So, if I’m following: Banks are lending to private equity firms to fund purchases of businesses.
Many of these businesses are SaaS which means their valuations are tumbling.
It seems possible that valuations tumble so much that the private equity owner no longer has any incentive to operate the business, bc all future cash flows will belong to the bank. What happens in practice then? Will banks actually step in and take operational control? Will the banks renegotiate terms such that the private equity owners are incentivized
to continue as stewards? Or, will they prefer to force a business sale immediately?
> Banks are lending to private equity firms to fund purchases of businesses.
Yes some businesses are SaaS but here's the real problem: Many businesses' sole purpose is _leveraged buy-outs_ which really is the devil in disguise.
It goes like this: A VC specialising in veterinary clinics finds a nice, privately owned town clinic with regular customers and "fair" prices, approach the owners saying "we love the clinic you've built! We'll buy your clinic for $2,500,000! You've really earned your exit!".
So now the VC lends the money from the bank, buys the clinic, and here's the important part: _they push the debt onto the clinic's books_. So all of a sudden the nice town clinic has $2,500,000 in debt, raise prices accordingly, ~~burn out personnel~~ slim operations accordingly, and any surplus that doesn't go to interest and amortization goes straight to the VC.
> now the VC lends the money from the bank, buys the clinic, and here's the important part: _they push the debt onto the clinic's books
This mostly correctly describes a leveraged buyout (LBO). LBOs are done by LBO shops, a type of private equity (PE) firm. Not VCs. (VCS do venture capital, a different type of PE.) And LBO debt isn’t “pushed” onto the company’s books, it’s never on the sponsor’s (LBO shop’s) books in the first place to any material extent.
Private credit, on the other hand, involves e.g. Blue Owl borrowing from a bank to lend to software businesses, usually without any taking control or equity. It’s fundamentally different from both LBOs and VC or any private equity inasmuch as it doesn’t have anything to do with the equity, just the debt. (Though some private credit firms will turn around and lend into a merger or LBO. And I’m sure some of them get equity kickers. But in that capacity they’re competing with banks. Not PE. Certainly not VC, though growth capital muddles the line between what is VC and other kinds of PE or even project financing.)
> So all of a sudden the nice town clinic has $2,500,000 in debt, raise prices accordingly...
From a financial engineering perspective this is wrong.
Both equity and debt have costs of capital. Debtholders expect interest, capital holders expect RoE. The money going to debt interest is money that would previously have gone to equity, but now does not because the equity is replaced with debt.
Crucially, the costs of debt is lower than the cost of equity because of the interest tax shield. Therefore, the vet clinic now requires less revenue to maintain or even increase its return to equity.
Technically true, but RoE expectations from a PE firm are typically a lot higher than from the original owners of a small business.
And the LBO model is much less resilient to economic headwind. Let's assume a 25% EBITDA margin business, with most costs fixed (like the clinic example). Unfortunately revenue drops 20% because of external factors. It would maybe have a tiny profit left, tax would also be tiny and there is no interest to pay. The shareholders receive near zero, absorbing most of the problem for a year waiting for times to get better.
Now the same business, same reported EBITDA, but paying a large interest sum every year to the bank. If revenue drops 20% they can't pay their interest, and banks don't just wait for next year. Now the business has the restructure, agree with the banks what that looks like, or face a bankruptcy risk.
While the new PE shareholder has a better RoE due to leverage in the upside scenario, the business (and the PE) could be completely cooked in a downside scenario. For the PE this is a calculated risk, they optimise the overall portfolio. But for the employees and customers this isn't a great scenario.
> the vet clinic now requires less revenue to maintain or even increase its return to equity
The small-town vet would have probably accepted a lower RoE. More critically, they’d have been more willing to absorb shocks to said RoE than a lender will to their debt payments.
An acquisition like that would have non-compete restrictions. And often the previous owners don't get 100% cash, they would receive part as shares in the new holding company.
They're not so silly as to have any personal or professional liability, they probably spin up a special purpose vehicle or llc to hold the bag if it all goes south
It’s analogous to a mortgage in a non-recourse state. If the borrower defaults the bank (or non-bank lender) gets the leveraged company, but can’t usually go upstream.
Ohhhh a live one! Sir do I have a wonderful bridge in Brooklyn to sell you! :)
Fun fact: banks fund this sort of nonsense constantly. I've asked about this before: why they do it. They must be making money I just don't know how. The LBO guys pay themselves massive management fees and dump the debt on the company so they walk away scott free.
My wild guess was the banks offload the eventual IPO onto investors and so make their money on the IPO fees and funneling their own clients the dead-man-walking shares. But I honestly don't know.
The usual arrangement for an LBO is to saddle the bought company, the vet in this example, with the debt,or spin off a secondary company from the vet with the poorest assets and most to all of the debt. It's all a scummy business.
If the VC borrows money from the bank and lends it to the clinic, the clinic is not on the hook to the bank. The clinic is on the hook to the VC and the VC is on the hook to the bank. Which means that if the clinic goes under, the VC takes the loss because it still has to repay the bank.
Nope. The clinic is the collateral to the bank. VC stand to loose nothing.
It does not happen overnight. But what happens is after they take control of the clinic or company they change the sales model to boost reoccurring revenue, this then allows the clinic or target company to take loans out. Because they look good on paper. The company then pays VC back when then pays bank back.
This can be done in about 6mo to 1 year process with some companies. The initial out of pocket expense is small and paid back very quickly.
I also forgot. Sometimes they will take the newly owned company and merge it. During that process they extract more money and load more debt onto the remaining entities, again making the VC money.
In some cases they can even get huge tax benefits by loading the company with debt which offsets the tax bill of the final entity.
When these transactions are done, within the span of a day multiple companies are created and merged and absolved.
> The clinic is the collateral to the bank. VC stand to loose nothing
This is actually a case where using the correct terminology clarifies.
VCs don’t do LBOs. Private equity firms do. When their deals go bust they lose the equity they invested. That equity is the first layer to take a loss. When that happens, the lenders—whether they be banks or private credit firms—take over the company, often converting some of their previous debt into equity.
There is a lot of risk in LBOs. It’s why they have such a mixed record.
> It does not happen overnight. But what happens is after they take control of the clinic or company they change the sales model to boost reoccurring revenue, this then allows the clinic or target company to take loans out. Because they look good on paper. The company then pays VC back when then pays bank back.
This was the missing bit for me. Thanks for taking the time to explain!
So yes, PE funds are probably overvalued right now and there are a lot of PE funds getting rich off management fees while not providing promised returns...but this comment is so wrong I don't know where to begin.
First, VC stands for venture capital, which is a subset of private equity that does zero LBOs and doesn't even acquire any businesses. VC funds buy equity in startups, and take on zero debt to do so. You have your boogiemen totally confused.
Second, the entire point of a PE fund that uses a leveraged buyout strategy is that they need to sell the acquired firm at a profit to make any returns to the fund. LBO funds don't 'cashflow' businesses, and saddling a business with a bunch of debt is antithetical to that purpose anyways.
Third, this is not "risk free revenue." It's a high risk strategy to use the debt to increase the value of the business by improving operations enough that you can sell it for a profit to the fund. If you saddle a company with debt and DON'T increase the value of the business beyond the debt you took on, the PE fund will not be in business for fund 2.
The risk-free revenue while the fund is alive comes from the management fees that investors in the fund pay (usually 2%, which is way too high IMO, but has nothing to do with the debt or the acquired businesses).
Please do not write confident sounding comments about things you don't understand, it spread misinformation and makes the internet a worse place.
It is absolutely possible (and even likely!) that a bad PE fund was the cause of the issue you're talking about. But there is also a media hysteria around PE, and a lack of understanding among the general public of what it is.
It's just as likely the business that was acquired was already failing or unsustainable to begin with (hence why the owner wanted out at low multiples). LBO funds don't acquire promising businesses at 5-10X revenue like tech companies do, they usually buy businesses at low multiples that are past their prime or failing in an attempt to revitalize them (with debt, since you can't raise capital by selling equity in a failing business).
Obviously this will not always work out great, given the trajectory of target companies was already not great to begin with. Momentum is the strongest factor in all markets.
The problem is, Private Equity has become a conspiratorial catchall boogieman and scapegoat for every problem under the sun, so it's hard for me to assess without further details of the situation.
Nit: beta is the strongest factor in all markets. Which is actually relevant for the success for PE funds in general, as a rising tide lifts all boats and people taking on debt to finance equity generally post outsized returns in bull markets.
Anyway, the rest of the stuff you're saying I agree with.
Yes, beta is the overwhelming source of returns. I was referring to factors in the sense of the University of Chicago research on market inefficiencies (where momentum is the strongest factor for inefficiency).
If you buy a “factor-weighted” etf the idea is it’s tilting you into those “factors” away from pure beta like buying whole market.
PE you could argue is largely just leverage plus an illiquidity factor play, since if PE just returned beta (which these days it might!) you’d be smarter to buy the S&P500 with equivalent leverage and not pay crazy fees.
Background: I work for a PE-owned company and I have friends in PE (associates up to MDs).
On your second point: LBOs aren't the only tool in the toolkit, and it's not as popular as it was decades ago, so I would lean towards the parent simply conflating "buying an ownership stake in a business in some capacity using other people's money" with the strict definition. Regardless, yes PE firms need to figure out how to get 20%+ IRR throughout a short timeframe (usually a 5 year holding/funding cycle) -- however this is through any means necessary. Philosophically, it's about increasing efficiency of operations and growing the business. In practice, it's financial engineering because PE firms do not have the operational skills to make any value-added changes to firms besides driving costs down.
Saddling a business with debt is reductionist. I've seen absolutely nonsensical financial structures that make no sense for a layman, but in practice end up "using the business' finances to 'own' (beneficially) the business" (see: at the most vanilla, the strategy of seller financing in SMBs). No this is not technically "putting debt on the books" but it is in all practical respects a novation/loan transfer that can leave the purchased co financially responsible for servicing any debt that was used in its purchase.
On your third point: what I wrote above can be used as context. It's not risk free revenue, frankly it's very risky unless you're in an inflationary environment where your assets will grow regardless of your business operations solely because the overarching economy is growing and you're riding a tailwind. However, it again boils down to financial engineering. It's not as simple as assets - liabilities = equity. The calculations used to determine valuations are so ridiculously convoluted. The amount of work that goes into financially analyzing businesses and finding "loop holes" that can justify higher prices is the core business model. The debt factors into it, but there's ways to maneuver around it through various avenues.
For example:
* debt-to-equity conversions (reclassification of debt as equity)
* refinancing
* sale-leaseback (selling company's assets to a 3rd party and using that money to pay down the debt, then leasing the equipment back)
* creative interpretations of what is actually debt (e.g. reclassifying real debt as a working capital adjustment or a "debt-like")
* dividend recapitalization (a nasty trick of loading the company with debt, paying that out as a dividend to the holdco, then selling the company at lower enterprise value. They still extracted value for their LPs/investors, despite the exit being lower)
* separating the debt from the operating company into a different holding company that services the debt
Private equity is a huge inflation driver. I'm thrifty, and for years I enjoyed a $10/mo phone provider, ~$12.39 with taxes. I even evangelized this carrier with some young parents who were struggling to get financial traction while paying off student loans.
Our affordable plan came to an end when the rates tripled! Turns out a private equity firm bought the company, jacked the rates on every customer, and sold it off again. This was not a fundamental cost being passed on in slightly increased fees -- it was private equity extracting millions from the people who can afford it the least. Across my financially optimized life, I see this happening repeatedly.
Personally, I can afford a more expensive cell phone bill. But I would imagine that many who have a $10/mo plan do not have many other options. I would like to punish the banks who are funding attacks on consumers. If by no other means, then by letting them fail.
> Banks are lending to private equity firms to fund purchases of businesses
Not quite. Private credit is to debt what private equity is to equity. (Technically, any non-bank originated debt that isn't publicly traded is private credit. Conventionally, it's restricted to corporate borrowers.)
So bank exposure to private credit generally means banks lending to non-banks who then lend to corporate borrowers.
You'll find plenty of talking heads on YouTube right noe claiming exactly this. Time will tell if private equity is actually wound up as tight as housing was in the GFC.
I don't think you're wrong if the following holds true: Before the housing bubble burst, banks lent funds to countless borrowers who couldn't, ultimately, afford their mortgage payments (because the banks didn't do their due diligence when underwriting the loans). This was widespread across pretty much every bank and mortgage banker. Not sure of the actual percentage of borrowers who, when all was said and done, had no business getting a mortgage for a house or condo, but suffice it to say it was well into the double digits percentage-wise (there's much more to this than simply banks and borrowers with Wall St. playing a major role in the collapse, but just keeping things simple).
In this private credit situation the analog for the banks are these private credit funds that have raised the capital they've lent from institutions and high-net-worth individuals (as opposed to banks, which have funds from consumer deposits). The analog to the individual mortgage borrowers from 2008 are actual companies.
To connect the dots, if the private credit funds were like the banks pre-2008, where due diligence was an afterthought, then this could turn out to be similar. So the real question is: are the borrowers (businesses in this case) swimming naked? Or do you believe the private credit funds when they say they actually conducted a good amount of due diligence when extending their loans? Once you know the percent of the companies that are naked you can evaluate whether this could/would end up similar to 2008. Nobody knows that yet, even, I suspect, the private credit funds themselves.
> This is just another form of that "shadow banking" system isn't it?
Private-credit lenders are literally shadow banks [1]. But I'd be cautious about linking any shadow banking with crisis. Tons of useful finance occurs outside banks (and governments). One could argue a classic VC buying convertible debt met the definition.
That said, the parallel to 2008 is this sector of shadow banking has a unique set of transmission channels to our banks. The unexpected one being purely psychological–when a bank-affiliated shadow bank gates redemptions, investors are punishing the bank per se.
Wouldn't they still owe interest to the banks on the money they borrowed, as well as the money they borrowed? I mean if all the money I make goes to the bank to pay off my mortgage my solution is not quitting my job, even though life is not very good under that situation.
Imagine you got a loan to buy a bunch of laundry machines to run a laundromat. But your laundromat earns $8,000 a month, and the loan payment is $10,000.
You can decide to sink $2,000 of your personal money into the laundromat every month, or you can give up.
Yeah, I'm going down a bit of a rabbit hole this morning. Turns out Wells Fargo's $59.7bn of private-credit lending is equal to 44% of its CE Tier 1 capital [1]. Meanwhile, Deutsche Bank got back to being Deutsche Bank while I was not looking [2].
I'm re-running some of the Fed's stress tests and, somehow, still find myself flabbergasted that DB is at the top of my risk list. Despite only having $12bn of exposure, if they see a 60% loss on that risk alone (assuming 60% recovery and 1.5x leverage), they breach their 4.5% capital requirement. That's the lowest threshold I'm finding across all of the banks the Fed stress tests.
Now 50% loss means wipe out. But given the size of the portfolio, there is also the concentration risk. A single private-credit firm going bust shouldn't take out a bank. But that seems–seems!–to be what I'm seeing.
With the current concentration of wealth and banking, it almost seems like there is an incentive for banks to ruin themselves when they end up in a little trouble.
If the bank has trouble, shareholders/executives lose - if the banking system has trouble... then QE will solve the bank trouble.
Are you saying that they're using their private-credit portfolio as a Tier 1 capitalization to meet their regulatory demands (not sure if the ~10-15 something% rule has come back yet?)
> they're using their private-credit portfolio as a Tier 1 capitalization
Banks' private-credit lending constitutes part of their risk-weighted assets. So yes, it's part of their CET1 [1], which is part of Tier 1 capital, and since it's equity measured it incorporates fucking everything.
