The recent collapses of Silicon Valley Bank and Signature Bank have raised significant concerns regarding the stability of the American financial systemAs observers reflect on these events, they wonder if this could spark a crisis akin to the downfall of Lehman Brothers in 2008. While it remains to be seen, what is clear is the profound impact of the Federal Reserve's monetary policies on the financial landscape of the United States, particularly in the year 2022. During this period, financial assets in the US plummeted by approximately $23 trillion, a staggering decline that surpassed the financial squeeze experienced during the global financial crisis of 2008. This stark reality underscores the vulnerability of financial institutions and the potential ramifications for both the economy and everyday citizens.

To better understand the evolution of US financial assets, one can refer to data released by the Federal Reserve, which provides a comprehensive visualization of these developments

This data not only highlights the composition of financial assets but also delineates who holds these assets—ranging from individual citizens to federal institutionsFurthermore, it lays out the liabilities and equity that accompany these assets, facilitating a multifaceted exploration of the financial system’s trajectory since World War II.

The spectrum of financial assets in the United States includes a variety of instruments—official reserve assets, Treasury cash, demand deposits, savings, bonds, loans, publicly traded company stocks, pension reserves, equity in privately held companies, as well as money market funds, mutual funds, exchange-traded funds, and various receivablesCollectively, these components illustrate the complexity and interconnectivity of the national financial system.

In 2022, the financial asset class witnessed a significant contraction, with a noted decrease of $22.8 trillion, accompanied by a reduction in liabilities and equity by $17.5 trillion

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Notably, these declines exceeded the financial downturns observed in 2008, marking the highest drop since World War IIThe decline was predominantly driven by reductions in the values of stocks, bonds, pension reserves, and mutual funds, with the most pronounced decreases occurring in the first three quarters of the yearInterestingly, a rebound was observed in the fourth quarter when the values of stocks and bonds began to recover, allowing financial assets to regain some traction.

The distribution of financial assets in the US is broad, encompassing households, non-profit organizations, non-financial businesses, financial institutions, and government entities at both the federal and local levels, as well as foreign investorsFollowing World War II, there was a rapid increase in the share of financial assets held by financial institutions and foreign capital, leading to a decline in the proportion of assets owned by households and non-profits

By 2022, the share of financial assets controlled by these entities had dipped below 35%.

The economic tumult brought about by the COVID-19 pandemic saw a remarkable increase in US financial assets, largely due to aggressive monetary and fiscal policiesOver the course of two years, financial assets jumped by more than $35 trillion, but they began to deflate once the Federal Reserve halted its quantitative easing measuresThis rapid accumulation and subsequent contraction of financial assets reveal the volatility introduced by governmental interventions in the economy.

To unpack the nature of financial assets, it’s essential to understand that many are essentially transactional mediums rooted in currencyMoney forms the backbone of all financial transactions, enabling a variety of asset classes such as stocks, bonds, loans, and pension reserves to function within the financial marketplace

Different stakeholders—be they households, government entities, or financial institutions—share ownership of these assets and the associated liabilities, thus engaging in a complex web of entitlements and responsibilities.

Unlike liquid assets such as cash and deposits that are easily convertible, bonds stand out as entities that do not guarantee value preservationAlthough a bond's nominal value remains stable, declining market prices do not reduce its issuer's debt obligationsHowever, the decrease in market prices can inflate the costs for issuers seeking to raise funds through new bond offerings.

2022's significant contraction in US financial assets outpaced the drop in liabilities and equity, primarily driven by declining bond valuesThe fluctuations in the market significantly impacted the prices and perceived stability of various types of financial securities

For example, the valuation of publicly traded stock is significantly influenced by the trading volume; thus, fluctuations in stock price are direct reflections of market sentiment and investor behavior.

Similarly, shared-equity financial assets like mutual funds and money market funds are susceptible to market dynamicsThe fluctuation in their shares often occurs with greater frequency than common stock, although the magnitude of price changes tends to be lower compared to equities.

Insurance-related financial assets, including life insurance and pension funds, also exhibit unique characteristicsThe changes in their asset sizes reflect both the inflow of contributions and shifts in the value of the financial assets they holdThe interplay between these two factors reveals the complexity of maintaining adequate funding levels and risk exposures.

Another noteworthy aspect of the US financial landscape post-World War II is the growing dominance of financial institutions

Their engaged transactions, from interbank trading to repurchase agreements and cross-border debts, have increasingly contributed to the financial system’s liabilities and equitiesThis trend illustrated a paradigm shift in the ownership of financial assets, with financial institutions now owning over 50% of these assets.

In the decades following the war, the United States emerged as the preeminent power in the global financial system, supplanting the UK in this roleThe synergistic evolution of the American financial structure not only shaped its own economic framework but also exerted a powerful influence on the global financial networkThis evolution in part enabled the US to export risks associated with its financial assets to other economies, thereby alleviating potential crises within its own financial system.

In response to the onslaught of the pandemic, the Federal Reserve reintroduced quantitative easing, coupled with nearly $5 trillion in stimulus funding from the federal government

This dual strategy had immediate effects on the stock market, driving a 'pseudo bull market' that ironically led to record inflation levels not seen in nearly 40 years.

As inflation began to spiral out of control, the Fed transitioned away from its quantitative easing policy in 2022, resorting to aggressive interest rate hikesBy this point, the benchmark interest rate had risen significantly beyond 4.33%. Such a shift correspondingly led to price declines across major asset categories, including stocks and government bonds, ultimately resulting in the largest recorded decline in US financial assets.

The rising costs of consumption due to inflation, coupled with elevated borrowing costs from interest rate hikes, created a scenario where the asset bubbles formed in the previous years showed signs of strainThe imbalances within the financial system, exacerbated by previous aggressive growth, hinted at underlying structural risks within the American financial architecture