Warren Buffett famously said that only when the tide goes out will you find out who’s been swimming naked. By this he meant that it’s only when money is no longer cheap will you find out who borrowed imprudently and which borrowers are at risk of default.

If ever Buffett’s adage had applicability, it has to be today after many years of ultra-easy US and world monetary policy. Now that the world’s major central banks have rediscovered old-time monetary-policy religion to regain control over inflation, we’re discovering that many large borrowers have been swimming naked — which could pose a risk to the stability of the world financial system.

That should give the Federal Reserve pause before it continues to raise interest rates at an unusually rapid pace.

In response to the 2020 COVID-induced recession, the world’s major central banks opened the monetary-policy spigots in an unprecedented manner. They wanted to spare the world economy from a downward spiral. Not only did they reduce policy interest rates to their zero lower bound; they also expanded their combined balance sheets by more than $10 trillion through large-scale bond purchases.

As might have been expected, the massive amount of central-bank money-printing surged world debt to a record level. It also led to the mis-pricing of that debt and a gross misallocation of capital. In particular, with the world awash in liquidity, markets did not distinguish between sound and unsound borrowers. Borrowers with weak credit records took advantage of this situation and borrowed large amounts at very low interest rates.

With the world’s central banks now being forced to slam on the monetary-policy brakes to bring down multi-decade inflation, the world credit cycle has turned. That is causing cracks to emerge in the world financial system all too reminiscent of the cracks that appeared in the run-up to the 2008 Lehman Bros. crisis. It comes as the borrowers find they cannot meet their debt-service obligations at the higher interest payment when their loans come due.

Over the past year, China’s Evergrande, with $300 billion in debt, along with 20 other Chinese property developers have defaulted on their loans. In the United Kingdom, last month the Bank of England had to bail out the UK pension system with a $65 billion intervention in the UK gilt market to save it from ill-advised derivative positions.

Meanwhile in the emerging market space, Argentina, Russia, Sri Lanka and Zambia have all defaulted on their loans. More such defaults are in the pipeline as capital is repatriated away from the emerging markets to the United States in search of higher interest rates.

More recently, the cryptocurrency market has been shaken by the run on FTX, a cryptocurrency trading platform. That has led to FTX’s bankruptcy and large losses for established names like Sequoia, SoftBank and BlackRock. It’s also contributed to the evaporation of more than $2 trillion in cryptocurrency wealth.

Past experience would suggest we are only at the start of a credit market shakeout that could have serious implications for world financial market stability. That’s particularly the case considering the global economy is very likely to experience a recession next year that could damage balance sheets. It also hardly helps matters that the Federal Reserve is now telling us that it expects to keep interest rates high for longer than it did before.

Following the 2008-09 Great Recession, efforts were made to strengthen the US banking system to withstand any future credit market event. But the same cannot be said about the largely unregulated non-bank part of the financial system that includes the hedge funds and private-equity funds. This could be setting us up for another Long-Term Capital Management-type crisis that shook the world economy in 1998.

With so many warning signs of credit-market troubles ahead, the Fed would be remiss to ignore those signals and charge ahead with further large interest-rate hikes that could invite a credit crisis. Rather, the more prudent course would be for the Fed to reduce the size of future interest-rate increases. That would give it time to see the lagged effects of its more hawkish monetary policy both on the economy and on the financial markets.

American Enterprise Institute senior fellow Desmond Lachman was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.