Why Everyone Is Freaking Out About Private Credit

My name is Tracy Alloway, I am the co-host of Bloomberg's All Thoughts podcast.

Tracy's been covering financial markets for a long time.

I always learned something from listening to her.

Do you remember what you were doing in the late summer, early fall of 2008?

Of 2008?

Oh my gosh.

And I had just switched jobs.

I'd actually left Bloomberg at that time, where I was covering airlines of all things in

London, and I had joined the financial times.

Just joined their finance and markets blog, which was called FT Alphaville, turned out

to be a phenomenal time to start covering finance and markets in sort of September 2008,

because not a single person at that time really seemed to understand what was going on.

So even though my background was actually in airlines and transportation and logistics,

I was able to be on an even playing field with people who had been covering banking and

finance for decades.

At the time, I worked for Bloomberg News covering economic policy in Washington, and I remember

the whispers that something was starting to go wrong in the mortgage market.

We all know what happened next, the financial crisis.

Now, some 18 years later, I'm hearing little conversations and worries about something

called the private credit market, a kind of financing that is very big in tech.

I think the vibes are actually very similar.

And in fact, if we just look at this on a sort of behavioral wall street basis, like let's

pretend to be anthropologists of the financial industry at the moment, some of the behaviors

you're seeing right now look very similar to what we saw in sort of 2007, 2008.

So you have some pretty big funds who are saying we're not going to let investors pull

out their money.

They're allowed to do that.

But the headlines are very similar to what we saw in 2007, 2008 with a few subprime

funds back then.

We're starting to see reports of private credit lenders having these sort of all hands on

deck phone calls where they're trying to reassure their employees.

We're starting to see major banks publish their exposure to private credit, which again,

if you were called early 2008, you had a lot of big banks publishing their own exposure

to subprime.

So, you know, history doesn't necessarily repeat, but it definitely rhymes and it's rhyming

right now.

Is the time to freak out?

Okay.

So everyone is asking that question.

I get frustrated when people talk about private credit and it's like, either it's a 2008

style financial crisis or it's not worth talking about at all.

That's the wrong way to think about it, in my opinion, like even if you're not going

to get a 2008 redux exactly, and again, remember 2008 was, you know, the worst financial

crisis that we've ever had, basically, certainly in modern times.

Even if you don't get that, it is definitely worth talking about private credit because

it's this huge, fast-growing industry.

It's become more and more important to both banks and insurers.

And I would argue everyone should care about what's going on with banks and insurers.

And it's also become this really important engine of financing and credit to the wider

economy.

So if you think about the past few years, we had pretty high interest rates, like higher

benchmark interest rates than we've had in a very long time.

We didn't really see a wave of bankruptcies from those additional financing costs.

The US economy kept growing.

A lot of people would argue that's because you had this additional outlet from private

credit, which was extending financing to corporate America.

So there are reasons to care about this, even if we're not talking about a 2008 repeat.

Today on the show, a big financial engine of the tech industry is looking more and more

uncertain.

It's time to pay attention.

I'm Lizzie O'Leary, and you're listening to WhatNextTBD, a show about technology, power,

and how the future will be determined.

Stick around.

So the words private credit, like, that makes sense, but I think a lot of people have no

idea what the private credit market is.

Let's do some private credit.

What a one.

What is it?

How does it work?

Yeah.

So it is totally fair to not totally understand what private credit actually is.

So definitions are going to vary.

Definitions of the size of the market certainly vary quite a lot.

I've seen estimates like 1.3 trillion in size all the way up to more than three trillion,

again, just depending on how you account for it.

But I think the other reason people are confused is because private credit kind of underwent

a rebranding exercise very quietly, and I only just realized this myself like last year.

But in the aftermath of the 2008 financial crisis, we used to call private credit shadow

banking.

And I was a US financial correspondent for the financial times at that time.

And I remember writing all these headlines about, you know, shadow banking sector growing

thanks to post 2008 banking regulation.

That's what we called it.

And the basic idea was that in the aftermath of 2008, policymakers did not want to see,

you know, a repeat of that particular financial crisis.

They did not want to be on the hook for bailing out banks yet again.

It was very politically unpopular, as you know.

And so they designed these post crisis rules that basically made it more difficult for

banks to engage in certain activities, including riskier lending.