4.5% is the U.S. minimum. Regulators start throwing their toys out of the pram when a bank breaches 7%. To be clear, I'm not seeing anyone in the near future breaching those limits. Deutsche Bank, the stupidest of the lot, seems to have let DB USA stuff most of the risk in its German AG.
Trouble has been brewing in private credit for quite a while, but lenders and investors have been reluctant to write anything down, resorting to all kinds of "extend and pretend" games to avoid write-downs.[a]
Funny enough Chinese State owned banks have been doing much the same for quite some time. No one ever defaults, loans are extended as long as it takes. Presumably the threat of being called into the next party meeting to explain yourself is sufficient motivation for the people running the business to pivot as many times as it takes until they find a way to make money. Worst case the state swaps someone else into leadership.
I say this to say... who knows? I guess if you shuffle deck chairs fast enough everything works out fine (?)
You can always tell when there is a problem. When things are fine the companies keep the profits to themselves. When things start to get dicey - foist it off onto retail investers.
Private equity (PE) is increasingly being introduced into 401(k) plans, driven by a 2025 executive order encouraging "democratization" of alternative assets. - Google AI
It's why as a retail investor, never buy things that would otherwise have not been available to you (but was to those "elite"/institutional investors previously).
Think pre-IPO buy-in. Investors in the know and other well connected institutional investors get first dibs on all of the good ones. The bad ones are pawned off to retail investors. It's no different with private credit and private equity. These sorts of deals have good ones and bad ones - the good ones will have been taken by the time it flows down to retail.
Even for good assets there's a price you shouldn't pay. People are joking(?) about triple-layer SPVs where you can get pre-IPO exposure but at higher-than-IPO price.
Google and Apple didn't go through ten funding rounds like today's startups do. Apple had one angel and three rounds, Google had one angel and literally just an A round after that; then retail investors could capture all the upside. Now there's way more time for private investors to pick the bones clean before it gets dumped on the public.
So unlike money-market funds, these private-credit funds can gate withdrawals and extend and pretend by turning cash coupons into PIKs. So I don't actually see credit concerns directly driving liquidity issues for the banks that didn't hold the risk on their balance sheet glares Germanically.
Instead, I think the contagion risk is psychological. Which is an unsatisfying answer. But if there are massive losses on e.g. DBIP and DB USA halts withdrawals, then the 2% stock loss Morgan Stanley suffered when it capped withdrawals [1] could become a bigger issue.
I believe the gated feature can be waived though it causes a precarious situation. It ends up with same psychology of a bank run -- people (institutions) concerned because they can't access funds or they think that the queue to exit a failing fund is too long - filled each quarter (i.e. by the time they redeem NAV has collapsed).
As Buffett said, "only when the tide goes out do you learn who has been swimming naked" - luckily, skimming the news, there's no obvious huge exogenous macroeconomic shocks on the horizon that could cause "the tide to go out" so to speak, so everything should be ok for now.
My understanding is that many private credit funds have been very lax about conducting basic due diligence on the creditworthiness of borrowers.
For example, take First Brands, a multi-billion-dollar company which filed for bankruptcy last year. First Brands had pledged the same assets as collateral for loans from multiple private-credit funds. Those loans were being carried at a fantasy NAV of 100 cents per dollar, until suddenly they were not. Did none of these lenders submit UCC filings so other lenders could check which assets had already been pledged as collateral? Did none of these lenders ever check to see which assets had already been pledged? Did all these lenders make loans based on blind trust?
Failing to check and verify that assets have not been pledged as collateral to other lenders is an amateur mistake. It's reckless, really. The equivalent in home-mortgage lending would for a mortgage lender never even bothering to check that a homeowner isn't getting multiple first-lien mortgages simultaneously on the same home, then forgetting to put the first lien on the property title.
My take is that for many private credit funds, NAVs are basically fantasy.
Do you know if First Brand's actions are considered fraud? Or was this entirely on the lenders to make sure they were in the clear regarding the collateral? Doesn't excuse the lack of diligence, but curious if there was some assumption of good faith that may have played a role in what diligence was or was not done.
If lenders are in fact not performing due diligence and passing off good credit as bad...sounds suspiciously like a 2008-like era where noone cared about the credit worthiness but just wanted to generate lines of credit.
Once you get outside of things that are highly standardized (like home loans to individuals) you quickly find out that no matter how regulated, finance is done on a handshake.
> The default rate among U.S. corporate borrowers of private credit rose to a record 9.2% in 2025
Emphasis added. Headline makes it sound like retail credit, not corporate specifically.
*Edit: Not misleading, just an unfamiliar term/usage from my perspective. I'm not a finance guy so didn't know the difference and assumed others wouldn't either. Mea culpa.
TBH "private credit" (meaning exactly what this article is talking about) is such a big thing in the finance industry that probably most finance industry people can't even fathom that the title is misleading to non-finance-industry people.
I'm not saying they are right. But it's like if you posted an article called "Python Is Eating the World" on a non-tech side and people got mad because they thought the article was about a wildlife emergency. Fair for them to be confused, but maybe not fair to accuse the title of being misleading (at least not intentionally).
Ha, yes I didn't even consider it meant anything other than corporate private credit. Otherwise we'd be talking about presumably mortgages or "consumer debt". Right?
It's some sort of Gell-Mann-Amnesia-like effect. I am accustomed to seeing thoughtful, informed discussion about technical topics on HN, so then it's jarring when something like this hits the front page and nobody seems to have any idea what they're talking about.
It's opposite Gell-Mann-Amnesia: I am a SWE and I come here because I find it one of the best places to keep abreast of the broader software world, not just the little corner of it that I'm currently working in. So in the things that I know well, I trust it. My wife is a medical professional, and so I know just enough to see that most medical conversations here are complete and utter nonsense.
So the mental model I have of the average HN contributor is basically that they are all SWE's- they know software engineering extremely well, and the farther you get from that the less valuable the conversation will be, and the more likely it will be someone trying to reason from first principles for 30 seconds about something that intelligent hard working people devote their careers to.
I’m coming at this loaded with jargon, so excuse my blind spot, but why would the term private credit bring to mind anything to do with retail specifically?
(The term private credit in American—and, I believe, European—finance refers to “debt financing provided by non-bank lenders directly to companies or projects through privately negotiated agreements” [1].)
>, by why would the term private credit bring to mind anything to do with retail specifically?
If a layman is unfamiliar that "private credit" is about business debts, and therefore only has intuition via previous exposure to "private X" to guess what it might mean, it's not unreasonable to assume it's about consumer loans.
"private insurance" can be about retail consumer purchased health insurance outside of employer-sponsored group health plans
"private banking" is retail banking (for UHNW individuals)
But "private credit" ... doesn't fit the pattern above because "private" is an overloaded word.
It surprises me that most people would read "private credit" to mean "retail credit" by default, but I also come to this loaded with jargon so I guess would defer to others on this. But to be clear, the title is not misleading to anyone who has any familiarity with the financial markets.
With the caveats that banks can originate private credit as long as it is separate from their reserve system credit (and consequently does not increase the money supply when originated)
I think you’re mistaken. We’ve been in a private credit bubble for a couple years at least, it’s in the finance/economic news every week and I’ve even started to hear regular NPR doing primers on it for normies. The term for “retail credit” is consumer debt or consumer debt. We don’t call it retail debt because the retailer is not actually a counterparty.
Out of curiosity where do you primarily get your news?
I think (but I don't move in such circles) that originally there was "redpilled" to refer to people playing "The Game" (pickup artists). Original reference is to The Matrix, of course.
That's exactly where my mind went as soon as I read the title. HN rules say to "use the original title, unless it is misleading". I think the original title meets the misleading bar but I can't speak for other readers.
"Private credit" is a finance term of art. It could be misleading if you don't have context for the correct definition, but that's true of many posts on this site.
Unless I'm misunderstanding something, this isn't that big of a number in the larger scale of US banking; According to the numbers in the article that's only about 2.5% of all bank lending (300B/1.2T, with the 1.2T being ~10%)
> this isn't that big of a number in the larger scale of US banking
It's not. It's just that we're seeing potentially 10% losses on the portfolio level [1], which could imply up to–up to!–5% losses to the banks' loans to those lenders.
Again, tens of billions of dollars of losses are totally absorbable. But Morgan Stanley's stock price took a hit when it gated one of these funds [2]. And some banks (Deutsche Bank, somehow, fucking again, Deutsche Bank) have small ($12n) but concentrated portfolios where a single wipeout could materially impair their ~$80bn of risk-weighted assets.
> Again, tens of billions of dollars of losses are totally absorbable.
They are, in isolation. The _problem_ is that PE doesn't generally trade assets in public, which means that valuation only really come when you're either wanting to buy, wanting to sell, wanting to re-loan or in deep shit.
But! banking can absorb a few billion right? yes, so long as people are not asking questions about other assets.
Because PE assets are not publicly traded (hence private in private equity) the value of assets are calculated at much lower rates than on a public market. This means that the assets that PE holds could be wildly over or under valued. The way we assess the value of PE holdings is thier looking at the Net Asset Value calculations (which might be done twice a year) or infer the value based on public information.
Now we are told that markets are rational and great at working the value of things. This dear reader is bollocks. Because PE is a black box, if a class of asset that they hold (ie SaaS buisnesses, or high street stores, or coffee trading etc) looks like its not doing well, people will start to write down the value of people holding loans given to PE, or shares in PE.
This creates contagion, because one PE company is in distress, the market goes "oh shit, the whole thing is on fire" and you get bank runs (because where is the money coming from to loan to PE? thats right banks, eventually)
Washington Mutual had $307 billion in assets, and one credit downgrade and a bank run of $16 billion in September 2008 was enough to get them shut down.
These private credit numbers are estimates provided by Moody's, who were famously clueless about the scale of mortgage bond risk even as they stamped them all with a AAA rating.
Someone else owns all the other credit. This is the 1st domino.
The liquidity challenges of a $1.2T shock to the economy is meaningful, because it has knock on effects on equity as well.
When private credit (which is propping up private valuation) falls, private equity also falls and then everyone realizes that everyone else has been swimming naked.
Update: original comment should be. 300B/1.2T*(10% of bank funds) = 2.5%. If I'm reading comment correct. Also I believe the whole private credit ecosystem is about 1T.
In a catastrophic scenario: if the whole asset class went to 0 (on the banks asset sheet they would lose 2.5% - absorbable pain assuming its not leveraged through creative financial mechanisms).
I would wager that risk is more concentrated on certain institutions instead of across the board so acute pain likely.
I've been told by the head of compliance of the largest European banking group that 2.5% is exactly the threshold at which they begin to be very worried/ at systemic risk
Apparently they operate on very low level of tolerable risk (way lower than I thought)
>2.5% is likely still survivable, but i think risk departments + regulators are all a lot less risk tolerant after seeing how quickly things went south in 2008 and worries about an out of control spiral
For those that want a broader context on private credit, the Bank for International Settlements has been publishing some great material on the topic, including the connections between private credit and other corners of the financial system. Some examples follow.
Reason this number caught my eye: last year the Fed's stress tests found "loss rates from [non-bank financial institution] exposures (i.e., the percentage of loans that are uncollectible) were estimated at 7%, under a severe recession in scenario one" [1].
That's the scenario in which unemployment goes to 10%, home prices crash by 33%, the stock market halves and Treasuries trade at zero percent yield [2].
The categorization the Fed uses for NBFI is broader than private credit. E.g. if a hedge fund gives a loan to a private company, that's not private credit because hedge funds seem to have their own category. And lending backed by securities is also in a different category, it seems.
So I guess the Fed expects these other kinds of lending to be safer than private credit?
What's odd is according to the article, this index estimated an ~8% default rate in 2024. So maybe the stress test was measuring something different? It's weird to think the stress test would find a lower loss rate during a severe recession than in the most recent year with data available.
The regulators were modeling a scenario where private credit was dragged down by a problem elsewhere in the economy, not one where the rest of the economy was dragged down by private credit. Everyone understands that center of a financial implosion is always worse than its effects on the broader economy, but regulators aren't tasked with stopping the explosion at ground zero, they are tasked with stopping contagion dominoes from falling, so that's what they model.
> maybe the stress test was measuring something different?
The Fed is measuring the loss on bank loans to the private-credit lenders. A 10% portfolio loss shouldn't result in those lenders defaulting to their banks.
By my rough estimate, one can halve the portfolio loss rate to get the NBFI-to-bank loss rate. So a 10% portfolio loss means we're around a 5% expected long-run loss to the banks. Which is still weirdly high, so I feel like I must be missing something...
Luckily debt will be solved by the power of AGI, right? Just one more data centre! One more GPU! It can nearly write a basic three tier application with only 10 critical security vulnerabilities all by itself!
Definitely think we’re in for a rough year financial prospects wise, and doesn’t even feel like we recovered from the 2008 crash properly.
Luckily debt will be solved by the power of AGI, right? Just one more data centre! One more GPU! It can nearly write a basic three tier application with only 10 critical security vulnerabilities all by itself!
If you read the article, it says the default is directly related to the sell off of software stocks, which are heavy private credit borrowers.
What caused the SaaS apocalypse? Gen AI.
I'm long on AI hardware companies for this reason.
Hundreds of financial institutions with greater or lesser responsibility for the crash in 2008 went under in those years[0]. The shareholders in almost all of these companies lost all of their money and the responsible employees lost their jobs. This includes some of the most guilty companies, like Washington Mutual, Countrywide Financial, IndyMac, Lehman Brothers, Merrill Lynch (through First Franklin Financial), Bear Stearns. But all these companies are completely forgotten now.
Instead everyone hates on Goldman Sachs. Sure, Goldman Sachs deserves hate, but of the big banks they were the _least_ guilty of the crash in 2008. Not saying they were saints, but in 2008 they were the least bad.
When you have people at the top of those institutions who made those decisions, and made enough money during their tenures to weather any length of unemployment and were sometimes even given a severance worth more money than the average American makes in a lifetime, going out of business or losing a job simply isn't enough.
It's one of the only investments of labor and time where the risk is not proportional to the return.
In order to create risk, you have to either claw back their money through civil action - which you can't because the entire point of incorporation is to separate the business entity from one's personal finances - or look at criminal charges. Otherwise, you have created a class of hyper-wealthy people who have no real incentive to perform in a way that is for the best interests of shareholders or society at large.
It's the reason we tie so much for regular people to employment in the US, like healthcare. Many argue that if you give the rank-and-file worker the kind of long-term financial security that just one or two years of being a C-suite executive at a major company, they won't work as hard. They won't make the best decisions. They won't be the dynamic workers our economy supposedly wants. That logic goes right out the window when a board goes hunting for a new CEO.
>The shareholders in almost all of these companies lost all of their money
How is that penalizing those responsible?
Isn't it a pretty big leap to go from penalizing those selling packaged fraudulent loans to the public (whom, to my knowledge were never prosecuted) to the shareholders losing money as protection against it happening again?
That's because debt IS money. Literally. If you create debt, you have created wealth. These people weren't punished so they could get back to creating new debt as quickly as possible.
The problem with credit defaults, especially private credit defaults, isn't that some private creditors lose some money, it's that twice that amount of money is destroyed, and disappears from the economy entirely.
Consequences would be nice, but actually forbidding it for the future would be enough. Obama promised to do it, but didn't, and everybody kind of forgot and moved on.
We sure did when Frank-Dodd was written by the legislative and then signed into law by the executive.
GP's comment is about the aftermath of 2008, entirely missing the fact that the legislative did in fact create laws which were signed by the executive and then later, in 2018, dismantled under a different administration.
