Private credit: Start of a new financial meltdown?

A little-known corner of the investment world is sending worrisome signals to the broader market, said Shawn Tully in Fortune. Until recently, it was “a glorious time to make money” if you happened to have parked your cash with one of the institutional investors that operates a private credit fund. These funds provide loans to companies that are too high risk to be serviced by traditional banks, and they became one of Wall Street’s “hottest investment crazes” when interest rates were high. But private credit is an opaque market, with no organized exchange and little accessible information, which can make investors jittery when the winds shift. Many of the borrowers were software and technology companies that are now under threat from artificial intelligence, and some investors are now “demanding their money back.” Shares of Blue Owl Capital, the largest publicly traded private lending firm, have fallen 50% in the past year, and it has “restricted withdrawals” and “ended its quarterly liquidity payments.”

“Is this 2008 all over again?” asked Martin Baccardax in Barron’s. When the housing market began to sour, “banks didn’t know where all the mortgage-bond risks lay,” and some prevented investors from exiting funds tied to the housing market. “There are worrying similarities today” with Blue Owl and other private lending firms. “The truth is we simply don’t know” where “the true risks in private-credit portfolios lie,” and that’s troubling. Investors may feel some global financial crisis “déjà vu,” said Gillian Tett in the Financial Times. But some perspective is warranted. The private credit industry is about $2 trillion in size, “so fairly small for the system as a whole,” reducing the risk of contagion. The wider financial system is also “better prepared for shocks,” thanks to post-2008 regulation that ensures big banks can absorb some pretty hefty losses. Nonetheless, the private capital bubble is “deflating”—perhaps “with a long hiss, not a pop.”

“Bad loans and failures are an ordinary part of a capitalist system,” said Judge Glock in City Journal, but private lending fills “a vital economic need” and should not be to blame for any wider financial meltdown. Private credit “is almost entirely devoted to lending to working companies that need money to grow,” particularly in the tech world. Investors can take their money out of these funds at any time, but the withdrawals are capped at 5% per quarter. This infuriates investors, but it makes the funds less likely to “suffer devastating runs or get forced into asset fire sales.” They are also “far less leveraged” than traditional banks that hold much more debt on their balance sheets. There are reasons to be worried about the economy. But private credit isn’t one of them.

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