And so what happened, you know, 2009 onwards, as you had the slow migration of riskier lending

outside of the banking system into other types of credit entities, and the one that springs

to mind right now is something called the business development company, a BDC.

What is that?

So it's basically an alternative lender.

It's, you know, a fund or a company that makes other loans.

And the big important thing to realize about BDCs is they're not regulated banks.

They are not deposit taking institutions.

So if a BDC gets in trouble because it makes a bunch of bad loans, theoretically, that's

not going to reverberate around the financial system in the same way that we saw in 2008

when banks made a bunch of bad mortgages and then, you know, built additional leverage

on top of that.

And that was the thinking.

The thinking was, well, we can't eliminate credit risk entirely from the financial system.

But what we can do is hive it off to these non-bank lenders, these shadow banks now called

private credit.

And that would help insulate us from any, you know, risk that might come about in future

years.

And so here we are in 2026 and shadow banking slash private credit has grown enormously

fast.

So again, we're talking like 1.8 to maybe $3 trillion worth of credit.

And that's something to emphasize here.

This is an incredibly fast growing industry.

It's actually, again, depending on the size of the market, bigger than the junk-rated

U.S. bond market now and the junk-rated U.S. bond market has been around since the 1970s.

So here is something that has gotten bigger than another market that's been here for decades

in just a few years.

I think that context is really helpful because you can say, oh my gosh, one trillion, three

trillion, that's a lot of money.

But also like, if you look at U.S. equity markets, we're talking 60 plus trillion.

This is big, but not enormous.

Yeah, it's a drop in the bucket of like U.S. financial assets overall.

But again, I think the speed and the rate of growth is really worth highlighting here.

It's been a phenomenally profitable business for a lot of the entities who have been engaging

in this activity.

And it's getting bigger, right?

So one thing worth mentioning here, again, going back to why we should actually care about

what private credit is doing, even if it's not necessarily going to lead to another 2008

style crisis, is we've just seen some of the rules around what can go into people's 401Ks

loosened up to include alternative assets, which would be private credit.

So what is private credit useful for?

Who wants this kind of different loan that's not a traditional bank loan that maybe, you

know, you're talking higher interest rates, but complicated terms, different terms, and

you or I would take for a very standard investment.

So you have it exactly right here.

There are reasons that people would actually want to engage in a private credit deal on

the part of investors.

If you invest in private credit, you're generally looking at juicier yields returns than you

would necessarily see from the public market.

If you're a company looking to borrow, you might want a deal of financing arrangement that's

more customizable, more suited to your particular business needs.

And it's probably helpful here if I just talk a little bit about the difference between

public and private credit markets.

So in public markets, you have loans and bonds.

And we generally say they're syndicated out to the market.

So there's a loan and you can sell it on to investors.

The loan or the bond is usually rated by one of the big credit rating agencies.

People are familiar with it's a triple A, whatever exactly like Moody's S&P, all those

familiar names.

And then that bond or loan gets traded in the open market.

Now it doesn't get traded as much as an equity, a stock, but it gets traded.

So there's some price discovery there.

You generally have a decent idea of how much that bond or loan is worth.

In the private credit market, you know, the clue is in the name, it's a private transaction

between investors, you know, maybe a club of investors and a company.

So it doesn't trade as much.

You don't have as much transparency on the price.

And often the deals are unrated.

So you're not getting as much information from a sort of third party service about how

the company is performing, what the balance sheet looks like.

You have to do your own due diligence.

And again, that's where you start to see some of the mistrust of the sector come in.

A lot of people will have opinions on what the opinion of the credit rating agencies

are worth anyway.

But like in a lot of the private credit deals, you don't have any ratings at all.

Our show focuses on sort of tech and power and how these things come together.

And private credit has been a pretty big deal in the tech industry.

And I wonder what if you could explain why this kind of financing is so appealing in

technology?

Yeah, it's a really good question.

So I would argue that tech is very attractive for investors in general.

It's generally believed to be a growth area.

And so a lot of investors naturally sort of migrate to that tech exposure.

And one thing that is true is once you start diving deeper into private credit overall

and looking at what types of industries have actually seen the most private credit activity

or private credit lending, there's a lot of software, a lot of software.

And this raises some interesting questions because now we are in the age of AI.

We are in the age of cloud code.

Cloud code.