In fact we rewarded them. We bailed them out by printing a lot of money. We then printed more money during the pandemic to pay people to stay home and watch Netflix. Probably a lot more examples. All that money flowing around that has no basis in actual productivity or value created. It's got to correct at some point. One of the corrections is how much more everything costs now, but I don't think that has fully absorbed the excess.
Exact opposite. We are in the midst of the COVID hangover.
So that govt money went to the wealthy to buy up houses (Californians bought real estate in the Midwest as investments and it drove up housing prices along with small immigration to these states)
Farmers etc benefited from bailouts when they were doing very well. It was a large blunder.
All that money directly led to housing inflation that still hasn't settled. The PPP loans were all forgiven (which massively favored business owners and upper class).
Meanwhile student loan forgiveness was overruled by the supreme court.
It's really hard to ignore the implication that it ended up being more like a wealth transfer than anything else.
It was inflationary but would spread out the pain over the recovery period after the crisis, the other option was to allow 100% of the pain to be felt immediately: economy shutting down, people losing their jobs, diminished household spending, less money circulating in the economy, businesses still running having fewer orders/customers, more people being laid off, all the way until the crisis passed.
Between the latter and the former I believe the former was a much smarter choice in the medium to long term.
We did. We created about $4 trillion. That just about neutralized the $4 trillion that evaporated in the crash, and the result was that we did not go through a deflationary collapse. You know that they did not create too much, because inflation was basically nothing for the next decade. It was flat until Covid.
Thanks, that was a perspective I hadn't thought about. But still doesn't seem like that taught any lessons, other than the taxpayers will bail out our carelessness.
I think it was a good call, yes. A deflationary collapse is incredibly damaging to the economy. The Great Depression was such a collapse, but there are others. The Panic of 1857, 1873, 1907... there's a long history of these.
The Fed avoided that. And they also avoided causing inflation. It was an amazing job of threading the needle. (One could argue that they caused a decade of stagnation, but in my view that was minor compared to the other options.)
Thank you for the thoughts. Do you think if we had ripped the band-aid off then it would have been completely disastrous? I don't mind saying that this economy is frustrating, and it feels like we keep kicking the can down the road. I'm confident I'm not the only person that feels this way, and I'm quite open to being wrong here. My guts says there's just too much money sloshing around, and it gets vacuumed up, leaving the majority feeling like nothing changed.
I'm asking this in as non-confrontational way as possible, what am I missing?
I think you may be missing that $4 trillion evaporated in 2008, and the scale of the catastrophe that would have caused if the Fed did nothing. What the Fed did then was, essentially, restore the amount of money to what it was in 2007. They were trying to turn 2008 into as much of a "nothing changed" as they could, and they did it quite well.
I think the economy can adjust to any amount of money; it's the abrupt change in the amount that causes problems (because it causes an abrupt change in the value of money).
I think you may be missing that I'm not saying the same thing about the pandemic response. I think that too much money got poured in during the pandemic years, and that has caused inflation, and we've been seeing that inflation since. I wonder if you are taking how you feel about the last five or six years, and mapping that onto the last 18 years.
Now, from 2008 to 2020 was not all roses. Things were kind of stagnant. The rich were probably doing better than you were, because assets like stocks and land went up in value as interest rates went down, but your wages didn't go up. So, it was reasonable for you to feel "there's too much money sloshing around" in things like stocks during those years.
But I think it got worse after Covid. The government air-dropped too much money in, and there has definitely been too much money sloshing around since then.
In all of this, I'm not really saying that you're wrong in feeling that there's too much money sloshing around, or that the economy is frustrating.
I mean people have been saying a crash is coming for years... Consumers recklessly purchased homes and cars at double their value, while relocating for remote work that was never long term in the eyes of their employer. Sounds like a receipt for disaster or a repeat of 2008- however, so much has changed since 2008... whatever happens, Black Swan! Hope "you" have your ducks in a row... As for AGI, lol. A box of matmuls isnt going to solve any real problems, so far, as you point out- is can barely write software. LLMs are basically gifted children. Smart sounding, lacking wisdom, chaotic, and likely just going to end up not that impressive. Either way- before we ever see AGI, we better get our heads out of the holes of the wealthy and enact UBI...
> I mean people have been saying a crash is coming for years
The internet working didn't make the Dotcom bubble not happen. Investors don't know anything about the new investment space and most of them are going to get hosed eventually. It's going to happen, and it'll be bad for people who are betting on it not happening.
> A box of matmuls isnt going to solve any real problems, so far, as you point out- is can barely write software
The concern here seems to be that the credit risk on the underlying borrowers is being transferred to banks through the loans made by the banks to the private credit firms. But the banks' lending to the private credit firms is subject to the same regulations and constraints as their lending to other borrowers (the same regulations and constraints that led them not to lend to the underlying borrowers in the first place). When banks lend to private credit funds/firms, it tends to be through senior, secured loans which will be less risky than the underlying loans.
> secured loans which will be less risky than the underlying loans
So, it's sort of like bundled mortgage securities, where you take some bad loans and mix them together to get a "less risky" loan, since the chance of them all defaulting at once is less than the chance of all but one defaulting.
Presumably, since banks (by definition, an intermediary) are involved, those are then recursively repackaged until they have an A+ rating, or some such nonsense, right? Also, I'm guessing there's no rule that says you can't intermingle these things across separate "independent" securities, even if the two securities end up containing fractions of the same underlying bad loans?
Clearly, like with housing, there's no chance of correlated defaults in a bucket of bad business loans that's structured this way!
In case you didn't quite catch the sarcasm, replace "housing loans" with "unregulated securities" and note that my description switches from describing the 2008 financial crisis to describing the Great Depression, or replace it with "bucket shops" (which would sell you buckets of intermingled stocks) and it would describe every US financial crisis of the 1800s.
> where you take some bad loans and mix them together to get a "less risky" loan, since the chance of them all defaulting at once is less than the chance of all but one defaulting
Yes. This is mathematically sound.
> those are then recursively repackaged until they have an A+ rating, or some such nonsense, right?
AAA-rated CLOs performed with the credit one would expect from that rating.
The problem, in 2008, wasn't that the AAA-rated stuff was crap. It was that it was ambiguous and illiquid.
> I'm guessing there's no rule that says you can't intermingle these things across separate "independent" securities, even if the two securities end up containing fractions of the same underlying bad loans
Defining independence in financial assets like this is futile.
> there's no chance of correlated defaults in a bucket of bad business loans that's structured this way
Software companies being ravaged by AI fears.
> replace "housing loans" with "unregulated securities" and note that my description switches from describing the 2008 financial crisis to describing the Great Depression
It also describes a lot of successful finance that doesn't reach the mainstream because it's phenomenally boring.
I don't think that's a true etymology of "bucket shop," which per my recollection of Livermore was just an off-track-betting parlor for ticker symbols, but where nobody actually bought the shares (bundled or otherwise). Strictly a retail swindle, having nothing directly to do with the risk/maturity bundling work you are criticizing above.
> No. Non-bank financial institutions (NBFIs a/k/a shadow banks) compete with banks. They also borrow from banks.
How is this inconsistent with what I said? I was just making the point that the reason for the rise of private credit is that banks are less willing / able to lend, particularly to riskier borrowers, as a result of post-2008 banking regulations. So private lenders have stepped in to fill that gap.
> the reason for the rise of private credit is that banks are less willing / able to lend, particularly to riskier borrowers, as a result of post-2008 banking regulations. So private lenders have stepped in to fill that gap
That may have been true once. It's rarely true now. Banks and shadow banks compete for the same borrowers.
Trouble has been brewing in private credit for quite a while, but lenders and investors have been reluctant to write anything down, resorting to all kinds of "extend and pretend" games to avoid write-downs.
I wonder if anyone can say if there’s much risk of sub prime private credit? Not sure if that’s the right term. My understanding is that synthetic CDOs are the rise again, this backed by private credit - which the article is discussing
My normal bank was acquired by Wells Fargo in 2008 and they also owned my mortgage.
When I went to pay off my mortgage in 2012 they required a cashier's check for the final payment of around $80.
I asked if we could do it electronically like all of the previous payments and they said no.
So I walked into my local bank asking for a cashier's check of that amount and the bank teller told me that most people would accept a personal check for that little. I said yeah but YOU don't. She looked at me funny.
So she asked who to make the cashier's check out to. I said "Wells Fargo" and she looked at me funny again and said "Wells Fargo is us, the check comes FROM Wells Fargo. Who do I put on the TO line" and I said "Wells Fargo"
She again looked at me funny and I explained that I am paying off my mortgage. Wells Fargo is where I have my bank account and my mortgage. She said "Can't we just do it electronically?" to which I said "You would think but apparently your employer can't handle that and told me to get a cashier's check and FedEx overnight to them."
Actually I believe they're just actually complying with new laws to disclose their balance sheets for these types of loans. Many other banks like JP Morgan have much higher amounts of these loans on their balance sheets, but refuse to report and are exploiting certain loopholes.
The requirement to disclose has only existed for a year I believe, but many are kicking the can or claiming that it would cause them issues.
- when a bank creates a loan, this has an effect on money supply in total
- when a private credit company "gives" a loan, it has no effect on total money supply and from balance sheet perspective its an accounting exchange on the asset side
A private credit firm is a non-bank entity that raises money from wealthy investors, pension funds, etc to loan out to businesses. The funds are generally locked up for several years to match the duration of the loans.
They also borrow money from banks to add leverage to this basic setup.
Not who you asked, but I think making the nuance between retail and corporate credit. With firms being corporate credit (i.e. we aren’t talking about individuals / retail).
- bonds. Loans interned to be bought by a range if investors and traded over time. Arranged and unwritten by investment banks.
- bank loans. The classic loan. The bank takes depositor money (that the depositor can take back anytime!) and loans it to someone or some company. The bank holds the loan
- private credit. Like a bank loan, but they get their money from long term investments by wealth people and institutions, add bank loans for leverage, and then hold the loan.
These are mostly syndicated. The traditional difference between loans and bonds was bank versus investment bank. The modern difference is in underwriting technique, degree of syndication/securitisation and loans mostly being floating and bonds mostly being fixed.
Convergent evolution in finance is actually a pet interest of mine. It seems like it's mostly driven by regulation. But the more you stare, the more the regulation appears like a canyon wall and the hydrology customs and connections. I'm not sure what the underlying geology is, however. Something bigger than customs or laws, but not so grand that it becomes ethereal.
The Banks get in trouble, and Gov has to step in. So Gov, reasonably, add regulations and restrictions. But the law can't be really specific, it requires gov employees to actually examine the bank and make decisions (eg about risk levels, etc).
The banks have a really large incentive to chip away at the effectiveness of the regulation. They hire lots of lawyers, consultants, notable economists, etc and just keep pushing on these rank and file gov regulators. They buy influence with politicians, and use that to pressure the regulators. They hire some of the regulators at very high pay, sending a signal to the others: play ball and a nice job awaits you.
Over time, they just wear down the regulators. The rules are interpreted to be mostly ineffective and nonsensical. Often at that point the politicians come in and just de-regulate.
The banks just have the incentive and focus to keep at it every day for years. No one else with power is paying attention.
That's not correctly stated. "Private Credit" is defined as non-bank lending. Banks are doing "public" lending in the sense of being regulated. Private lending is any sort of financial instrument issued outside of those guard rails.
It's generally felt to be risky and volatile, but useful. Basically, it's never illegal just to hand your friend $20 even if the government isn't watching over the process to make sure you don't get scammed. This is the same thing at scale.
It is. (EDIT: It's a mixed bag. OP was correctly calling out a definitional error.)
Banks have loaned $300bn mostly to private-credit firms. Those firms then compete with the banks to do non-bank lending. It's a weird rabbit hole and I'm grumpy after a cancelled flight, but it feels like I'm in the middle of a Matt Levine writeup.
"Most of the private credit loans were floating rate and tied to the federal funds rate, which has persisted at a high level over the past three years. Fitch pointed to this as a catalyst for last year's defaults."
I wanted to dismiss that and say ... but it's not really historically high. I suppose it really is not IF you look WAY back. It actually has persisted at a relatively high level if you look back to 2009, which is more than a short time now.
I guess it is fair to say the federal funds rate has persisted at a high level over the past three years now isn't it?
Also interesting to note, "Fitch recorded NO defaults in the software sector last year. The rating agency noted it categorizes software issuers into their main target market sectors when applicable."
The problem of the current situation is that even 5% is considered as a high interest for many people, if not most of them. Inflation already pushes up the base price, and if the interest rate keeps on 5% and above many people simply won't consume, which will further pull down the economy.
For example, we decided to keep our vehicle for another 4-5 years instead of buying a new one. The same Hyundai vehicle of the same model, but different year (2026 v.s. 2020), has gone up 8,000 CAD (10K CAD considering tax), with a much higher rate (5.99% v.s. 0%). There is no way I'm buying another car in the foreseeable future. We can definitely afford it, but we won't.
The whole world has pushed up prices of food, housing and pretty much everything higher. This is the real problem -- although I wouldn't say it is the root problem.
i dont think the inflationary seventies and eighties are great lodestar
low interest rates are historically a sign of a stable polity and economy. so if anything, we want the conditions for prolonged low interest rates, rather than prolonged high interest rate.
I've never heard the term private credit so I googled it.
> Private credit refers to loans provided to businesses by non-bank institutions—such as private equity firms, hedge funds, and alternative asset managers—rather than traditional banks
.
Is that correct?
So if these companies go under does anyone care? If they go under are they a systemic risk to the economy like the banks in 2008 that got a taxpayer bailout?
> At the Financial Times, Jill Shah and Eric Platt report:
>JPMorgan Chase ... informed private credit lenders that it had marked down the value of certain loans in their portfolios, which serve as the collateral the funds use to borrow from the bank, according to people familiar with the matter. >...
>The loans that have been devalued are to software companies, which are seen as particularly vulnerable to the onset of AI. ...
From what i can tell the problem isn't that an individual who had cash to invest in a private (tech in this case) company goes down
the problem is that a company "private credit firms run retail-focused funds (“business development companies” or BDCs)" which took out a bunch of loans to invest in private tech companies is now having the underlying assets that they got those loans against (long term investments in private tech companies) valued lower.
the link im missing is what happens when people who also invested in BDCs want their money back, where their actual money is locked up in long term investments made to private tech companies, and their ability to get loans is now valued lower. I think this is called a "run" where if someone starts pulling money out, and ultimately you cant, then its a race to get your money out before others do, which applies to both the individuals and the institutional loans.
Note: my quotes are from the bloomberg newsletter i mention, which helped me, not the OP article. And i am writing as much to clarify my own thinking as from a place of understanding. I welcome clarification.
It is a systemic risk because its size and credit risk is opaque, like mortgage-backed securities were in 2008.
Banks needs to disclose the % of non-performing home, auto, business loans to rating agencies and regulatory bodies so their credit risk is known, and so regulators they can set rules on how loose or tight lending criteria should be in the industry. With 'financial innovation' like tranched mortgage bonds rolling up thousands of mortgages at various levels of credit risk into one, they can be traded without anyone actually knowing what the default risk is.
With private credit, there is no disclosure requirement because the lenders are not banks. PC is financing the entire AI datacenter boom, without which GDP growth in the US is effectively zero. If PC defaults rise, the bottom could rapidly fall out of the S&P 500, which is already being hit by the oil price crisis, and affect people's 401Ks and retirement savings.
> So if these companies go under does anyone care? If they go under are they a systemic risk to the economy like the banks in 2008 that got a taxpayer bailout?
