Foundations and Fault Lines

What AI Optimism Isn’t Accounting For

Markets today are running a high-stakes experiment in selective perception. The AI-led surge in capex and stock valuations has become the dominant narrative, casting a long, shimmering shadow over less glamorous but potentially far more consequential developments beneath the surface. Two of the most pressing risks are institutional decay at the top of the US economic system and a brewing storm in the unregulated private credit market. Neither fits neatly into an AI-hype story, which is precisely why they deserve closer attention.

Private Credit: The Hidden Risk Pileup

The First Brands bankruptcy, recently filed in Delaware, is easy to dismiss as a run-of-the-mill corporate collapse. That would be a mistake. The auto-parts distributor, heavily backed by private credit, reportedly pledged the same assets to multiple lenders, a basic violation that raises red flags not just about the borrower, but about the ecosystem that funded it.

This may be the canary in the coal mine for a market segment that has ballooned in size and significance without the scaffolding of proper oversight. If early reports hold, the fraud wasn't sophisticated, it was lazy. And yet, few seem surprised. Why?

Because underwriting discipline in private credit has been deteriorating for years. With trillions in dry powder and intense pressure to deploy capital, many lenders have drifted toward a model that prioritizes speed over scrutiny. Add in the absence of regulatory standards that govern traditional banks, and you get a perfect environment for risk mispricing, creative accounting, and, in extreme cases, outright deception.

We should not assume this is an isolated incident; we should also assume that a significant share of credit exposure today is built on underwriting decisions that would not withstand meaningful stress. Combine weak covenants, inflated collateral, and the incentive to roll or refinance rather than confront problems head-on, and the outcome is predictable: losses, cover-ups, and contagion. Capital flooding into AI infrastructure may keep markets buoyant for now, but it won’t offset the drag from widespread defaults if the private credit sector begins to unravel.

A Politicized Fed: Crisis Without a Compass

At the same time, another risk is quietly escalating: the politicization of the Federal Reserve.

Historically, the Fed has served as the grown-up in the room: not always perfect, but independent enough to stabilize markets in times of stress. However, the growing influence of ideologically loyal nominees threatens to transform the Fed into an institution less guided by economic logic and more by political convenience. Since returning to the White House, President Trump has moved quickly to assert more direct control over the Federal Reserve. His administration has signaled an intent to nominate Fed officials based on ideological loyalty and alignment with the administration’s political agenda rather than independent economic expertise. This raises the risk of a central bank guided less by inflation data or labor market dynamics and more by campaign messaging and electoral calculations.

This might not be catastrophic during calm conditions, but crises are defined by uncertainty, and that’s when independent central banking matters most. Imagine a scenario where inflation resurges and the Fed’s instinct isn’t to tighten, but to mirror a political demand for lower rates. Beyond bad economics, it’s a credibility crisis. And once the Fed’s credibility is lost, it’s not easily rebuilt.

Acknowledging Two Economies: Narrative vs. Reality

This disconnect between a booming AI narrative and weakening economic fundamentals isn’t theoretical. It’s observable. In her recent New York Times piece, “There Are Two Economies: A.I. and Everything Else” (Oct. 2025), Natasha Sarin, professor of law and co-founder of The Budget Lab at Yale,  articulates this divergence clearly. Her argument that AI is masking the effects of damaging policy decisions and weakening the natural feedback loops that would normally drive reform mirrors what we’re seeing on the ground. One economy is visibly surging while the other is quietly eroding.

None of this fits the current mood, which is still defined by tech optimism and a sense that AI will fix (or at least outgrow) whatever macro headaches come along. But just because markets are celebrating innovation doesn’t mean the foundations beneath them are stable. In fact, the more dependent performance becomes on one sector (and one narrative), the more brittle the structure becomes.

AI may be the future, but it won’t stop a credit unwind, it won’t neutralize institutional decay, and it won’t save a market that decides, suddenly, that trust is gone in balance sheets, central banks, or the system itself. The deeper question isn’t whether AI can justify its current price tag, it’s whether the rest of the system can handle what’s coming if it can’t.