There are a lot of people out there right now who think that that poses an existential

threat to a lot of SaaS businesses, software as a service.

Exactly.

This idea that, you know, I might have a piece of software that I have dedicated customers

to, but someone out there can use cloud code to basically replicate that entire service

and absolutely demolish my business model in the space of weeks potentially.

So that's where a lot of the concern around private credit has come from.

This idea that, well, a big chunk of it is actually two software companies because they

were a big part of the U.S. economy.

They still are a big part of the U.S. economy.

But now they're a big part of the U.S. economy with a large question mark over their future.

And so that's where we started to see some of the anxieties over private credit actually

erupt.

One of the worries right now with private credit and software is that we're talking about

software companies with a lot of intangible assets.

It's basically just, you know, I guess some computers, some engineers, server or space

and a brand.

And so if those really start to fail, private credit investors won't necessarily have a lot

of hard assets that they can tap to try to make up their losses.

So there's some nuance here.

One of the kind of dorky things that I wanted to ask you about is how to value these things

and how their valuation gets looked at on, you know, a balance sheet or someone's portfolio

because it's different than a lot of other assets.

And that has added to some of this worry.

Could you explain that part of it?

Yeah.

So this goes back to the difference between public versus private loans and bonds.

And if you think, I'm going to go one step higher and talk about the stock market right

now.

But, you know, if you want to know the value of a Tesla share, you can look it up pretty

easily.

It's trading, you know, hundreds, thousands, possibly millions of times per day and there's

a live price quote that tells you exactly how much that thing would sell for if you were

to go into the market right now and actually try to unload some of your exposure.

But private credit, that's not really the case.

Okay.

Again, these things do not trade on a regular basis, if at all.

And so what tends to happen when it comes to valuations is if you are a private credit

fund, you have all of these private assets on your book, you hire a third party pricing

service provider experts in pricing and they're going to look at that particular private

loan or private bond on a probably quarterly basis.

And they're going to try to triangulate from other, you know, figures, other external

signs.

How much they think that bond or loan is actually worth at that particular moment in time.

Obviously, people tend to get a little bit nervous about that.

The idea being, well, you know, the market probably moves faster than on a quarterly basis.

And so if you're doing this on a quarterly lag, it might mean that the marks are

falling behind reality.

What it also means is that if everyone were to try to sell their private credit at once

and basically head for the exits at once, it is very unlikely that they're actually

going to be able to crystallize the marks that are currently on their books.

After the break, the AI industry has been doing some funky financing too.

Could we be headed for a combination private credit, AI debt, doomsday scenario?

So what we have seen recently is that some people want to take their money out.

What has that done?

So we've had a bunch of headlines about private credit funds basically saying that they're

limiting the amount of money that investors in their fund can take out.

And the reaction that you tend to get when you see those headlines, there are a lot of

private credit bros out there who will say, well, obviously, this is the way the funds

are supposed to work.

If you read the prospectus for the fund, if you read the documentation, it says right

there that the manager is allowed to limit redemptions as they see fit.

And again, there's some reasonable intent behind doing this.

And the intent is basically trying to stop the scenario that I just described to you,

which is everyone heading for the exits all at once.

And the fund having to liquidate at basically fire sale emergency prices.

So the idea is, well, if you can kind of create an orderly exit from the fund, if you

can manage the outflows, then the fund doesn't have to sell as much at depressed prices

when everyone's panicking.

And it can kind of manage its way through a down cycle in the credit market.

That all seems very reasonable.

But it doesn't really stop the fundamental thing that is happening here, which is you have

a lot of investors who are worried about getting out at the moment and maybe private credit

funds will be able to manage their way through the cycle.

But also, it's a very different environment to how those funds have been operating for

the past four or five years.

You know, you think, again, private credit was a huge success story on Wall Street.

It was all inflows.

It was all investors looking for additional yield.

Now the tide is turning.

And so people, again, are getting pretty nervous because this is something that private

credit hasn't really had to deal with before.

There's this other aspect of this that I wanted to ask you about, which is slightly different.

Many of the companies that are big in the AI boom are also selling their debt largely so

that they can get more money without having to dilute their stock by selling it.

How much is that tied to the overall credit worry?

It just feels like there's a lot of debt going around.

Yeah, so this is where I start to get a little bit concerned is the sort of interconnectedness

of all of this happening at the same time.