Mostly, no, which is exactly why private credit has become so big in recent years: they are making the loans the banks can't or don't want to make, because the banks are subject to a bunch of additional regulations, which are designed to reduce the probability of banks going bust and having to be bailed out.
But it can be difficult to judge second order effects in finance. It's possible that a lot of private credit houses going bust would indirectly and perhaps unexpectedly hurt the broader economy. An obvious one being companies that are reliant on private credit going bust because their financing needs can no longer be met.
Also, with this administration in the US I wouldn't entirely rule out bailouts for some of the more politically connected private lenders.
> But it can be difficult to judge second order effects in finance.
Another obvious question to ask is who is providing the money that is being lent? Those are the people who now won't be paid back. The assumption is that these are people with predictable, long-term obligations who can lock up their cash for a long time: pensions, insurance companies, endowments, etc. Hopefully they are allocating a responsible amount of their portfolio to something as risky as private credit, but as the details are private, it can be really hard to know.
There has also been a big push over the past year to put private credit assets into retail 401k's (which, in theory, also should be okay with locking up funds for a long time, but in practice, maybe less so), most insidiously by having private credit assets held in target date funds (which are the default funds for many plans).
Many private credit funds also increase their leverage by borrowing from actual banks.
All of that should pose less systemic risk than if banks subject to bank runs were lending all of the money. But that has to be balanced by the fact that these are unregulated entities taking more risks than banks would. Long-term average default rates on high-yield bonds are around 4%, so 9.2% is high, but not in panic-inducing territory yet. Who knows what they will look like in the event of an actual recession.
> So if these companies go under does anyone care?
This is nowhere near as bad as the 2008 crisis, no. The banks don't really use the checking/savings account money for this. If you've invested in something that either invests in Private Credit or is reliant on Private Credit, then it'll suck for you personally.
...
One teeny tiny extremely important detail: Private Credit is bankrolling the AI industry's datacenter construction. If anything happens to significantly increase interest rates, several datacenter companies and Oracle go bankrupt. The other big tech firms have taken on lots of debt as well so expect spending cuts there too, even if they survive.
The systemic risk isn't in "bankers fucked it up again", it's in the AI bubble.
He's one of the "Big Short" guys but more importantly he has great guests on. Everyone is trying to teach & inform, not sell.
He's been calling this risk out for over a year, especially once the White House started trying to allow retirement accounts access to private credit. For a lot of people that was the big alert, even before Jamie Dimon said he saw "cockroaches".
I can't remember the names. Best bet if you don't want to listen is to just get summaries or transcriptions of the episodes you can an LMM questions on.
The info on his podcasts isn't telling you who to short. It's more who has gone under & general knowledge.
I'm not surprised. Weren't we getting signals like 3 or 4 months ago that used car repossessions were ticking up? That's a breaking point for folks. The economic boulder keeps rolling and I'm not wearing any shoes. Spiking the price of oil is definitely going to help. This too shall pass?
Since a lot of people here aren't familiar with the private credit situation, here's my understanding, which comes almost entirely from reading Money Stuff, a daily column by Matt Levine. If you are a tech person who wants to learn about finance, I recommend it! It's a lot more entertaining than most finance industry reporting.
"Private credit" is an idea that has been hot in finance for the last several years, originating from the great financial crisis (GFC). After the GFC, regulations made it very hard for banks to make business loans with any kind of risk anymore. So instead, new non-bank institutions stepped in to make loans to businesses. These "private credit" institutions raise money from investors, and lend it to businesses.
The investors are usually institutions who are OK with locking up their money long-term, like insurance companies and pension funds. This all seems a lot safer than having banks making loans: banks get their funding from depositors, who are allowed to withdraw their deposit any time they want. So a bank really needs to hold liquid assets so they are prepared for a run on the bank, and corporate borrowing is not very liquid. Insurance companies and pension funds have much more predictability as to when they actually will need their money back, so can safely put it in private credit with long horizons.
It's not quite so clean, though.
It's actually common for banks to lend money directly to private credit lenders, who then lend it out to companies. But when this happens, typically the bank is only lending a fraction of the total and arranges that they get paid back first, so it's significantly less risky than if they were loaning directly to the companies. Of course, the non-bank investors get higher returns on their riskier investment.
And the returns have been pretty good. Or were. With the banks suddenly retreating from this space, there was a lot of money to be made filling the gap, and so private credit got a reputation for paying back really good returns while being more predictable than the stock market.
But this meant it got hot. Really hot.
It got so hot that there were more people wanting to lend money than there were qualified borrowers. When that happens, naturally standards start to degrade.
And then interest rates went up, after having been near-zero for a very long time.
And now a lot of borrowers are struggling to pay back their loans on time. And the lenders need to pay back investors, so sometimes they are compromising by getting new investors to pay back the old ones, and stuff. It's getting precarious.
Meanwhile a lot of private credit institutions are hoping to start accepting retail investors. Not because retail investors have a lot of money and are gullible, no no no. 401(k) plans are by definition locked up for many years, so obviously should be perfect for making private credit investments! Also those 401(k)s today are all being dumped into index funds which have almost zero fees, whereas private credit funds have high fees. Wait, that's not the reason though!
But just as they are getting to the point of finding ways to accept retail investors, it's looking like the returns might not be so great anymore. Could be a crisis brewing. Even if the banks are pretty safe, it's not great if pensions and insurance companies lose a lot of money...
There is so much misinformed fear-mongering about private credit right now.
Important Facts:
1) The majority of private credit funds are classed as "permanent capital". When you put money into these vehicles, you give the Asset Manager discretion over when to give the money back. Redemptions are often gated at ~5% per quarter.
(So there cannot, by definition, be a run on the bank)
2) Credit is senior to equity, so if you expect mass defaults in private credit, it means the majority of private equity is effectively wiped out. Private equity has to be effectively a 0 before private credit takes any losses.
3) The average "recovery rate" for senior secured loans is 80%. Even if private equity gets wiped to 0, the loss that private credit incurs is cushioned significantly by the collateral backing the loan. These are not unsecured loans the borrower can just walk away from.
(The price of senior secured loans dropped by ~30% in 2008, as a worst case datapoint)
4) Default rates on many of the major private credit managers is ~<1% in recent years. There are other estimates stating higher default rates, but that often classifies PIK income as a default. A loan modified and extended with added PIK that ultimately gets repaid is not a "true" default.
5) Finally, it's true that NAVs are likely overstated, but generally it's by a modest amount. Every Asset Manager today could go out tomorrow, mark NAVs down by 20% and suddenly there is no crisis.
(The stocks of Asset Managers have already traded down such that this seems expected and priced in anyway)
> Private equity has to be effectively a 0 before private credit takes any losses
Technically yes. But the overlap between private equity as it's commonly described and private credit is slim.
> average "recovery rate" for senior secured loans is 80%
Oooh, source? (I'm curious for when this was measured.)
> A loan modified and extended with added PIK that ultimately gets repaid is not a "true" default
True. It's a red flag, nonetheless.
> Every Asset Manager today could go out tomorrow, mark NAVs down by 20% and suddenly there is no crisis
Correct. The question is if 20% is enough, and if a 20% markdown creates a vicious cycle as funding for e.g. re- or follow-on financing dries up.
You seem knowledgable about this. I'm coming in as an equities man. Would you have some good sources you'd recommend that make the dovish cash for private credit today?
> Oooh, source? (I'm curious for when this was measured.)
It depends when you measure, but you can Google around and find figures in the 60-80% range. 80% may have been a bit on the optimistic end of the range. But it's important to note that a "default" doesn't imply a 0.
Of course this will depend on the covenants, underwriting standards, type of collateral.
I would guess software equity collateral recovery rates are lower than hard assets like a building. (Which is why I personally don't like Software loans, nothing to do with AI)
> Correct. The question is if 20% is enough, and if a 20% markdown creates a vicious cycle as funding for e.g. re- or follow-on financing dries up.
I think it's almost certain that new fundraising for private credit will be materially hindered going forward. But this just limits the growth rate of these firms, does not introduce any "collapse" risk.
They may move from net inflows to net outflows and bleed AUM over a period of some years.
If NAVs were inflated previously, they may be forced to mark down the NAV to meet redemptions rather than using inflows to payoff older investors.
In the world of credit, 20% is an enormous haircut. Again, senior secured loans fell by around 30% peak to trough in 2008.
We have the public BDC market as a comparison point where the average price/book is around 0.80x. So the public market is willing to buy credit strategies at a 20% discount to stated NAV.
The real systemic risk here, if we were to reach for one, is really that these fears become self fulfilling.
If investors pull funds out of credit strategies en-masse, there is no first order systemic issue, but it means borrowers of many outstanding loans may not be able to secure refinancing as money is drying up.
This could lead to a self-fulfilling default cycle. But this would be a fear driven default cycle, there is no fundamental issue with cash flows of borrowers or otherwise (in aggregate, currently).
Finally, in regards to the asset managers themselves, many are quite diversified.
Yes, they have private credit funds, but many have real estate funds, buyout funds etc. OWL is one of the biggest managers of data center funds, for example (which they also got hammered for on AI bubble fears)
Given how depressed pricing is in public REITs, for example, I expect a lot of asset managers to pivot towards more real asset funds.
So, if I hold a bunch of Private Equity, and my holdings need a continuity of business loan, would I:
(a) have the holding take out the debt, exposing 100% of my stake
or,
(b) have the holding divest a piece of itself, giving me control of the existing and new entities, then have that piece take out the debt, exposing 0% of my stake?
I imagine any PE firm worth its salt would go with option (b).
Presumably regulators would sometimes try to block such deals, but I cannot imagine that happening during the current administration. (Do the regulators even still work for the US government? I thought they were mostly fired.)
Similarly, I can imagine the banks refusing to lend in scenario (b), but I cannot imagine bank leadership being allowed to make such a decision if the PE firm is politically connected to the current administration.
It sounds like you're effectively describing some fraud scheme.
A smart lender will not issue loans without real collateral. If you create a subsidiary, that subsidiary has to have sufficient collateral and cashflow to secure a loan.
^ Encase the link also responds with this for you:
Access Denied
You don't have permission to access "http://www.marketscreener.com/news/us-private-credit-defaults-hit-record-9-2-in-2025-fitch-says-ce7e5fd8df8fff2d" on this server.
Private credit is cracking and lending standards are tightening behind the scenes. If you’re not building cash reserves right now you’re going to wish you had. The distressed opportunities ahead go to whoever kept dry powder while everyone else was chasing growth.
If your business is light on free cash flow (ie everyone in AI at the moment) buckle up as there are storm clouds ahead. If you’re running a business that relies on external cash (VCs, loans/bonds, etc) to keep things going things will get very ugly.
This is not my field of expertise, but I modeled keeping cash reserves to buy distressed assets. Unless I was able to perfectly predict the crash, the outcome was still better to not time the market.
Well it only took 5 years of destroying responsible savers with every policy imaginable to make sure they get crushed by those who availed themselves of the negative real rate loan inflation machine. How many people are left remaining that were dumb enough to take that strategy and are still standing? If you were operating on a cash basis for the last 5 years you were mostly wiped out by people leveraged to the 9s on debts and meanwhile your buying power was erased.
Interest rates on things like CDs and low-risk bonds have been decent for a while now. It’s not been painful to sit on cash reserves provided you were smart about where the cash was parked.
It’s not an either/or, it’s just a question of who was participating in the boom while preparing for storms ahead vs those all in on the boom.
What implodes in the period ahead are things that are massively over leveraged and can’t absorb a hit without doubling down again with more funding/loans and such. These are the folks and companies that get wiped out.
Interest rates on things like CDs and low-risk bonds have been decent for a while now. It’s not been painful to sit on cash reserves provided you were smart about where the cash was parked.
Just make sure you can unpark it, else you're SVB.
You're not wrong it's always good to have cash but certain allocations could have done 50%-100% return on investment while a CD brought ~5.5% for a while. Look at S&P since 2021. Knowing when to transition from cash, liquidity, other instruments is what kills/allows people to survive. We can't all do the same thing, it's almost as if it's economic ecological evolution, random death.
In actuality, the CPI is lower than inflation because technological advancement, automation, and economies of scale (due to globalization etc) are driving consumer prices low. In other words, if factories are still producing things like they were 20 years ago, the CPI would have been much higher, and that higher number is closer to what should have been the inflation number.
A better measure is what % of the total money supply you have.
I.e. you started out with 2e-20 % of the total money, and after 5 years you now have 1e-20 % of the total money, then whatever happened to CPI, you've been diluted and you would probably have been better off investing in something else other than cash.
That makes sense in theory, but in reality what "total money supply" is is a complete can of worms and basically impossible to measure
> if factories are still producing things like they were 20 years ago, the CPI would have been much higher, and that higher number is closer to what should have been the inflation number
This is an impossible counterfactual to test. In reality, tracking value across time requires adjusting for immeasurable preferences. This is why inflation is really only a useful measure for personal purposes across periods of years. It’s only macro economically interesting across a generation and close to meaningless longer than a human lifespan.
I think it's so obvious that no testing is needed, but generally I don't disagree with your take.
The thing is one really needs to understand what "real yields" mean when investing in bonds, i.e. it means your purchasing power with respect to cheap commodities tracked by the CPI is preserved, but it doesn't necessarily mean "value" (whatever that means in the abstract) is retained.
> it means your purchasing power with respect to cheap commodities tracked by the CPI is preserved
CPI isn't a measure of commodities. And "CPI" is a bit of shorthand, given there are pretty much as many measures of consumer and producer prices as there are economists.
> it doesn't necessarily mean "value" (whatever that means in the abstract) is retained
This is what any measure of inflation ultimately seeks to measure. Purchasing power is intrinsically tied to the basket of goods and services its measuring. That basket varies across people and time as preferences vary.
Decent is fine if you're about to retire and want to avoid risk but I wouldn't recommend parking your wealth in CDs/bonds if your retirement is still 15+ years out, personally. The government has to print money to bail itself out which means things are going to inflate quite a bit, just look at what gold has done in anticipation of this.
Banks bailed out the hedge funds in '98, then the taxpayer bailed out the banks in '08, then the government bailed out the taxpayer in '20... now monetary policy from the fed has to prevent the government from defaulting.
> If you’re running a business that relies on external cash (VCs, loans/bonds, etc) to keep things going things will get very ugly.
Honestly thrilled to hear it. The AI bubble needs to burst so we can find out what's actually useful, start requiring real business models again, and get rid of all the noise and waste.
The problem is all these over-leveraged sectors will drag everybody else. And guess who will be bailed out? Heads they win, tails everybody but them loses.
> The problem is all these over-leveraged sectors will drag everybody else
Well, the good news is that's what good public policy is for, to blunt the impact of the damage with strong anti-trust enforcement and careful cash injections to weak-but-critical areas of the economy to help stabilize in rough times.
Now, hang on for just one moment while I crawl out from under this rock and take a look at who we have entrusted to set our public policy.
The problem is, what assets remain of a company that doesn't own anything material? OpenAI, Anthropic - they don't own datacenters that could be auctioned off. All they own is training data and trained weights, and both are relatively worthless.
The game that all the AI companies are playing is to be the last dog standing at all costs, because that kind of dominance is a money printer.
People have cried wolf or been wrong about incoming crashes and bubble pops so many times that this signal -- whether it's a good signal or not -- simply won't change anything I do.
I'm sure someone somewhere could make a trade off of this article and this signal is definitely for them.
It is incredibly hard to make money going short. Even if you are right about the direction, most short positions require interest payments to hold, or have some sort of decay built into the structure. So timing is everything and even then, if the underlying security slowly grinds down (instead of a quick abrupt move) you could still lose if the interest/decay on the short position outruns the downward movement on the underlying.
