Is everything contained in the private credit market?
An affirmative ‘yes’ was the conclusion recently offered by Federal Reserve Chair Jerome Powell.
“We’re looking for connections to the banking system, and things that might, you know, result in contagion. We don’t see those right now. Interest rates are in a good place.”
Don’t mind the sudden appearance of restrictive redemption gates or the aggressive marking down of distressed collateral by the big banks behind closed doors. There’s supposedly nothing to see here.
Over the last decade, private credit was the ultimate speculative stretch for yield in a stubbornly low-yield world. It offered the seductive promise of higher reward, without the potential pain of higher risk. It became a fashionable place where wealthy investors could eke out a few additional percentage points of seemingly risk-free income and flatter their sophisticated egos in the process.
But now an eerie and familiar sense of impending déjà vu has settled over this shadow market. It’s a tragic movie we’ve already seen before. The one where localized and contained instability rapidly becomes systemic. Where financial contagion breaks out like a deadly virus through a crowded grade school classroom before anyone thinks to wash their hands.
The illusory liquidity promised by the private credit market’s biggest and most prestigious funds has effectively evaporated overnight. If you want your hard-earned money back today, it’s simply tough luck. Too bad. So sad. You absolutely can’t have it until some obscure, undetermined date in the distant future.
What’s going on in the private credit market? Why were the exits suddenly bolted shut?
Let’s explore…
Trapped Capital
Investors in Morgan Stanley’s North Haven BDC, for example, recently asked for 10.9 percent of their money back. The fund handed back less than half that amount, effectively trapping the rest. At Cliffwater, requests hit 14 percent, yet a cap was set at 7 percent.
Over at BlackRock, their $26 billion HPS fund hit its 5 percent redemption limit. Of course, 5 percent’s at least something. At Blue Owl, nothing gets through the gate. Quarterly redemptions from its OBDC II fund have been eliminated entirely.
Investors in Apollo’s private credit fund requested to redeem 11.2 percent of their outstanding shares. The firm gated requests at 5 percent, only paying out $730 million of the more than $1.5 billion requested.
Then there’s Blackstone, which is not to be confused with BlackRock. The world’s largest alternative asset manager had to inject $400 million of its own cash to stem a full-blown bank run. And this was with a 7 percent cap.
When the big lenders must reach into their own pockets to honor withdrawals, it’s not out of virtue or generosity. It’s because they’re concerned about what happens when investors simultaneously try to sell what they can.
The bull case for private credit was always built on the idea that these managers were better underwriters than the banks. They knew their borrowers. They had covenants.
Well, the 2025 data just provided some unexpected clarity. The default rate for U.S. private credit hit 9.2 percent last year. For context, the historical safe average is between 2 percent and 3.5 percent. We have officially exceeded the default levels of the 1998 LTCM crisis and the 2020 COVID shock.
Why is the private credit market running aground?
Offshore Shell Games
From what we gather it was inevitable. The structural integrity of these over-leveraged portfolios was built upon the shifting sands of cheap credit and floating-rate debt. Now the harsh reality of sustained relatively higher rates is finally tearing the foundation completely apart.
These higher rates, relative to where they were several years ago, have resulted in the interest expense for a mid-sized software company or a manufacturing plant to double. Add in the AI-driven disruption that is currently destroying SaaS valuations (a favorite sector for lenders like Blue Owl), and you have a recipe for a wipeout.
If you think you’re without risk because you aren’t a private credit market investor, think again. Do you have savings in a bank account? Is your retirement part of a pension fund? Do you pay insurance premiums?
According to Moody’s, as of last October, private credit loan exposure by U.S. banks was nearly $300 billion. These banks – perhaps, your bank – are exposed.
What’s more, many of these loans use payment-in-kind (PIK) structures. This allows companies to pay interest with more debt rather than cash. With the prospect of rates staying relatively high due to war-driven inflation, these debt piles are becoming unruly.
There’s also the prospect of outright fraud. Steve Eisman, the guy who famously made big bucks betting against collateralized debt obligations prior to the 2008 subprime mortgage crisis, recently raised concerns about the integrity of the private credit market. He believes a certain mischief has infected the life insurance industry, calling it “a slow brewing scandal which could be one day a great financial crisis.”
Eisman and forensic accountant Tom Gober have detailed some unsettling irregularities. From what they’ve uncovered, the big private credit management firms use captive insurance divisions to buy their own private credit while offloading billions in liabilities to offshore reinsurance subsidiaries that file no U.S. financial statements.
According to Gober, “insurers are offloading liabilities to shell subsidiaries in Bermuda, Barbados and the Cayman Islands, then underfunding them. In one case he reviewed, $7 billion in liabilities were backed by roughly $200 million in real assets. The rest was filled with contingent instruments he compared to a lottery ticket before the drawing.”
Do these types of financial shenanigans give you a warm fuzzy?
Who Do You Believe?
Where there’s smoke, there’s fire.
Naturally, Fed Chair Powell wants people to think the smoke is coming from a controlled burn of raked leaves; not a structure fire that could conflagrate the entire city. Thus, he says the Fed sees no connection between the private credit market redemption crisis and the banking system.
We’d take his statements with a grain of salt. If you recall, on March 28, 2007, then Fed Chair Ben Bernanke argued that subprime was a small, isolated corner of the market that didn’t touch the real banks, saying:
“The ongoing tightening of lending standards, although an appropriate market response, will reduce somewhat the effective demand for housing, and foreclosed properties will add to the inventories of unsold homes. At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”
At the time of Bernanke’s statement, the big banks were loaded to the gills with these toxic assets. It wasn’t contained at all.
Exactly one year later, Bear Stearns went belly up. Then, on September 15, 2008, after being in operation for 158 years, Lehman Brothers disappeared from the face of the earth.
“When I find a short seller, I want to tear his heart out and eat it before his eyes while he’s still alive.”
These were the futile threats made by Lehman Brothers CEO Dick “The Gorilla” Fuld just prior to his firms epic collapse.
Today, Powell, like Bernanke before him, is trying to obscure reality. And the reality is that JPMorgan is already marking down private-credit collateral and restricting lending to the very funds that need bank repurchase agreement lines to survive.
Who do you believe?
Powell says there’s no connection to the banking system. JPMorgan’s markdown book says otherwise.
[Editor’s note: Get a free copy of an important special report called, “Cash Machine – Why You Should Own this Mineral Royalty with a 12% Yield,” when you join the Economic Prism mailing list today. If you want a special trial deal to check out MN Gordon’s Wealth Prism Letter, you can grab that here.]
Sincerely,
MN Gordon
for Economic Prism
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