New York
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For months, investors and analysts have kept a close eye on the shadowy corner of finance known as private credit, where alarm bells have stoked fears of a repeat of the 2008 financial crisis.
Whether those alarms amount to a handful of isolated bad bets or a more menacing systemic weakness in the $1.8 trillion sector is far from clear. But if the latter is even a remote possibility, it’s worth understanding what the heck is going on.
Very simply, the term refers to investors lending money directly to private businesses, bypassing banks. The borrowers — mostly smaller companies that banks would consider too risky or complex for a traditional loan — pay a higher interest rate in exchange for quick access to capital and flexible financing terms.
Here’s how it usually works: Big asset managers (think Blackstone, better known for buying companies outright) pool funds from big investors like pensions or insurance companies looking for higher returns than they can find in, say, the bond market. Those private-credit funds lend money directly to businesses that may otherwise struggle to get loans.
It’s not a new practice, but it became a much bigger business after the 2008 financial crisis, when governments tightened lending restrictions on banks.
Trouble is, private credit problems can quickly become public problems.
“You’ve got an opaque set of loans, in many cases, backing an opaque set of companies,” Steve Sosnick, chief strategist at Interactive Brokers, told me. “You can come up with a scenario where it’s unpleasant but relatively benign, but you can also come up with a scenario wherein a lot of mistakes are being papered over.”
And while recent turmoil in private credit appears isolated, he said, the interconnected nature of financial markets would make a major blow-up everyone’s problem if credit markets seize up and banks are forced to write down losses.
“That doesn’t mean we’re set up for a private credit disaster that will unfold the same way the subprime mortgage disaster unfolded,” he said. At the same time, “there are echoes” of that earlier reckoning.
Blue Owl, Blackstone and Beyond
In recent weeks, investors in private credit have been demanding their money back amid concerns that lenders overvalued loans tied to risky companies — many of which are software firms whose businesses may be disrupted by artificial intelligence. Some analysts expect AI to spark a wave of defaults among middle-market software and business service companies that became especially attractive to private lenders during the pandemic.
Much of the anxiety on Wall Street has focused on asset manager Blue Owl, which last month was hit with a surge of withdrawal requests, forcing it to halt redemptions and liquidate assets to repay its backers.
Although Blue Owl tried to reassure Wall Street that the decision was not a sign of weakness, the company’s stock has taken a beating, falling 15% in the past two weeks. Bets that Blue Owl’s stock will drop even more have also surged, with so-called short positions against the firm hitting an all-time high this week, according to data from analytics company S3 Partners.
Anxiety spiked again this week after Blackstone, the private equity giant, scrambled to meet $3.8 billion in redemption requests from its flagship private credit fund. According to Bloomberg, at least 25 senior leaders from across the firm pitched in some $150 million from their own wallets to cover the outlay.
Shares of other alternative asset managers, including KKR, Ares Management and Carlyle, have also taken a hit.
“This is the first real test of the market,” said John Bringardner, executive editor of Debtwire. “People were lending a bit too freely in that aftermath of Covid, when the markets were flush… What you’re seeing is some of that shake out.”
For some prominent investors, the parallels to the subprime mortgage crisis seem obvious. Jamie Dimon, the head of JPMorgan Chase, said some firms are “doing dumb things” and raised concerns about “cockroaches” in private credit. Mohamed El-Erian wondered on X last month whether trouble at Blue Owl was a “canary in the coal mine” moment reminiscent of 2007.
But there isn’t a clear consensus on Wall Street, and some fund managers and bank analysts have dismissed the concerns as overblown.
“We just need to step back and put it in perspective, this is not that big of a deal,” Brookfield Corp. CEO Bruce Flatt told Bloomberg TV this week. “It is definitely not an ’08, it has got nothing to do with ‘08.”
Still, the privacy inherent in private credit often leaves an information vacuum that observers fill with worst-case scenarios. Private credit isn’t nearly as large as the pre-2008 housing market, but Bringardner also noted there are “echoes” of that period in the “irrational exuberance” around lending over the past five years, as well as the complexity of the financial structures that have been built around the sector.
“I’m not yet seeing some fundamental thing that’s going to bring down the entire economy in the way that we saw in ’08 … But there are a lot of things going on,” he added, noting the new war in the Middle East that’s threatening to choke off oil supplies around the globe. “There are just too many things going on right now to make anyone confident in this economy for the foreseeable future.”
At this moment, Sosnick says, the smart investors will have their heads on a swivel, keeping an eye on private credit without panicking.
There’s an adage based on an Ernest Hemingway line that comes into play, he added: “How did you go broke? ‘Slowly at first, then all at once.’ And that’s how these crises unravel.”