I have been actively trading in the market for a little over a year now, and while winning on a short position is probably the most satisfying trade for me, the overwhelming majority of those trades are losses and at this point I mostly treat them as hedges. I suspect that is true for most market participants as well.
Even if this was a reliable signal for most of us it shouldn't change anyway. Timing the market is hard, so if you have a job keep investing in your retirement accounts and let dollar cost averaging work it out - odds are you are buying at fire sale prices. If you are one of those who lose your job - it doesn't matter much if the economy is good or bad, you need to adjust a lot of things (even in the best of times sometimes by chance you can be out of work for a long time)
If you are the manager of a mutual fund you can take useful action on signals like this if you can figure out what they mean. Most people don't have enough money to be worth trying to take action.
You may not be able to properly let dollar cost averaging do its thing if you rely on your job to invest, since there's a high correlation between periods where people are out of work and periods where asset prices are lower.
Even in the worst part of the great depression 75% of the people had a job. Most years where much better.
Don't get me wrong, if you don't have a job things are bad. If you have a job but it isn't giving good raises, or it is a worse job than you are qualified for things are bad. However things are not hopeless for the majority of people even when things are really bad, and you can get through it.
"Signals" are rubbish. The market is irrational and will change its mind at random.
This is, however, one of many indicators of an overall wobbling system. It would be a good time, not make the line go up, but to look for ways to stabilize the economy as a whole.
Which is unfortunately a hard question. One could theorize that we should do different things than the thing we've been doing for the past year or so, but of course there will be many who say that we just haven't done it hard enough yet.
It is easy to keep your head above water level for surprisingly long times. Just look how some people in retail manage to rack up credit card and other type of debt.
And it is especially so when money given is not their own, but instead they get to take cut. Which these funds can do. They might even just take promises that you will pay in future and even allow adding the interest on top of loan amount. Numbers look good, bonuses look good.
Fundamentally this can only last so long and now is the time it starts to blow up.
Yea the market will correct any time now from 2009.
Things will stay the way they are for as long as people want them to. The economy and money is fundamentally made up. It’s so funny when these types come out and start talking about made up fundamentals as if they are physics.
Employers will never be able to pay a living wage, because the real problem is a lack of housing. Rents and mortgages will always outrun wage increases in the current market.
Well, the question isn't "is there any consequence for the bank managers"? The answer to that is "No, never, not even during the French Revolution".
The question is "How long can they keep extracting money before the economy implodes?"
The people producing macroeconomic indicators in the US were fired about 6 months ago for putting out an honest report. Since then there's been very little correlation between public sentiment on the economy and the official indicators.
So, we're definitely in some sort of overhang situation, where the economy is imploding, but the stock market goes up. I think that's unprecedented in the US. In developing countries, when this happens, it usually leads to things like hyperinflation.
So, I guess the real questions are: "How do you short the dollar?", and "How can you tell when the banks start doing it?" so you know when to jump off the merry-go-round.
Zionism is an ideology, not a "minority group". People associate with it due to their values (most often, Christianity), not because of the way they were born.
The US Ponzi scheme coming to an end. It works great while everything is going up.
2008 Financial Crisis was triggered by Oil prices. There were lots of problematic structural elements that were fine if nobody looked close. Oil was just the sideway hit on the building to knock it over.
Just takes a nudge to collapse. And here we go again.
I thought it was by the layers upon layers of interconnected unregulated derivatives valued at a few orders of magnitude above the underlying subprime mortgages given to anyone with a pulse.
> it was by the layers upon layers of interconnected unregulated derivatives valued at a few orders of magnitude above the underlying subprime mortgages given to anyone with a pulse
It was interconnected derivatives and structured products linked to banks that caused a liquidity crisis in the former to cause a crisis of confidence in the latter.
Meanwhile: "In the letter, Morgan Stanley said the fund wasn’t designed to offer full liquidity because of the nature of its investments, and that credit fundamentals across the underlying portfolio have been broadly stable. The bank's shares fell 2% in premarket trading Thursday" [1].
> liquidity crisis in the former to cause a crisis of confidence in the latter
Wait what? Your thesis is the GFC was caused by a liquidity crunch/bank run? Isn't that... not true?
Isn't the proximal to distal chain of events government encouraged subprime loans -> inaacurately valued MBS -> exponential, unregulated derivative instruments -> leveraged contagion. What does market confidence have to do with any of that?
> your thesis is the GFC was caused by a liquidity crunch/bank run? Isn't that... not true?
It's absolutely proximally true and it's not just my thesis. From Wikipedia: "The first phase of the crisis was the subprime mortgage crisis, which began in early 2007, as mortgage-backed securities (MBS) tied to U.S. real estate, and a vast web of derivatives linked to those MBS, collapsed in value. A liquidity crisis spread to global institutions by mid-2007 and climaxed with the bankruptcy of Lehman Brothers in September 2008, which triggered a stock market crash and bank runs in several countries" [1].
The subprime crisis shouldn't have been bigger than the S&L crisis [2]. What turned it into a financial crisis was the credit crunch that followed. That crunch was caused by folks running on banks that had sponsored these products.
On "inaccurately valued MBS," note that the paper marked AAA mostly paid out like a AAA security. It would be like if you were perfectly good for your word and I lent you money, but then I wanted to sell on that debt to a third party who didn't trust you at a 50% discount. What does "properly valued" mean in that context? It's ambiguous in a dangerous way. (In this analogy, you wind up paying back the debt at face value. But years later, albeit on schedule.)
it did. GFC was a financial recession no doubt, but oil prices was one of the final things that tipped everything over. Oil prices climbed high, slowed economic activity a bit, and the whole financial that teetering just collapsed.
I did make a snarky derivatives comment elsewhere in the thread, but I do see you're not wrong about oil prices peaking at $138 in June 2008 (Lehman collapsed in September 2008): https://fred.stlouisfed.org/series/DCOILBRENTEU
This time it took ~35 blows with a sledgehammer. You have to be impressed with the degree of resilience here, even a chaos monkey like Trump has a hard time completely destroying the US economy even when all checks & balances utterly fail.
Trump is a symptom, not a cause. One of probably hundreds of mediocre failsons gifted unbelievable wealth in the birth lottery who’s greatest achievement in life was managing to not lose all of it to his awful business acumen and utter refusal to listen to a single living person.
Every industry’s leadership is full of trumps, many more palatable personally, many far better spoken, many even with better politics but none fundamentally are any actually better for society. They don’t understand their company, the products it makes, they have utterly no care for anything besides the quarterly stock price and their lack of care costs real people their jobs and ruins the products we use every day.
And, they are why every company is ripping the copper out of its own walls instead of actually building a business that will last.
It’s more accurate to say that the private credit market was created by the government adding new regulations, not removing them. Business development corporations have existed since the 80s but they didn’t explode in popularity as business loan originators until Dodd Frank and other post-2008 regulations made it more difficult for banks to lend money. This led small and medium size businesses to seek out credit from firms like Ares et al instead.
And to make matters worse, those who remove regulations then get voted out, but show up on infotainment "opinion" shows disguised as news broadcasts....and whine that those who were voted in to fix the mess aren't fixing the problem fast enough, so those who caused the problem should be voted back in. And lo and behold, they get voted back in, to cause more damage.
Its un-fixable. The situation cant be explained simply enough for the majority of americans. Even if some of them do mange to understand, it will be quickly forgotten amid the flood of trump sewage we are sprayed with every day.
I think we'll get there (to explanation), but it'll be through the lizard-brain-level pain of poverty instead of rational understanding unless we get much better at communicating to the least willing to listen among us.
Pretty sure the solution that US politicians will find will be to create new dollars out of thin air, so instead of increasing taxes they increase the money supply.
Of course this is going to increase prices, but then they can blame China / Russia / Iran whoever is the scapegoat at that time.
It would cause inflation, isn’t that sort of a tax on people who have more wealth than income? (Which includes people like retirees, so, I’m not saying this is a universally good thing).
Theoretically yes, but in practice the wages of people already not making much have not tracked inflation and there's no reason to believe that they will now. That means any inflation is also a tax on them.
Poor people are hit a lot harder, but rich still have to pay capital gains on inflation even despite having no real change in value. So the rich pay inflation at the rate * 0.2. Poor pay it at the rate * 1.0 (5x the rate of the rich).
> rich still have to pay capital gains on inflation
“Pay” is doing a lot of work there. My house is half equity half debt. The debt gets to be paid off with inflated dollars. And I pay no capital gains on the appreciation. I can, however, tap it for liquidity if I need it.
Rich people don't tend to have a sizeable portion of their worth tied up in their primary residence (and even then, IIRC there is a cap on capital gains exception), otherwise property tax would turn into a wealth tax for them which obviously they want to avoid. Non-primary residences still require paying capital gains. The inflated value you paid off with debt for a non-primary residence still gets captured as capital gain in the end when you actually want to sell the house for money.
> isn’t that sort of a tax on people who have more wealth
Classically, yes, particularly when that wealth is closer to productive capital. In modern economies, the rich also hold a lot of debt, which lets them benefit from inflation.
Many of these businesses are SaaS which means their valuations are tumbling.
It seems possible that valuations tumble so much that the private equity owner no longer has any incentive to operate the business, bc all future cash flows will belong to the bank. What happens in practice then? Will banks actually step in and take operational control? Will the banks renegotiate terms such that the private equity owners are incentivized to continue as stewards? Or, will they prefer to force a business sale immediately?
Yes some businesses are SaaS but here's the real problem: Many businesses' sole purpose is _leveraged buy-outs_ which really is the devil in disguise.
It goes like this: A VC specialising in veterinary clinics finds a nice, privately owned town clinic with regular customers and "fair" prices, approach the owners saying "we love the clinic you've built! We'll buy your clinic for $2,500,000! You've really earned your exit!".
So now the VC lends the money from the bank, buys the clinic, and here's the important part: _they push the debt onto the clinic's books_. So all of a sudden the nice town clinic has $2,500,000 in debt, raise prices accordingly, ~~burn out personnel~~ slim operations accordingly, and any surplus that doesn't go to interest and amortization goes straight to the VC.
Debt and collateral on the veterinary clinics.
Risk free revenue to the VC.
This mostly correctly describes a leveraged buyout (LBO). LBOs are done by LBO shops, a type of private equity (PE) firm. Not VCs. (VCS do venture capital, a different type of PE.) And LBO debt isn’t “pushed” onto the company’s books, it’s never on the sponsor’s (LBO shop’s) books in the first place to any material extent.
Private credit, on the other hand, involves e.g. Blue Owl borrowing from a bank to lend to software businesses, usually without any taking control or equity. It’s fundamentally different from both LBOs and VC or any private equity inasmuch as it doesn’t have anything to do with the equity, just the debt. (Though some private credit firms will turn around and lend into a merger or LBO. And I’m sure some of them get equity kickers. But in that capacity they’re competing with banks. Not PE. Certainly not VC, though growth capital muddles the line between what is VC and other kinds of PE or even project financing.)
From a financial engineering perspective this is wrong.
Both equity and debt have costs of capital. Debtholders expect interest, capital holders expect RoE. The money going to debt interest is money that would previously have gone to equity, but now does not because the equity is replaced with debt.
Crucially, the costs of debt is lower than the cost of equity because of the interest tax shield. Therefore, the vet clinic now requires less revenue to maintain or even increase its return to equity.
And the LBO model is much less resilient to economic headwind. Let's assume a 25% EBITDA margin business, with most costs fixed (like the clinic example). Unfortunately revenue drops 20% because of external factors. It would maybe have a tiny profit left, tax would also be tiny and there is no interest to pay. The shareholders receive near zero, absorbing most of the problem for a year waiting for times to get better.
Now the same business, same reported EBITDA, but paying a large interest sum every year to the bank. If revenue drops 20% they can't pay their interest, and banks don't just wait for next year. Now the business has the restructure, agree with the banks what that looks like, or face a bankruptcy risk.
While the new PE shareholder has a better RoE due to leverage in the upside scenario, the business (and the PE) could be completely cooked in a downside scenario. For the PE this is a calculated risk, they optimise the overall portfolio. But for the employees and customers this isn't a great scenario.
The small-town vet would have probably accepted a lower RoE. More critically, they’d have been more willing to absorb shocks to said RoE than a lender will to their debt payments.
or some manager at it? it must be easy enough to raise that starting money, if the PE firm could get the loan
How is that risk free? If the clinic goes bankrupt the VC will be on the hook for the rest of the loan. It’s not free money.
Ohhhh a live one! Sir do I have a wonderful bridge in Brooklyn to sell you! :)
Fun fact: banks fund this sort of nonsense constantly. I've asked about this before: why they do it. They must be making money I just don't know how. The LBO guys pay themselves massive management fees and dump the debt on the company so they walk away scott free.
My wild guess was the banks offload the eventual IPO onto investors and so make their money on the IPO fees and funneling their own clients the dead-man-walking shares. But I honestly don't know.
"lends" -> "borrows", right?
The VC lends (the money from the bank) which the vc borrowed, to the clinic.
They are a sort of middle man. It the clinic is on the hook to the bank and the Vc takes fist cut before playing the bank.
Eg. The vc only risked the company they were buying, and gets paid first.
It does not happen overnight. But what happens is after they take control of the clinic or company they change the sales model to boost reoccurring revenue, this then allows the clinic or target company to take loans out. Because they look good on paper. The company then pays VC back when then pays bank back.
This can be done in about 6mo to 1 year process with some companies. The initial out of pocket expense is small and paid back very quickly.
I also forgot. Sometimes they will take the newly owned company and merge it. During that process they extract more money and load more debt onto the remaining entities, again making the VC money.
In some cases they can even get huge tax benefits by loading the company with debt which offsets the tax bill of the final entity.
When these transactions are done, within the span of a day multiple companies are created and merged and absolved.
There is little to no risk for the VC
This is actually a case where using the correct terminology clarifies.
VCs don’t do LBOs. Private equity firms do. When their deals go bust they lose the equity they invested. That equity is the first layer to take a loss. When that happens, the lenders—whether they be banks or private credit firms—take over the company, often converting some of their previous debt into equity.
There is a lot of risk in LBOs. It’s why they have such a mixed record.
This was the missing bit for me. Thanks for taking the time to explain!
First, VC stands for venture capital, which is a subset of private equity that does zero LBOs and doesn't even acquire any businesses. VC funds buy equity in startups, and take on zero debt to do so. You have your boogiemen totally confused.
Second, the entire point of a PE fund that uses a leveraged buyout strategy is that they need to sell the acquired firm at a profit to make any returns to the fund. LBO funds don't 'cashflow' businesses, and saddling a business with a bunch of debt is antithetical to that purpose anyways.
Third, this is not "risk free revenue." It's a high risk strategy to use the debt to increase the value of the business by improving operations enough that you can sell it for a profit to the fund. If you saddle a company with debt and DON'T increase the value of the business beyond the debt you took on, the PE fund will not be in business for fund 2.
The risk-free revenue while the fund is alive comes from the management fees that investors in the fund pay (usually 2%, which is way too high IMO, but has nothing to do with the debt or the acquired businesses).
Please do not write confident sounding comments about things you don't understand, it spread misinformation and makes the internet a worse place.
IF you have problems with the vocab and terms, fine. But I have seen personally this issue in my life, that is affecting my bank account.
And we have seen example after example of these LBO's ruining otherwise functioning businesses. It's happening. All over the place.
Your anecdotes and the anecdotes in media are no statistical evidence for "this is happening all over the place".