And Richard Bookstaber actually wrote a great piece in, I think it was The New York Times

recently, talking about this idea that, well, you know, AI is basically driving the US

economy at the moment or has been for the past year or so.

For a while.

Yeah, if you start to break down some of what we've seen in US GDP, a lot of that is just

going into building the infrastructure data centers needed for AI.

And a lot of that financing is coming from various parts of the credit market.

Now, it might be a bank loan, but it might also be a private financing deal.

It might be a securitization of data center cash flows.

And so the worry to me is if you start to see some doubts about the hyperscaler build,

I guess, at the same time that you're seeing doubts about the credit market.

And this is kind of setting aside everything that's happening with the Iran situation and

the overall stock market.

But you have a chance here for a lot to unravel all at once.

And that, like, that to me is kind of concerning.

I mean, we just saw one of OpenAI's data centers canceled because it couldn't reach terms

with Oracle.

Like, there is no business in that kind of funding or a boros.

I never pronounce that word correctly or a boros.

Yeah, it's a good word.

It's a good word to describe it.

Yeah.

If you add to that, the other things that you just mentioned, gas prices are rising.

The stock market is bouncing around every other day based on what the president says.

And we don't know what's going to happen in Iran.

How does the Trump administration look at the private credit market?

Does it say this is not our problem Wall Street's got this or E, this might be something

that bleeds over into the rest of the economy?

Yeah.

So I think there's a world where the Trump administration can kind of wash its hands

of private credit and say, you know what, this is not a systemic issue.

This is something that lies outside the banking system.

But again, I would argue that there are two things to worry about in that context.

So number one is something I talked about earlier, which is this idea that private credit

because it's grown so fast, especially in recent years, has basically been this additional

spigot for the U.S. economy.

You know, if you're maybe a smaller, medium-sized business looking for financing in an era of

higher rates, private credit could be your go-to in some situations.

So if the private credit spigot gets shut off, suddenly you have a bunch of companies that

might find it more difficult to get loans.

The other potential concern, and this is where we start to see shades of 2008, is it is

not entirely clear how much exposure some of the banks actually have to the private credit

system.

And the reason I say that is because even though we talked earlier about banks not wanting

or not being able to extend as much risky credit in the aftermath of 2008 because of all

those new rules, they have still managed to find a way to have a piece of the private credit

pie.

I thought they weren't supposed to do that because of Dodd-Frank.

Yeah, so it's kind of weird, and I've been describing the relationship between banks

and private credit as frenemies because they're basically competing for the same business,

but they're also partnering up in order to do it.

So actually Moody's report hit my inbox saying that bank exposure to non-depository financial

institutions, so private credit, shadow banks, non-banks is now 1.4 trillion, which is

up from basically nothing, so that would be about 10% of total loan exposure in the deposit

taking banking system versus maybe 1% or 2% 10 years ago.

So there is exposure there, and the concern is that if you have a bunch of banks who

are basically lending to non-banks who are lending to riskier credits, that that's going

to come back into the deposit taking realm, which is exactly what post-financial crisis

rules were meant to eliminate.

The other vector where this could become kind of systemic is one of the big buyers of private

credit has been insurance companies, and insurers and banks are where if you're a regulator

or a policy maker in the Trump administration, you probably should start getting a little

bit nervous.

Are they doing that at all?

After all, they've had an extremely deregulatory push in this administration.

Yeah, it's hard for me to judge, right?

Like this is not necessarily the most transparent administration of all time.

The headlines I've seen so far, we have had one of the insurance regulators say that they

are going to take a harder look at some of the unrated private credit sitting on insurer

balance sheets, and they could potentially require insurers to hold more capital against

that private credit.

Again, that was a change that was announced fairly recently, so we haven't actually seen

much action on that front.

The action that we have seen is in the deregulatory bent as you describe it, which is, well,

let's allow retail investors, mom and pop, to have access to private credit and alternative

assets in their 401Ks if they want to.

Okay, so this is where I was going with this, because I think if you are not someone

who follows the markets or who is particularly interested in this, this might sound confusing.

But as you have mentioned, the Department of Labor recently released this proposed

rule that would allow alternative assets like private credit to be in Americans retirement

accounts.

And that, to me, is like, hey, even if all of this stuff makes your head spin, you maybe

should pay attention to this because suddenly, if it's in your retirement account and we

have a big problem, that's an everybody problem.

