Private Credit: The Next Risk in the Financial System

[00:01] problems building in the private credit markets. And this is just another warning sign of how weak our economic situation really is. I want to shed some light on the situation. Before we get into the details, I want to explain to

[00:14] you what private credit is. Traditionally, when companies needed to borrow money, they went to the banks, and banks would provide loans to businesses. But after the financial crisis in 2008,

[00:26] regulators placed stricter rules on the banks, and banks were required to hold more capital, and they became more cautious about lending. Consequently, instead of banks making the loans, investment funds started to

[00:38] do it. So, some examples are Blackstone, Apollo Global Management, Ares Management, Blue Owl Capital, KKR, BlackRock, etc. So, these funds raise money from investors, and then they lend that money

[00:53] directly to the companies. So, that's what's called private credit. And this market has grown incredibly fast, one of the fastest-growing parts of the financial system. It's now a $3 trillion market, which includes direct

[01:07] lending to companies, asset-backed lending, real estate credit, infrastructure debts, and distressed credit funds. Now, the reason why investors have been attracted to private credit is straightforward simple. It's

[01:21] because these loans typically offer higher yields than traditional bonds. So, investors might earn 8%, 10%, or sometimes even higher returns. And during the years when interest rates were extremely low, they looked very

[01:35] But the environment has changed dramatically. Interest rates are now years ago, and that's where some of the stress in the system is beginning to appear. And let me explain why. So, the first thing I want to point out is that

[01:50] most private credit loans are floating-rate loans. This means that the interest rate paid by the borrower is going to go up when the interest rate rises. So, during the years when the interest

[02:02] rates were near zero, this wasn't a big problem. But over the past few years, the Federal Reserve raised interest rates aggressively to fight inflation. And as a result, borrowing costs for many companies have surged.

[02:15] So, some companies that were paying maybe 4% or 5% interest on their debts are now paying 10% or even more. And that's a huge increase in their interest And for companies that already have a lot of debts, that I mean, as you can

[02:30] imagine, that can become a very serious problem. And several indicators suggest that financial stress among borrowers is increasing. So, here's something that I want to point out. Credit rating

[02:42] agencies have been reporting more downgrades than upgrades for companies that rely on private credits. In other words, more companies are being viewed as financially weaker. And we're also starting to see higher delinquency

[02:55] and default rates among borrowers. So, right now, estimates suggest that private credit default rates are around 5% to 6%, somewhat higher than historical averages.

[03:08] these levels are still well below what you would typically see during a major financial crisis. So, while defaults are rising, the situation is still considered manageable for the time being. Okay, another issue

[03:22] that's getting major attention right now is liquidity, and this one's very important. Historically, private credit funds raised money mostly from large institutional investors. We're talking

[03:34] about pension funds, insurance companies, etc. Now, these types of investors, they typically commit their money for long periods of time. So, fund managers in that type of situation where you're

[03:46] dealing with those types of clients, they didn't have to worry too much about money back. But in recent years, that's started to change. More private credit funds,

[03:58] they've been offering products aimed at wealthy individual investors. And these types of funds are sometimes called semi-liquid funds. And they allow investors to request withdrawals periodically.

[04:11] So, for example, investors might be allowed to redeem a small percentage of their investments every quarter. And that sounds reasonable. But the problem is that it can cause or create a mismatch.

[04:25] So, what I'm talking about is that the loans themselves may last for 5 to 7 years, you know, that'd be typical. But investors may want their money back much sooner. And recently, some private credit funds have started seeing higher

[04:37] redemption requests from investors. So, listen, I just want you to know that the situation was already shaky back in 2025, but it's been escalating ever since in 2026. Like the Blue Owl redemptions, like you might have heard

[04:51] of that, that caused a stir. And now you have others joining in, you know, from BlackRock, you know, Cliffwater is now in the headlines, and probably other names that you're familiar with, such as Morgan Stanley.

[05:04] And that's not all. These are just a few examples. But okay, listen. I'm sure that BlackRock and Blackstone, they're going to be fine because they are the behemoths in the industry, you know,

[05:16] institutions, they're probably going to be in serious trouble. Now, I want to be absolutely clear about this. Right now, these events are early stress signals. We are not in the middle of financial crisis. I mean,

[05:31] it's definitely not good, but we're not in panic mode yet. because these funds, they still have performing loans. The defaults are considered moderate, and redemption limits are built into the fund

[05:45] structure. So, it's not like the redemptions themselves are something alarming, but yeah, it's the quantity that is alarming. be saying like don't be concerned at all, and here's why.

[05:59] If you have one institution facing large withdrawal requests, then it's going to be an isolated incident. But when several major firms experience withdrawal pressure like this all at the same time, then yeah, that's going to be

[06:13] a red flag. But basically, these funds are not bankrupt. The issue is that investors want their money back faster than the loans are being repaid. So, that's the underlying problem. Now, I just want to

[06:25] step back and look at the bigger picture. Why does any of this matter for the broader economy? Okay, the reason is that private credit markets, like it's become such an important source of financing for

[06:38] businesses. And if lenders become more cautious or if defaults rise significantly, then it could reduce the availability of credit. And when credit becomes harder to obtain, businesses may cut back on their

[06:51] investments, their hiring, and expansion. So, that's one of the ways that financial stress can spill over into the Now, this doesn't necessarily mean that private credit will cause the next

[07:04] financial crisis, but it is an area of the financial system that regulators and investors have been watching more closely. Now, in some ways, private credit has become part of what economists sometimes call

[07:17] the shadow banking system. So, I'm sure you heard that before, but now you understand what it is. So, it performs the functions that banks used to perform, but it's outside the traditional banking sector now. Okay, so

[07:29] here's one issue that can become dangerous. Sometimes stress in credit markets develops slowly. But then, once the defaults begin rising, the situation can change very quickly.

[07:42] to monitor credit markets very closely, the health of the markets. Because credit conditions can sometimes provide early warning signals about the broader economy. So, for example, back in the financial

[07:55] crisis during 2008, stress first appeared in certain parts of the credit markets. It began with subprime mortgages. And over time, those problems spread through the financial system. And I want to be very clear about this, too.

[08:09] The private credit market today is not the same as a subprime mortgage market back in 2008. The structure of the loans is different, the investors are different. But the thing is that history shows that rapidly

[08:22] growing areas of finance sometimes face challenges when the economic conditions And that's exactly what we may be starting to see. The private credit industry grew very rapidly during a period of extremely low interest rates.

[08:37] But now the environment is very different. Borrowing costs are higher, economic growth is slowing in many areas, cautious. So, the key question going forward is

[08:50] this. Will the private credit market navigate this period smoothly, or will rising defaults create more significant problems? But right now, the evidence suggests that we're seeing early signs of stress, not a full-blown crisis.

[09:04] Of course, the big question is, is it going to spiral out of control or not? But I just want you to know that periods of rapid growth are often followed by periods of adjustments. And the private credit market may simply be entering

[09:18] that adjustment phase. But I just want you to know because this market has become so large, its health matters, not just for investors, but well. So, it's something that economists,

[09:30] regulators, and market participants are going to be paying close attention to. I educational. Please subscribe. Thank you for the support, and I wish you a very for the support, and I wish you a very nice day. Take care.