Yes, PEs/LBOs deserves criticism, but "PE" and "LBO" isn't a one size fits all situation.
It's just as likely the business that was acquired was already failing or unsustainable to begin with (hence why the owner wanted out at low multiples). LBO funds don't acquire promising businesses at 5-10X revenue like tech companies do, they usually buy businesses at low multiples that are past their prime or failing in an attempt to revitalize them (with debt, since you can't raise capital by selling equity in a failing business).
Obviously this will not always work out great, given the trajectory of target companies was already not great to begin with. Momentum is the strongest factor in all markets.
The problem is, Private Equity has become a conspiratorial catchall boogieman and scapegoat for every problem under the sun, so it's hard for me to assess without further details of the situation.
Nit: beta is the strongest factor in all markets. Which is actually relevant for the success for PE funds in general, as a rising tide lifts all boats and people taking on debt to finance equity generally post outsized returns in bull markets.
Anyway, the rest of the stuff you're saying I agree with.
If you buy a “factor-weighted” etf the idea is it’s tilting you into those “factors” away from pure beta like buying whole market.
PE you could argue is largely just leverage plus an illiquidity factor play, since if PE just returned beta (which these days it might!) you’d be smarter to buy the S&P500 with equivalent leverage and not pay crazy fees.
On your second point: LBOs aren't the only tool in the toolkit, and it's not as popular as it was decades ago, so I would lean towards the parent simply conflating "buying an ownership stake in a business in some capacity using other people's money" with the strict definition. Regardless, yes PE firms need to figure out how to get 20%+ IRR throughout a short timeframe (usually a 5 year holding/funding cycle) -- however this is through any means necessary. Philosophically, it's about increasing efficiency of operations and growing the business. In practice, it's financial engineering because PE firms do not have the operational skills to make any value-added changes to firms besides driving costs down.
Saddling a business with debt is reductionist. I've seen absolutely nonsensical financial structures that make no sense for a layman, but in practice end up "using the business' finances to 'own' (beneficially) the business" (see: at the most vanilla, the strategy of seller financing in SMBs). No this is not technically "putting debt on the books" but it is in all practical respects a novation/loan transfer that can leave the purchased co financially responsible for servicing any debt that was used in its purchase.
On your third point: what I wrote above can be used as context. It's not risk free revenue, frankly it's very risky unless you're in an inflationary environment where your assets will grow regardless of your business operations solely because the overarching economy is growing and you're riding a tailwind. However, it again boils down to financial engineering. It's not as simple as assets - liabilities = equity. The calculations used to determine valuations are so ridiculously convoluted. The amount of work that goes into financially analyzing businesses and finding "loop holes" that can justify higher prices is the core business model. The debt factors into it, but there's ways to maneuver around it through various avenues.
For example:
* debt-to-equity conversions (reclassification of debt as equity)
* refinancing
* sale-leaseback (selling company's assets to a 3rd party and using that money to pay down the debt, then leasing the equipment back)
* creative interpretations of what is actually debt (e.g. reclassifying real debt as a working capital adjustment or a "debt-like")
* dividend recapitalization (a nasty trick of loading the company with debt, paying that out as a dividend to the holdco, then selling the company at lower enterprise value. They still extracted value for their LPs/investors, despite the exit being lower)
* separating the debt from the operating company into a different holding company that services the debt
Our affordable plan came to an end when the rates tripled! Turns out a private equity firm bought the company, jacked the rates on every customer, and sold it off again. This was not a fundamental cost being passed on in slightly increased fees -- it was private equity extracting millions from the people who can afford it the least. Across my financially optimized life, I see this happening repeatedly.
Personally, I can afford a more expensive cell phone bill. But I would imagine that many who have a $10/mo plan do not have many other options. I would like to punish the banks who are funding attacks on consumers. If by no other means, then by letting them fail.
Not quite. Private credit is to debt what private equity is to equity. (Technically, any non-bank originated debt that isn't publicly traded is private credit. Conventionally, it's restricted to corporate borrowers.)
So bank exposure to private credit generally means banks lending to non-banks who then lend to corporate borrowers.
Business development companies [0]. Blue Owl. BlackRock [1].
> are these buy side created SPVs?
Great question! Not always [2].
[0] https://www.reuters.com/business/finance/private-credit-fund...
[1] https://www.blackrock.com/corporate/newsroom/press-releases/...
[2] https://www.datacenterdynamics.com/en/news/meta-secures-30bn...
In this private credit situation the analog for the banks are these private credit funds that have raised the capital they've lent from institutions and high-net-worth individuals (as opposed to banks, which have funds from consumer deposits). The analog to the individual mortgage borrowers from 2008 are actual companies.
To connect the dots, if the private credit funds were like the banks pre-2008, where due diligence was an afterthought, then this could turn out to be similar. So the real question is: are the borrowers (businesses in this case) swimming naked? Or do you believe the private credit funds when they say they actually conducted a good amount of due diligence when extending their loans? Once you know the percent of the companies that are naked you can evaluate whether this could/would end up similar to 2008. Nobody knows that yet, even, I suspect, the private credit funds themselves.
Private-credit lenders are literally shadow banks [1]. But I'd be cautious about linking any shadow banking with crisis. Tons of useful finance occurs outside banks (and governments). One could argue a classic VC buying convertible debt met the definition.
That said, the parallel to 2008 is this sector of shadow banking has a unique set of transmission channels to our banks. The unexpected one being purely psychological–when a bank-affiliated shadow bank gates redemptions, investors are punishing the bank per se.
[1] https://en.wikipedia.org/wiki/Non-bank_financial_institution
Imagine you got a loan to buy a bunch of laundry machines to run a laundromat. But your laundromat earns $8,000 a month, and the loan payment is $10,000.
You can decide to sink $2,000 of your personal money into the laundromat every month, or you can give up.
[1] https://www.sec.gov/Archives/edgar/data/72971/00000729712500...
[2] https://www.reuters.com/business/finance/deutsche-bank-highl...
Recruitment tables should just have a banner that reads 'we've already spent your bonus on legal fees, here's some chocolate'
Now 50% loss means wipe out. But given the size of the portfolio, there is also the concentration risk. A single private-credit firm going bust shouldn't take out a bank. But that seems–seems!–to be what I'm seeing.
If the bank has trouble, shareholders/executives lose - if the banking system has trouble... then QE will solve the bank trouble.
It's a game of chicken, though. The folks at Lehman and SVB didn't cash out. JPMorgan did. (Both times. Actually, all of the times since 1907.)
Been a bit out of the finance game
Banks' private-credit lending constitutes part of their risk-weighted assets. So yes, it's part of their CET1 [1], which is part of Tier 1 capital, and since it's equity measured it incorporates fucking everything.
4.5% is the U.S. minimum. Regulators start throwing their toys out of the pram when a bank breaches 7%. To be clear, I'm not seeing anyone in the near future breaching those limits. Deutsche Bank, the stupidest of the lot, seems to have let DB USA stuff most of the risk in its German AG.
[1] https://www.investopedia.com/terms/c/common-equity-tier-1-ce...
tick-tock, tick-tock, tick-tock...
---
[a] https://news.ycombinator.com/item?id=47351462
I say this to say... who knows? I guess if you shuffle deck chairs fast enough everything works out fine (?)
Private equity (PE) is increasingly being introduced into 401(k) plans, driven by a 2025 executive order encouraging "democratization" of alternative assets. - Google AI
Think pre-IPO buy-in. Investors in the know and other well connected institutional investors get first dibs on all of the good ones. The bad ones are pawned off to retail investors. It's no different with private credit and private equity. These sorts of deals have good ones and bad ones - the good ones will have been taken by the time it flows down to retail.
So unlike money-market funds, these private-credit funds can gate withdrawals and extend and pretend by turning cash coupons into PIKs. So I don't actually see credit concerns directly driving liquidity issues for the banks that didn't hold the risk on their balance sheet glares Germanically.
Instead, I think the contagion risk is psychological. Which is an unsatisfying answer. But if there are massive losses on e.g. DBIP and DB USA halts withdrawals, then the 2% stock loss Morgan Stanley suffered when it capped withdrawals [1] could become a bigger issue.
[1] https://www.wsj.com/livecoverage/stock-market-today-dow-sp-5...
Or never invoked. It's a safety feature for the fund and, arguably, systemic stability.
People eventually want to spend their money.
What is the risk, probability of actualizing the risk, and the outcome of actualized risk?
The ticktock ticktock routine reads like baseless fearmongering to me.
For example, take First Brands, a multi-billion-dollar company which filed for bankruptcy last year. First Brands had pledged the same assets as collateral for loans from multiple private-credit funds. Those loans were being carried at a fantasy NAV of 100 cents per dollar, until suddenly they were not. Did none of these lenders submit UCC filings so other lenders could check which assets had already been pledged as collateral? Did none of these lenders ever check to see which assets had already been pledged? Did all these lenders make loans based on blind trust?
Failing to check and verify that assets have not been pledged as collateral to other lenders is an amateur mistake. It's reckless, really. The equivalent in home-mortgage lending would for a mortgage lender never even bothering to check that a homeowner isn't getting multiple first-lien mortgages simultaneously on the same home, then forgetting to put the first lien on the property title.
My take is that for many private credit funds, NAVs are basically fantasy.
Oh boy, if this is the case, oh boy.
Lessons not learned indeed.
I resorted to the mortgage-lending analogy so others could quickly grok what multi-pledging means.
> The default rate among U.S. corporate borrowers of private credit rose to a record 9.2% in 2025
Emphasis added. Headline makes it sound like retail credit, not corporate specifically.
*Edit: Not misleading, just an unfamiliar term/usage from my perspective. I'm not a finance guy so didn't know the difference and assumed others wouldn't either. Mea culpa.
I'm not saying they are right. But it's like if you posted an article called "Python Is Eating the World" on a non-tech side and people got mad because they thought the article was about a wildlife emergency. Fair for them to be confused, but maybe not fair to accuse the title of being misleading (at least not intentionally).
So the mental model I have of the average HN contributor is basically that they are all SWE's- they know software engineering extremely well, and the farther you get from that the less valuable the conversation will be, and the more likely it will be someone trying to reason from first principles for 30 seconds about something that intelligent hard working people devote their careers to.
I’m coming at this loaded with jargon, so excuse my blind spot, but why would the term private credit bring to mind anything to do with retail specifically?
(The term private credit in American—and, I believe, European—finance refers to “debt financing provided by non-bank lenders directly to companies or projects through privately negotiated agreements” [1].)
[1] https://corporatefinanceinstitute.com/resources/capital_mark...
If a layman is unfamiliar that "private credit" is about business debts, and therefore only has intuition via previous exposure to "private X" to guess what it might mean, it's not unreasonable to assume it's about consumer loans.
"private insurance" can be about retail consumer purchased health insurance outside of employer-sponsored group health plans
"private banking" is retail banking (for UHNW individuals)
But "private credit" ... doesn't fit the pattern above because "private" is an overloaded word.
Makes sense. Thanks. Private here is as in private versus public companies.
Yes.
It surprises me that most people would read "private credit" to mean "retail credit" by default, but I also come to this loaded with jargon so I guess would defer to others on this. But to be clear, the title is not misleading to anyone who has any familiarity with the financial markets.
Out of curiosity where do you primarily get your news?
A lot of the datacenter buildout has been financed with private credit [1].
> financial blackpilling
?
[1] https://www.bloomberg.com/news/articles/2026-02-02/the-3-tri...
Any idea as to the etymology? What was the black pill? Is it a Matrix reference?
Meta: why are incel neologisms so catchy?
someone not knowing the definition != misleading title
It's not. It's just that we're seeing potentially 10% losses on the portfolio level [1], which could imply up to–up to!–5% losses to the banks' loans to those lenders.
Again, tens of billions of dollars of losses are totally absorbable. But Morgan Stanley's stock price took a hit when it gated one of these funds [2]. And some banks (Deutsche Bank, somehow, fucking again, Deutsche Bank) have small ($12n) but concentrated portfolios where a single wipeout could materially impair their ~$80bn of risk-weighted assets.
[1] https://www.reuters.com/business/us-private-credit-defaults-...
[2] https://www.wsj.com/livecoverage/stock-market-today-dow-sp-5...
They are, in isolation. The _problem_ is that PE doesn't generally trade assets in public, which means that valuation only really come when you're either wanting to buy, wanting to sell, wanting to re-loan or in deep shit.
This means that something like MFS can happen (https://www.reuters.com/business/finance/mfs-creditors-claim...) where assets appear to be used to raise two different loans without the other lender knowing.
But! banking can absorb a few billion right? yes, so long as people are not asking questions about other assets.
Because PE assets are not publicly traded (hence private in private equity) the value of assets are calculated at much lower rates than on a public market. This means that the assets that PE holds could be wildly over or under valued. The way we assess the value of PE holdings is thier looking at the Net Asset Value calculations (which might be done twice a year) or infer the value based on public information.
Now we are told that markets are rational and great at working the value of things. This dear reader is bollocks. Because PE is a black box, if a class of asset that they hold (ie SaaS buisnesses, or high street stores, or coffee trading etc) looks like its not doing well, people will start to write down the value of people holding loans given to PE, or shares in PE.
This creates contagion, because one PE company is in distress, the market goes "oh shit, the whole thing is on fire" and you get bank runs (because where is the money coming from to loan to PE? thats right banks, eventually)
[1] https://fred.stlouisfed.org/series/TOTBKCR
These private credit numbers are estimates provided by Moody's, who were famously clueless about the scale of mortgage bond risk even as they stamped them all with a AAA rating.
The liquidity challenges of a $1.2T shock to the economy is meaningful, because it has knock on effects on equity as well.
When private credit (which is propping up private valuation) falls, private equity also falls and then everyone realizes that everyone else has been swimming naked.
In a catastrophic scenario: if the whole asset class went to 0 (on the banks asset sheet they would lose 2.5% - absorbable pain assuming its not leveraged through creative financial mechanisms).
I would wager that risk is more concentrated on certain institutions instead of across the board so acute pain likely.
Apparently they operate on very low level of tolerable risk (way lower than I thought)
Total bank balance sheets are about $25T.
---
[0] https://www.bis.org/publ/qtrpdf/r_qt2503b.htm [1] https://www.bis.org/publ/bisbull106.pdf [2] https://www.bis.org/publ/work1267.pdf
That's the scenario in which unemployment goes to 10%, home prices crash by 33%, the stock market halves and Treasuries trade at zero percent yield [2].
[1] https://www.mfaalts.org/industry-research/2025-fed-stress-te...
[2] https://www.federalreserve.gov/publications/2025-june-dodd-f...
So I guess the Fed expects these other kinds of lending to be safer than private credit?
The Fed is measuring the loss on bank loans to the private-credit lenders. A 10% portfolio loss shouldn't result in those lenders defaulting to their banks.
By my rough estimate, one can halve the portfolio loss rate to get the NBFI-to-bank loss rate. So a 10% portfolio loss means we're around a 5% expected long-run loss to the banks. Which is still weirdly high, so I feel like I must be missing something...
Definitely think we’re in for a rough year financial prospects wise, and doesn’t even feel like we recovered from the 2008 crash properly.
What caused the SaaS apocalypse? Gen AI.
I'm long on AI hardware companies for this reason.
Instead everyone hates on Goldman Sachs. Sure, Goldman Sachs deserves hate, but of the big banks they were the _least_ guilty of the crash in 2008. Not saying they were saints, but in 2008 they were the least bad.
0: This list only covers banks, not non-banks like Countrywide Financial: https://en.wikipedia.org/wiki/List_of_bank_failures_in_the_U...