Absolutely.

And a lot of people are going to see that headline about the proposed change and think that,

well, this sounds like retail as exit liquidity, right?

This sounds like a bunch of professional investors in private credit are now looking for someone

to shift the stuff onto.

And one of the things that you will hear from private credit experts all the time is,

oh, it's not that the asset class is inherently risky.

It's that you have to do your due diligence.

You're talking about these customized deals between a single or a club of lenders and a

particular company.

They're not being rated.

They're not being put out into the overall market for other investors to judge.

And so it's really up to the lender to figure out if they're doing a smart deal.

It is very hard as a sort of ordinary investor, mom and pop is the classic example, to figure

out whether or not, you know, something that is as opaque as private credit is actually

being, you know, well managed and with deal terms that are favorable to the lender.

Like the idea that someone with a 401k is going to be able to have very good insight into

whatever private credit is getting stuffed into their retirement portfolio, I think is

very difficult to argue.

I have this really strong memory from 2008 that like I think about all the time.

It was when Congress passed the initial tarp proposal.

I don't really think they've got to pass it when they came out with the proposal.

And I was sitting on the floor holding my little microphone right next to Ben Bernanke.

And I could see that his hands were shaking.

And I didn't really know that much about this at the time because I had just started

but I had this moment of realizing, oh my God, the Fed chairman's hands are shaking.

This seems bad, but what made it bad was that it was so systemic, that it was so interconnected.

And I guess my biggest question for you is how interconnected is the private credit market?

Is it Ben Bernanke's handshake or is it some company's fail and it sucks for them,

but we're okay.

So I think this is exactly the question to be asking right now.

And I'm going to tell you right away, I do not have the exact answer.

I'm not sure anyone does at the moment, but again, like that is why the regulators should

be looking into this and why even if their hands aren't necessarily shaking just yet,

their hands should be very busy, you know, typing and looking up interconnections and exposure

and leverage built upon leverage within the financial system.

There are some like little hints of areas that I would be worried about.

So I mentioned that the banks have been lending to private credit entities in the sort of roundabout way

and that there is exposure there in a way that we didn't have before.

One of the ways the banks have managed that exposure is they've been striking something

called a synthetic risk transfer where they basically ensure some of their credit exposure

in the market by striking a deal with other investors.

And again, like you covered the financial crisis.

If you hear the word synthetic risk transfer, yes, yes, I start thinking synthetic CDO

and I'm like, that's no, that was bad. It was really bad.

Exactly. And there are some estimates floating around for like how big those deals actually are

in the market. And again, they're not like they're not numbers that would immediately set alarm bells

ringing. But again, in 2007, 2008, a lot of these interconnections weren't clear

at that time either, right? Like we had to kind of figure out that there were subprime

mortgages and people had built derivatives on top of subprime mortgages.

And then people had used subprime mortgages as collateral in the interbank lending system,

the repo market. And it's hard to figure those things out.

Like all of those markets tend to be very, very opaque.

And once you add private credit in the mix and then try to figure out what's going on with

private credit being used as collateral in the repo market, it just becomes very, very difficult

to untangle. So I would be surprised, maybe this is me projecting some hopefulness on the situation,

but regulators should be looking at this right now. They should be trying to figure out what

those exposure figures and those interconnections actually look like. We're probably not at these

sort of foothills of a 2008 style financial crisis. But again, that doesn't mean that you

shouldn't think about it. It doesn't mean that you shouldn't worry about it. This is an important

part of the financial system. It's a fast growing part of Wall Street and it's an important source of

financing for corporate America. And we should really be trying to understand how it all works.

And I would imagine if you are running an AI company right now, you should be thinking

pretty hard about this stuff. Absolutely.

Tracy Alloy, thank you so much for coming on.

Thank you so much for having me. It was fun to reminisce about the 2008 financial crisis.

Tracy Alloy is a co-host of the Odd Lots podcast. All right, that is it for our show today.

What Next TBD is produced by Patrick Fort and edited by Evan Campbell.

Paige Osburn is the senior supervising producer for What Next and What Next TBD.

Mia Lobelle is the executive producer here at Slate. TBD is part of the larger What Next Family

and we'll be back on Sunday with an experiment in vibe coding. I'm Lizzie O'Leary. Thanks so much for listening.