Cockroaches in Private Credit
By Bartlett Naylor
Energy markets roil because of Trump’s Iran war, crypto prices collapse, and private credit now raises systemic threat questions.
American finance should not be based on delusional wishful thinking, but the stunning rise in bank lending to private credit and private equity requires a leap without understanding the gap. That’s because, government oversees bank lending, but private equity and credit operate without transparency. Failures surprise.
Warning sounds abound.
• Giant Blue Owl Capital now tries to “convince investors that its $300 billion portfolio of investments and loans is actually worth what Blue Owl says,” noted the New York Times.
• Cliffwater, a major private credit firm, face heavy redemption requests. Giants Blackrock and Blackstone also report significant redemptions.
• Richard Bookstaber, a former hedge fund manager who foresaw the 2008 Wall Street crash, worries that private credit along with overinvestment in artificial intelligence and now the oil price squeeze from the Iran war may send the economy reeling again.
Average Americans may suffer from failures in the private markets. Pension funds sometimes invest in these products. The California Public Employees Retirement Fund maintains substantial exposure to this market. The Trump administration’s Department of Labor now proposes to allow 401(k) managers to slide into these troubled waters.
The greatest current exposure comes from banks, which are backed by taxpayer guarantees. According to the recent FDIC report on bank lending to the sector of lenders that aren’t regulated, known as non-bank financial institutions, rose more than 20 percent annually from 2010 through 2024. That’s three times the rate of the second fastest growth sector for bank lending, namely, multi-family housing.
Private credit, which totals some $1.8 trillion, leads the list of unregulated lenders receiving money from the mega-banks. For context, the total equity of the six mega-banks totals about $1.14 trillion. (That’s the gap between assets and liabilities.)
JP Morgan, a major lender to private credit, warns of problems. CEO Jamie Dimon acknowledged the sector as probably infested with “cockroaches.”
Before the rise of private credit and private equity, companies seeking capital applied to a bank. There, at least in theory, a set of regulated ledgers and public requirements provided a modicum of sobriety. But the modern appetite for higher returns during a period of historically low interest rates drove many investors into the arms of non-bank lenders willing to take greater risks. These are the private credit funds—behemoths that operate in a twilight zone, unanswerable to stress tests or regular examinations.
Banks may also loan to private credit firms instead of directly making a bank business loan to evade certain regulatory accounting restrictions, according to a survey by the Federal Reserve.
Whatever the reason, regulated bank lending into private credit and equity simply channels risk into the sector that the public may be asked to bail out lest massive failures send tremors through the real economy.
The danger is not merely the scale, now measured in the trillions. This skyscraper of debt rises from a foundation of “mark-to-model” valuations. This means these funds may grade their own homework. There isn’t a public market, such as for a common stock, that sets prices with every trade. Again, these funds are private. Even the investors in these funds don’t know the price. The system relies on delusional wishful thinking.
Apologists may assure that so-called sophisticated investors rule this market. But hubris often serves as a leading indicator of problems.
In addition to opacity, private credit and equity help dismantle thriving companies and undermine services. To generate those higher yields, this private credit and equity sector drives up prices, reduces staff and often destabilizes their portfolio companies. Gretchen Morgenson’s These Are the Plunderers explores the human cost.
Banks should not support private markets. They should make business loans directly, not escape prudential accounting standards. Their loans should help companies grow, not debase them.