It's one of the only investments of labor and time where the risk is not proportional to the return.
In order to create risk, you have to either claw back their money through civil action - which you can't because the entire point of incorporation is to separate the business entity from one's personal finances - or look at criminal charges. Otherwise, you have created a class of hyper-wealthy people who have no real incentive to perform in a way that is for the best interests of shareholders or society at large.
It's the reason we tie so much for regular people to employment in the US, like healthcare. Many argue that if you give the rank-and-file worker the kind of long-term financial security that just one or two years of being a C-suite executive at a major company, they won't work as hard. They won't make the best decisions. They won't be the dynamic workers our economy supposedly wants. That logic goes right out the window when a board goes hunting for a new CEO.
There's zero real risk involved.
How is that penalizing those responsible?
Isn't it a pretty big leap to go from penalizing those selling packaged fraudulent loans to the public (whom, to my knowledge were never prosecuted) to the shareholders losing money as protection against it happening again?
OK.
> If you create debt, you have created wealth.
No, you have created money. Money is not the same as wealth. If you create money without creating wealth, then it's inflationary.
Just a minor nit. The rest of your post I agree with.
The legislative produced Frank-Dodd...which Trump and Republicans later scaled back...
GP's comment is about the aftermath of 2008, entirely missing the fact that the legislative did in fact create laws which were signed by the executive and then later, in 2018, dismantled under a different administration.
It's a matter of simple facts here.
So that govt money went to the wealthy to buy up houses (Californians bought real estate in the Midwest as investments and it drove up housing prices along with small immigration to these states)
Farmers etc benefited from bailouts when they were doing very well. It was a large blunder.
Meanwhile student loan forgiveness was overruled by the supreme court.
It's really hard to ignore the implication that it ended up being more like a wealth transfer than anything else.
Between the latter and the former I believe the former was a much smarter choice in the medium to long term.
We did. We created about $4 trillion. That just about neutralized the $4 trillion that evaporated in the crash, and the result was that we did not go through a deflationary collapse. You know that they did not create too much, because inflation was basically nothing for the next decade. It was flat until Covid.
Covid... yeah, that was inflationary.
Do you think replacing that 4T was a good call? I'm struggling to see how it was the right play.
The Fed avoided that. And they also avoided causing inflation. It was an amazing job of threading the needle. (One could argue that they caused a decade of stagnation, but in my view that was minor compared to the other options.)
I'm asking this in as non-confrontational way as possible, what am I missing?
I think the economy can adjust to any amount of money; it's the abrupt change in the amount that causes problems (because it causes an abrupt change in the value of money).
I think you may be missing that I'm not saying the same thing about the pandemic response. I think that too much money got poured in during the pandemic years, and that has caused inflation, and we've been seeing that inflation since. I wonder if you are taking how you feel about the last five or six years, and mapping that onto the last 18 years.
Now, from 2008 to 2020 was not all roses. Things were kind of stagnant. The rich were probably doing better than you were, because assets like stocks and land went up in value as interest rates went down, but your wages didn't go up. So, it was reasonable for you to feel "there's too much money sloshing around" in things like stocks during those years.
But I think it got worse after Covid. The government air-dropped too much money in, and there has definitely been too much money sloshing around since then.
In all of this, I'm not really saying that you're wrong in feeling that there's too much money sloshing around, or that the economy is frustrating.
The internet working didn't make the Dotcom bubble not happen. Investors don't know anything about the new investment space and most of them are going to get hosed eventually. It's going to happen, and it'll be bad for people who are betting on it not happening.
> A box of matmuls isnt going to solve any real problems, so far, as you point out- is can barely write software
Code monkey cope.
You seem to be answering a number of other questions in the post so interested to hear your impetus for sharing in the first place.
nb: thank you for being an ongoing contributor to the site! I see your handle cropping up a lot in substantive conversations
Yes.
> the same regulations and constraints that led them not to lend to the underlying borrowers in the first place
No. Non-bank financial institutions (NBFIs a/k/a shadow banks) compete with banks. They also borrow from banks.
> When banks lend to private credit funds/firms, it tends to be through senior, secured loans which will be less risky than the underlying loans
Correct. Assuming 1.5x leverage and 60% recovery, you'd expect no more than half of portfolio losses to transmit to their lenders.
So, it's sort of like bundled mortgage securities, where you take some bad loans and mix them together to get a "less risky" loan, since the chance of them all defaulting at once is less than the chance of all but one defaulting.
Presumably, since banks (by definition, an intermediary) are involved, those are then recursively repackaged until they have an A+ rating, or some such nonsense, right? Also, I'm guessing there's no rule that says you can't intermingle these things across separate "independent" securities, even if the two securities end up containing fractions of the same underlying bad loans?
Clearly, like with housing, there's no chance of correlated defaults in a bucket of bad business loans that's structured this way!
In case you didn't quite catch the sarcasm, replace "housing loans" with "unregulated securities" and note that my description switches from describing the 2008 financial crisis to describing the Great Depression, or replace it with "bucket shops" (which would sell you buckets of intermingled stocks) and it would describe every US financial crisis of the 1800s.
Yes. This is mathematically sound.
> those are then recursively repackaged until they have an A+ rating, or some such nonsense, right?
AAA-rated CLOs performed with the credit one would expect from that rating.
The problem, in 2008, wasn't that the AAA-rated stuff was crap. It was that it was ambiguous and illiquid.
> I'm guessing there's no rule that says you can't intermingle these things across separate "independent" securities, even if the two securities end up containing fractions of the same underlying bad loans
Defining independence in financial assets like this is futile.
> there's no chance of correlated defaults in a bucket of bad business loans that's structured this way
Software companies being ravaged by AI fears.
> replace "housing loans" with "unregulated securities" and note that my description switches from describing the 2008 financial crisis to describing the Great Depression
It also describes a lot of successful finance that doesn't reach the mainstream because it's phenomenally boring.
How is this inconsistent with what I said? I was just making the point that the reason for the rise of private credit is that banks are less willing / able to lend, particularly to riskier borrowers, as a result of post-2008 banking regulations. So private lenders have stepped in to fill that gap.
That may have been true once. It's rarely true now. Banks and shadow banks compete for the same borrowers.
tick-tock, tick-tock, tick-tock...
The finance industry's main innovation is rent seeking.
We all know what is going to happen, it's just a question of when.
anything Wells Fargo leads in must be bad
July 10, 2009
https://www.denverpost.com/2009/07/10/lewis-wells-fargo-so-b...
My normal bank was acquired by Wells Fargo in 2008 and they also owned my mortgage.
When I went to pay off my mortgage in 2012 they required a cashier's check for the final payment of around $80.
I asked if we could do it electronically like all of the previous payments and they said no.
So I walked into my local bank asking for a cashier's check of that amount and the bank teller told me that most people would accept a personal check for that little. I said yeah but YOU don't. She looked at me funny.
So she asked who to make the cashier's check out to. I said "Wells Fargo" and she looked at me funny again and said "Wells Fargo is us, the check comes FROM Wells Fargo. Who do I put on the TO line" and I said "Wells Fargo"
She again looked at me funny and I explained that I am paying off my mortgage. Wells Fargo is where I have my bank account and my mortgage. She said "Can't we just do it electronically?" to which I said "You would think but apparently your employer can't handle that and told me to get a cashier's check and FedEx overnight to them."
She rolled her eyes and then started laughing.
The requirement to disclose has only existed for a year I believe, but many are kicking the can or claiming that it would cause them issues.
- when a bank creates a loan, this has an effect on money supply in total
- when a private credit company "gives" a loan, it has no effect on total money supply and from balance sheet perspective its an accounting exchange on the asset side
They also borrow money from banks to add leverage to this basic setup.
There are kind of 3 types of loans:
- bonds. Loans interned to be bought by a range if investors and traded over time. Arranged and unwritten by investment banks.
- bank loans. The classic loan. The bank takes depositor money (that the depositor can take back anytime!) and loans it to someone or some company. The bank holds the loan
- private credit. Like a bank loan, but they get their money from long term investments by wealth people and institutions, add bank loans for leverage, and then hold the loan.
These are mostly syndicated. The traditional difference between loans and bonds was bank versus investment bank. The modern difference is in underwriting technique, degree of syndication/securitisation and loans mostly being floating and bonds mostly being fixed.
The Banks get in trouble, and Gov has to step in. So Gov, reasonably, add regulations and restrictions. But the law can't be really specific, it requires gov employees to actually examine the bank and make decisions (eg about risk levels, etc).
The banks have a really large incentive to chip away at the effectiveness of the regulation. They hire lots of lawyers, consultants, notable economists, etc and just keep pushing on these rank and file gov regulators. They buy influence with politicians, and use that to pressure the regulators. They hire some of the regulators at very high pay, sending a signal to the others: play ball and a nice job awaits you.
Over time, they just wear down the regulators. The rules are interpreted to be mostly ineffective and nonsensical. Often at that point the politicians come in and just de-regulate.
The banks just have the incentive and focus to keep at it every day for years. No one else with power is paying attention.
Broadly speaking, privately-held companies are called firms. Colloquially, it tends to connote closely-held companies.
Like, when a bank originates a mortgage, that mortgage gets traded, much like private debts don’t.
It's generally felt to be risky and volatile, but useful. Basically, it's never illegal just to hand your friend $20 even if the government isn't watching over the process to make sure you don't get scammed. This is the same thing at scale.
It is. (EDIT: It's a mixed bag. OP was correctly calling out a definitional error.)
Banks have loaned $300bn mostly to private-credit firms. Those firms then compete with the banks to do non-bank lending. It's a weird rabbit hole and I'm grumpy after a cancelled flight, but it feels like I'm in the middle of a Matt Levine writeup.
I guess it is fair to say the federal funds rate has persisted at a high level over the past three years now isn't it?
https://www.macrotrends.net/2015/fed-funds-rate-historical-c...
Also interesting to note, "Fitch recorded NO defaults in the software sector last year. The rating agency noted it categorizes software issuers into their main target market sectors when applicable."
For example, we decided to keep our vehicle for another 4-5 years instead of buying a new one. The same Hyundai vehicle of the same model, but different year (2026 v.s. 2020), has gone up 8,000 CAD (10K CAD considering tax), with a much higher rate (5.99% v.s. 0%). There is no way I'm buying another car in the foreseeable future. We can definitely afford it, but we won't.
The whole world has pushed up prices of food, housing and pretty much everything higher. This is the real problem -- although I wouldn't say it is the root problem.
i dont think the inflationary seventies and eighties are great lodestar
low interest rates are historically a sign of a stable polity and economy. so if anything, we want the conditions for prolonged low interest rates, rather than prolonged high interest rate.
> Private credit refers to loans provided to businesses by non-bank institutions—such as private equity firms, hedge funds, and alternative asset managers—rather than traditional banks .
Is that correct?
So if these companies go under does anyone care? If they go under are they a systemic risk to the economy like the banks in 2008 that got a taxpayer bailout?
From that newseltter:
> At the Financial Times, Jill Shah and Eric Platt report:
>JPMorgan Chase ... informed private credit lenders that it had marked down the value of certain loans in their portfolios, which serve as the collateral the funds use to borrow from the bank, according to people familiar with the matter. >...
>The loans that have been devalued are to software companies, which are seen as particularly vulnerable to the onset of AI. ...
From what i can tell the problem isn't that an individual who had cash to invest in a private (tech in this case) company goes down
the problem is that a company "private credit firms run retail-focused funds (“business development companies” or BDCs)" which took out a bunch of loans to invest in private tech companies is now having the underlying assets that they got those loans against (long term investments in private tech companies) valued lower.
the link im missing is what happens when people who also invested in BDCs want their money back, where their actual money is locked up in long term investments made to private tech companies, and their ability to get loans is now valued lower. I think this is called a "run" where if someone starts pulling money out, and ultimately you cant, then its a race to get your money out before others do, which applies to both the individuals and the institutional loans.
Note: my quotes are from the bloomberg newsletter i mention, which helped me, not the OP article. And i am writing as much to clarify my own thinking as from a place of understanding. I welcome clarification.
Banks needs to disclose the % of non-performing home, auto, business loans to rating agencies and regulatory bodies so their credit risk is known, and so regulators they can set rules on how loose or tight lending criteria should be in the industry. With 'financial innovation' like tranched mortgage bonds rolling up thousands of mortgages at various levels of credit risk into one, they can be traded without anyone actually knowing what the default risk is.
With private credit, there is no disclosure requirement because the lenders are not banks. PC is financing the entire AI datacenter boom, without which GDP growth in the US is effectively zero. If PC defaults rise, the bottom could rapidly fall out of the S&P 500, which is already being hit by the oil price crisis, and affect people's 401Ks and retirement savings.
Mostly, no, which is exactly why private credit has become so big in recent years: they are making the loans the banks can't or don't want to make, because the banks are subject to a bunch of additional regulations, which are designed to reduce the probability of banks going bust and having to be bailed out.
But it can be difficult to judge second order effects in finance. It's possible that a lot of private credit houses going bust would indirectly and perhaps unexpectedly hurt the broader economy. An obvious one being companies that are reliant on private credit going bust because their financing needs can no longer be met.
Also, with this administration in the US I wouldn't entirely rule out bailouts for some of the more politically connected private lenders.
Another obvious question to ask is who is providing the money that is being lent? Those are the people who now won't be paid back. The assumption is that these are people with predictable, long-term obligations who can lock up their cash for a long time: pensions, insurance companies, endowments, etc. Hopefully they are allocating a responsible amount of their portfolio to something as risky as private credit, but as the details are private, it can be really hard to know.
There has also been a big push over the past year to put private credit assets into retail 401k's (which, in theory, also should be okay with locking up funds for a long time, but in practice, maybe less so), most insidiously by having private credit assets held in target date funds (which are the default funds for many plans).
Many private credit funds also increase their leverage by borrowing from actual banks.
All of that should pose less systemic risk than if banks subject to bank runs were lending all of the money. But that has to be balanced by the fact that these are unregulated entities taking more risks than banks would. Long-term average default rates on high-yield bonds are around 4%, so 9.2% is high, but not in panic-inducing territory yet. Who knows what they will look like in the event of an actual recession.
Banks have lend to these institutions as they couldn't lend themselves. Might be systematic risk.
Lot of pension capital is tied to these vehicles. So they go under. Many people won't be getting their pensions in short or long term...
This is nowhere near as bad as the 2008 crisis, no. The banks don't really use the checking/savings account money for this. If you've invested in something that either invests in Private Credit or is reliant on Private Credit, then it'll suck for you personally.
...
One teeny tiny extremely important detail: Private Credit is bankrolling the AI industry's datacenter construction. If anything happens to significantly increase interest rates, several datacenter companies and Oracle go bankrupt. The other big tech firms have taken on lots of debt as well so expect spending cuts there too, even if they survive.
The systemic risk isn't in "bankers fucked it up again", it's in the AI bubble.
https://podcasts.apple.com/bz/podcast/the-real-eisman-playbo...
He's one of the "Big Short" guys but more importantly he has great guests on. Everyone is trying to teach & inform, not sell.
He's been calling this risk out for over a year, especially once the White House started trying to allow retirement accounts access to private credit. For a lot of people that was the big alert, even before Jamie Dimon said he saw "cockroaches".
Any figures or lenders he's focussed on?
The info on his podcasts isn't telling you who to short. It's more who has gone under & general knowledge.
"Private credit" is an idea that has been hot in finance for the last several years, originating from the great financial crisis (GFC). After the GFC, regulations made it very hard for banks to make business loans with any kind of risk anymore. So instead, new non-bank institutions stepped in to make loans to businesses. These "private credit" institutions raise money from investors, and lend it to businesses.
