highest levels since the 19th century, above the levels of 1929 and only slightly below the peak of the dotcom boom. They are around 41 times earnings and over 67 times earnings if current exaggerated incomes are normalised. In comparison, CAPE reached 32.6 times and 44.2 times earnings before the crashes in 1929 and 2000, respectively.
The ratio of US share market’s capitalisation to GDP, known as the Buffett indicator, is over 230 percent of GDP, the highest recorded level. Valuations of non-US equities are also extended, although to a lower degree. Property, the largest repository of global wealth, is overvalued by up to 50 percent using price-to-affordability metrics, although there are significant locational discrepancies.
Price rises have outstripped underlying cash flows. Across 10 countries that account for 60 percent of global GDP, as of 2025, $620 trillion in real assets—like machinery and equipment, infrastructure, buildings, natural resources, and intellectual property—support over $1,800 trillion in financial assets representing eventual claims against the same property and cash flows. Since 2000, wealth growth has reflected valuation gains in financial assets, especially real estate, rather than changes in productive assets. For every $1 in net new investment in real assets over the past 20 years, liabilities have grown by almost $4, of which about $2 is debt.
As of mid-2026, global debt has reached around $350 trillion or 308 percent of world output, up from around $210 trillion a decade ago. There are layers of leverage with investors, fund and businesses borrowing at the same time against the underlying cash flows.
Debt must be repaid or refinanced. Much of this borrowing was taken out during periods of near-zero rates and renewals, if possible, will be at a higher cost. Cash insufficiency threatens failures and credit losses. As interest rates rise, there are already pockets of distress amongst less creditworthy borrowers.
In parallel, investors, pension funds and insurers rely on cash flows from their investments to finance spending or meet contractual payouts. Lack of distributions and write-offs reduce available funds that underpin economy activity creating adverse feedback loops. Simultaneously, higher volatility feeds risk models, triggering margin calls and involuntary deleveraging as lenders tighten liquidity.
The cost of capital is rising. The era of low government bond yields may have ended. Higher-for-longer rates are probable due to cost pressures from wars, disruption of supply chains, and national-security-driven reshoring. Premiums for risky assets, which have declined to historical lows, will rise to compensate for increased instability. The rising gap between required returns and cash generation undermines asset prices.
Linkages between financial institutions, derivatives and securitisation create multiple paths that will rapidly transmit shocks, making it difficult to isolate and control problems. Investment behaviours exacerbate strains, as passive indexed investments and rule-based quantitative trading styles relying on momentum increase fragility.
There are familiar financial misdemeanours. True indebtedness is understated by the proliferation of off-balance-sheet financing arrangements, which at Alphabet, Microsoft, Amazon, Meta and Oracle alone have reached $1.65 trillion, compared to $1.35 trillion in on-balance-sheet debt. Post-Enron auditor reforms are being watered down to make share listings ‘great again’.
Traditional buffers are weaker. With consolidation in banking markets, market-making—which, in a crisis, plays a critical role in warehousing risk purchased at a discount—is weaker. It is dominated by investors and quantitative trading firms, who when volatility increases frequently withdraw from trading. This lower trading liquidity is creating potential larger dislocations where there is forced selling or multiple participants simultaneously unwind positions.
Regulators are perversely reducing bank capital requirements at a time when they are likely to be needed. The decreases, lobbied for by the banks, are intended to boost economic growth by more debt-financed consumption and investment ignoring existing elevated levels of borrowing. The argument is that the changes will simplify rules and lower compliance costs.
Given ongoing issues at individual institutions, it is unclear whether the changes are justified. Regulators argue the need for recalibrating standards to better match actual asset risks. Given that by most measures actual exposures have become riskier, it is difficult to make the case for reductions. In reality, the relaxation is designed to enhance profitability on shareholder’s funds and also allow more distributions to shareholder and share buybacks.
The ability of governments and central banks to intervene is uncertain. Public finances are stretched by intractable budget deficits and the highest levels of government debt outside of war. The average budget deficit across the Organisation for Economic Co-operation and Development is 4.6 percent of GDP, with few countries in surplus. The average government debt-to-GDP ratio in OECD countries now exceeds 112 percent—well above the pre-2007 average of around 72 percent. A sizeable portion of this is now funded not by long-term holders, but by hedge funds.
Central bank balance sheets, at around $20 trillion (below the peak of over $25 trillion), are well above their $5 trillion level in 2007. Modest interest rates and inflation concerns limit the scope for large cuts. Central bank credibility is also low due to the adverse effects of novel policies, like quantitative easing and zero-interest rates.
Poor forecasting, most notably the post-pandemic ‘transitory’ inflation debacle, and their inability to prevent serial monetary crisis, has damaged their reputations. Public appetite for bailouts, which persistently benefit high-income groups and well-connected institutions, is unknown. This is complicated now, with significant proportions of the risk being outside regulated deposit-taking institutions.
Financial markets now resemble a bonfire waiting for someone to toss a match into it. Investors and policymakers are remarkably complacent assuming that a financial crash cannot happen or that they are well prepared. But as General Chuck Yeager, the first man to break the speed of sound, understood: “At the moment of truth, there are either reasons or results.”
Satyajit Das | Former banker and author of the forthcoming book, The Everything Bubble
(Views are personal)