The investors are usually institutions who are OK with locking up their money long-term, like insurance companies and pension funds. This all seems a lot safer than having banks making loans: banks get their funding from depositors, who are allowed to withdraw their deposit any time they want. So a bank really needs to hold liquid assets so they are prepared for a run on the bank, and corporate borrowing is not very liquid. Insurance companies and pension funds have much more predictability as to when they actually will need their money back, so can safely put it in private credit with long horizons.
It's not quite so clean, though.
It's actually common for banks to lend money directly to private credit lenders, who then lend it out to companies. But when this happens, typically the bank is only lending a fraction of the total and arranges that they get paid back first, so it's significantly less risky than if they were loaning directly to the companies. Of course, the non-bank investors get higher returns on their riskier investment.
And the returns have been pretty good. Or were. With the banks suddenly retreating from this space, there was a lot of money to be made filling the gap, and so private credit got a reputation for paying back really good returns while being more predictable than the stock market.
But this meant it got hot. Really hot.
It got so hot that there were more people wanting to lend money than there were qualified borrowers. When that happens, naturally standards start to degrade.
And then interest rates went up, after having been near-zero for a very long time.
And now a lot of borrowers are struggling to pay back their loans on time. And the lenders need to pay back investors, so sometimes they are compromising by getting new investors to pay back the old ones, and stuff. It's getting precarious.
Meanwhile a lot of private credit institutions are hoping to start accepting retail investors. Not because retail investors have a lot of money and are gullible, no no no. 401(k) plans are by definition locked up for many years, so obviously should be perfect for making private credit investments! Also those 401(k)s today are all being dumped into index funds which have almost zero fees, whereas private credit funds have high fees. Wait, that's not the reason though!
But just as they are getting to the point of finding ways to accept retail investors, it's looking like the returns might not be so great anymore. Could be a crisis brewing. Even if the banks are pretty safe, it's not great if pensions and insurance companies lose a lot of money...
Important Facts:
1) The majority of private credit funds are classed as "permanent capital". When you put money into these vehicles, you give the Asset Manager discretion over when to give the money back. Redemptions are often gated at ~5% per quarter.
(So there cannot, by definition, be a run on the bank)
2) Credit is senior to equity, so if you expect mass defaults in private credit, it means the majority of private equity is effectively wiped out. Private equity has to be effectively a 0 before private credit takes any losses.
3) The average "recovery rate" for senior secured loans is 80%. Even if private equity gets wiped to 0, the loss that private credit incurs is cushioned significantly by the collateral backing the loan. These are not unsecured loans the borrower can just walk away from.
(The price of senior secured loans dropped by ~30% in 2008, as a worst case datapoint)
4) Default rates on many of the major private credit managers is ~<1% in recent years. There are other estimates stating higher default rates, but that often classifies PIK income as a default. A loan modified and extended with added PIK that ultimately gets repaid is not a "true" default.
5) Finally, it's true that NAVs are likely overstated, but generally it's by a modest amount. Every Asset Manager today could go out tomorrow, mark NAVs down by 20% and suddenly there is no crisis.
(The stocks of Asset Managers have already traded down such that this seems expected and priced in anyway)
Technically yes. But the overlap between private equity as it's commonly described and private credit is slim.
> average "recovery rate" for senior secured loans is 80%
Oooh, source? (I'm curious for when this was measured.)
> A loan modified and extended with added PIK that ultimately gets repaid is not a "true" default
True. It's a red flag, nonetheless.
> Every Asset Manager today could go out tomorrow, mark NAVs down by 20% and suddenly there is no crisis
Correct. The question is if 20% is enough, and if a 20% markdown creates a vicious cycle as funding for e.g. re- or follow-on financing dries up.
You seem knowledgable about this. I'm coming in as an equities man. Would you have some good sources you'd recommend that make the dovish cash for private credit today?
It depends when you measure, but you can Google around and find figures in the 60-80% range. 80% may have been a bit on the optimistic end of the range. But it's important to note that a "default" doesn't imply a 0.
Of course this will depend on the covenants, underwriting standards, type of collateral.
I would guess software equity collateral recovery rates are lower than hard assets like a building. (Which is why I personally don't like Software loans, nothing to do with AI)
> Correct. The question is if 20% is enough, and if a 20% markdown creates a vicious cycle as funding for e.g. re- or follow-on financing dries up.
I think it's almost certain that new fundraising for private credit will be materially hindered going forward. But this just limits the growth rate of these firms, does not introduce any "collapse" risk.
They may move from net inflows to net outflows and bleed AUM over a period of some years.
If NAVs were inflated previously, they may be forced to mark down the NAV to meet redemptions rather than using inflows to payoff older investors.
In the world of credit, 20% is an enormous haircut. Again, senior secured loans fell by around 30% peak to trough in 2008.
We have the public BDC market as a comparison point where the average price/book is around 0.80x. So the public market is willing to buy credit strategies at a 20% discount to stated NAV.
The real systemic risk here, if we were to reach for one, is really that these fears become self fulfilling.
If investors pull funds out of credit strategies en-masse, there is no first order systemic issue, but it means borrowers of many outstanding loans may not be able to secure refinancing as money is drying up.
This could lead to a self-fulfilling default cycle. But this would be a fear driven default cycle, there is no fundamental issue with cash flows of borrowers or otherwise (in aggregate, currently).
Finally, in regards to the asset managers themselves, many are quite diversified.
Yes, they have private credit funds, but many have real estate funds, buyout funds etc. OWL is one of the biggest managers of data center funds, for example (which they also got hammered for on AI bubble fears)
Given how depressed pricing is in public REITs, for example, I expect a lot of asset managers to pivot towards more real asset funds.
(a) have the holding take out the debt, exposing 100% of my stake
or,
(b) have the holding divest a piece of itself, giving me control of the existing and new entities, then have that piece take out the debt, exposing 0% of my stake?
I imagine any PE firm worth its salt would go with option (b).
Presumably regulators would sometimes try to block such deals, but I cannot imagine that happening during the current administration. (Do the regulators even still work for the US government? I thought they were mostly fired.)
Similarly, I can imagine the banks refusing to lend in scenario (b), but I cannot imagine bank leadership being allowed to make such a decision if the PE firm is politically connected to the current administration.
A smart lender will not issue loans without real collateral. If you create a subsidiary, that subsidiary has to have sufficient collateral and cashflow to secure a loan.
^ Encase the link also responds with this for you:
If your business is light on free cash flow (ie everyone in AI at the moment) buckle up as there are storm clouds ahead. If you’re running a business that relies on external cash (VCs, loans/bonds, etc) to keep things going things will get very ugly.
It’s not an either/or, it’s just a question of who was participating in the boom while preparing for storms ahead vs those all in on the boom.
What implodes in the period ahead are things that are massively over leveraged and can’t absorb a hit without doubling down again with more funding/loans and such. These are the folks and companies that get wiped out.
Just make sure you can unpark it, else you're SVB.
In actuality, the CPI is lower than inflation because technological advancement, automation, and economies of scale (due to globalization etc) are driving consumer prices low. In other words, if factories are still producing things like they were 20 years ago, the CPI would have been much higher, and that higher number is closer to what should have been the inflation number.
I.e. you started out with 2e-20 % of the total money, and after 5 years you now have 1e-20 % of the total money, then whatever happened to CPI, you've been diluted and you would probably have been better off investing in something else other than cash.
That makes sense in theory, but in reality what "total money supply" is is a complete can of worms and basically impossible to measure
This is an impossible counterfactual to test. In reality, tracking value across time requires adjusting for immeasurable preferences. This is why inflation is really only a useful measure for personal purposes across periods of years. It’s only macro economically interesting across a generation and close to meaningless longer than a human lifespan.
The thing is one really needs to understand what "real yields" mean when investing in bonds, i.e. it means your purchasing power with respect to cheap commodities tracked by the CPI is preserved, but it doesn't necessarily mean "value" (whatever that means in the abstract) is retained.
CPI isn't a measure of commodities. And "CPI" is a bit of shorthand, given there are pretty much as many measures of consumer and producer prices as there are economists.
> it doesn't necessarily mean "value" (whatever that means in the abstract) is retained
This is what any measure of inflation ultimately seeks to measure. Purchasing power is intrinsically tied to the basket of goods and services its measuring. That basket varies across people and time as preferences vary.
Banks bailed out the hedge funds in '98, then the taxpayer bailed out the banks in '08, then the government bailed out the taxpayer in '20... now monetary policy from the fed has to prevent the government from defaulting.
Honestly thrilled to hear it. The AI bubble needs to burst so we can find out what's actually useful, start requiring real business models again, and get rid of all the noise and waste.
Well, the good news is that's what good public policy is for, to blunt the impact of the damage with strong anti-trust enforcement and careful cash injections to weak-but-critical areas of the economy to help stabilize in rough times.
Now, hang on for just one moment while I crawl out from under this rock and take a look at who we have entrusted to set our public policy.
The game that all the AI companies are playing is to be the last dog standing at all costs, because that kind of dominance is a money printer.
It’s like hoping for the apocalypse thinking you’re of course the hardcore survivalist. When in reality you’ll get eaten first.
I'm sure someone somewhere could make a trade off of this article and this signal is definitely for them.
I have been actively trading in the market for a little over a year now, and while winning on a short position is probably the most satisfying trade for me, the overwhelming majority of those trades are losses and at this point I mostly treat them as hedges. I suspect that is true for most market participants as well.
- position has significant negative carry (what you're talking about there)
- stock/bond prices are nominal and the government constantly prints the denominator so prices tend to go up even if there's no actual growth
- for equities there is a genuine long term positive drift over time even if the denominator doesn't change
So yes, it's hard to make money going short and timing is everything
If you are the manager of a mutual fund you can take useful action on signals like this if you can figure out what they mean. Most people don't have enough money to be worth trying to take action.
Don't get me wrong, if you don't have a job things are bad. If you have a job but it isn't giving good raises, or it is a worse job than you are qualified for things are bad. However things are not hopeless for the majority of people even when things are really bad, and you can get through it.
This is, however, one of many indicators of an overall wobbling system. It would be a good time, not make the line go up, but to look for ways to stabilize the economy as a whole.
Which is unfortunately a hard question. One could theorize that we should do different things than the thing we've been doing for the past year or so, but of course there will be many who say that we just haven't done it hard enough yet.
Page 22 (French but it's just numbers, you can read it). <https://www.eib.org/files/publications/thematic/gems_default...>
And it is especially so when money given is not their own, but instead they get to take cut. Which these funds can do. They might even just take promises that you will pay in future and even allow adding the interest on top of loan amount. Numbers look good, bonuses look good.
Fundamentally this can only last so long and now is the time it starts to blow up.
Things will stay the way they are for as long as people want them to. The economy and money is fundamentally made up. It’s so funny when these types come out and start talking about made up fundamentals as if they are physics.
Veteran fund manager George Noble warns that a private credit crisis may be unfolding in real time
https://finance.yahoo.com/news/veteran-fund-manager-george-n...
We are definitely in the year 2000 in this cycle [0] and between now and somewhere in 2030, a crash is incoming.
Let's see how creative the banks will get to attempt to escape this conundrum. But until then...
Probably nothing.
[0] http://news.ycombinator.com/item?id=45960032
They don't need to get creative, they just need to buy congress or the administration. Same as they've done every time things get messy.
And you know what? It works every time.
The question is "How long can they keep extracting money before the economy implodes?"
The people producing macroeconomic indicators in the US were fired about 6 months ago for putting out an honest report. Since then there's been very little correlation between public sentiment on the economy and the official indicators.
So, we're definitely in some sort of overhang situation, where the economy is imploding, but the stock market goes up. I think that's unprecedented in the US. In developing countries, when this happens, it usually leads to things like hyperinflation.
So, I guess the real questions are: "How do you short the dollar?", and "How can you tell when the banks start doing it?" so you know when to jump off the merry-go-round.
2008 Financial Crisis was triggered by Oil prices. There were lots of problematic structural elements that were fine if nobody looked close. Oil was just the sideway hit on the building to knock it over.
Just takes a nudge to collapse. And here we go again.
Not by the subprime mortgages given to anyone with a pulse?
It was interconnected derivatives and structured products linked to banks that caused a liquidity crisis in the former to cause a crisis of confidence in the latter.
Meanwhile: "In the letter, Morgan Stanley said the fund wasn’t designed to offer full liquidity because of the nature of its investments, and that credit fundamentals across the underlying portfolio have been broadly stable. The bank's shares fell 2% in premarket trading Thursday" [1].
[1] https://www.wsj.com/livecoverage/stock-market-today-dow-sp-5...
Wait what? Your thesis is the GFC was caused by a liquidity crunch/bank run? Isn't that... not true?
Isn't the proximal to distal chain of events government encouraged subprime loans -> inaacurately valued MBS -> exponential, unregulated derivative instruments -> leveraged contagion. What does market confidence have to do with any of that?
It's absolutely proximally true and it's not just my thesis. From Wikipedia: "The first phase of the crisis was the subprime mortgage crisis, which began in early 2007, as mortgage-backed securities (MBS) tied to U.S. real estate, and a vast web of derivatives linked to those MBS, collapsed in value. A liquidity crisis spread to global institutions by mid-2007 and climaxed with the bankruptcy of Lehman Brothers in September 2008, which triggered a stock market crash and bank runs in several countries" [1].
> government encouraged subprime loans -> inaacurately valued MBS -> exponential, unregulated derivative instruments -> leveraged contagion
The subprime crisis shouldn't have been bigger than the S&L crisis [2]. What turned it into a financial crisis was the credit crunch that followed. That crunch was caused by folks running on banks that had sponsored these products.
On "inaccurately valued MBS," note that the paper marked AAA mostly paid out like a AAA security. It would be like if you were perfectly good for your word and I lent you money, but then I wanted to sell on that debt to a third party who didn't trust you at a 50% discount. What does "properly valued" mean in that context? It's ambiguous in a dangerous way. (In this analogy, you wind up paying back the debt at face value. But years later, albeit on schedule.)
[1] https://en.wikipedia.org/wiki/2008_financial_crisis
[2] https://en.wikipedia.org/wiki/Savings_and_loan_crisis
Oil was more of the outside force that put a shock to that weak system.
I don't remember oil getting expensive back then, but it's a long time ago.
But it was swept under the rug, it was hidden by market constantly going up.
Ponzi schemes can hide in a market going up, because nobody is trying to pull money back out.
Suddenly everyone wanting their money, and the shortfall suddenly become apparent.
Oil prices suddenly made everyone try to pull money out, and 'woops there is nothing here'.
Every industry’s leadership is full of trumps, many more palatable personally, many far better spoken, many even with better politics but none fundamentally are any actually better for society. They don’t understand their company, the products it makes, they have utterly no care for anything besides the quarterly stock price and their lack of care costs real people their jobs and ruins the products we use every day.
And, they are why every company is ripping the copper out of its own walls instead of actually building a business that will last.
Of course this is going to increase prices, but then they can blame China / Russia / Iran whoever is the scapegoat at that time.
“Pay” is doing a lot of work there. My house is half equity half debt. The debt gets to be paid off with inflated dollars. And I pay no capital gains on the appreciation. I can, however, tap it for liquidity if I need it.
Classically, yes, particularly when that wealth is closer to productive capital. In modern economies, the rich also hold a lot of debt, which lets them benefit from inflation.
Don't let anyone who bought into this way of life get away with robbing the rest of us.
And don't let anyone who brought children into this cruelty hear the end of it: what they did was evil.