Is Private Credit About To Crash The Global Economy?

0:00 Amidst all of the chaos last week, the world's largest asset manager, BlackRock,

0:04 quietly announced something that should be

0:05 making a lot of people extremely worried.

0:07 They would be limiting withdrawals on one of their flagship credit funds

0:11 that currently has or at least had $26 billion worth of assets under management.

0:15 Now, I know that there is a lot going on in the world right now,

0:18 and compared to some of the headlines we have seen in the past week,

0:22 this might sound pretty minor,

0:23 but a hiccup like this in these markets could genuinely be the sign,

0:26 symptom, and cause of something much scarier.

0:28 On one hand, people pulling money out of these kinds of funds is

0:32 a sign that things are not going well amongst even the most high-end investors.

0:36 On the other hand, the fact that they can't get their money out

0:39 is a symptom of people predicting things are about to get much worse.

0:42 And on the third hand,

0:43 a shocking amount of everyday businesses have been propped

0:46 up by the easy lending done by these firms.

0:48 If their money stops flowing, it could easily cause much larger knock-on effects

0:52 throughout the real economy in extremely direct ways.

0:54 But before we get too hyperbolic,

0:56 it's important to understand exactly what these funds

0:58 were supposed to do and more importantly, what they have actually been doing.

1:03 Because depending on your interpretation of this business model,

1:05 this headline is either little more than dumb investors not understanding what

1:09 they invested in, or it's the modern equivalent of a bank run.

1:13 The total debt outstanding in this highly risky

1:15 class of finance is now over $2 trillion, almost twice as much as the $1.3

1:19 trillion in subprime mortgage lending done in 2008.

1:22 And with an alarming number of parallels,

1:24 it's clear to see why some people are getting nervous.

1:28 Now, that alone is not great.

1:30 But it gets worse.

1:31 If one Black Rockck fund really was the only fund having problems,

1:35 it could probably just be written off

1:37 as a concerning but ultimately isolated incident.

1:40 Unfortunately though, this week's announcement was just the latest and so far

1:44 largest example of major issues in these multi-trillion dollar private markets.

1:48 I I I want to start with Black Rockck.

1:51 Black Rockck Black Rockck said that about

1:53 54% of investors redemption requests were granted.

1:55 That means for a loan to go from 100 to zero,

1:59 something really dramatic has had to happen to the company.

2:02 Walgreens is laying off workers.

2:04 About 500 locations will close before the end of the current fiscal year.

2:08 Blue Owl Capital closed almost 8% lower.

2:10 Blue AL has become kind of the whipping boy for private credit.

2:13 Private equity, private credit is a mess.

2:15 Firms are saying this will be the year.

2:17 We'll see if that's the case.

2:19 Okay, so just like private equity,

2:21 the definition of private credit is actually pretty broad.

2:25 Private credit is just any lending done by non-bank institutions

2:28 in privately negotiated terms rather than

2:30 being done through corporate bond sales.

2:32 If you were to loan money to a friend so that they can start their business,

2:36 that is technically private credit.

2:37 But today, the scope and scale of these private deals

2:40 for huge amounts of debt has grown for three distinct reasons.

2:43 In the bad days, if a business needed to raise cash,

2:45 but it didn't want to sell shares,

2:47 it would either go to its bank to take out a loan from them,

2:51 or if the company was really large, it could issue bonds with set terms,

2:54 just like the federal government does for its debt.

2:56 The system worked well enough for a while,

2:59 but then several things changed that allowed

3:01 private credit to slip in between the cracks

3:04 and eventually become one of the most

3:06 important lending facilities in the global economy.

3:07 The first was that starting in 1982, like most good things,

3:11 the number of individual banks in America peaked

3:13 and it has been consistently downhill since then.

3:16 Today, there are less than a third as many

3:18 commercial banks as there were 40 years ago.

3:20 And that happened at the same time the overall financial industry got much,

3:24 much larger in both absolute terms and as a share of the overall economy.

3:29 All of this to say what you probably already knew.

3:32 banks responded to the lack of anti-competitive enforcement and too

3:35 big to fail bailouts by getting too big to fail.

3:38 Today, the average bank is not really interested

3:40 in providing loans to individual companies outside of very

3:43 rigid conditions because their skill means that they

3:46 can make more money with broad market products.

3:47 An easy way to think of this is that a local burger shop might make

3:51 a special order burger just for you

3:52 and your friends if you patronize them enough.

3:54 But no matter how many times you do go to McDonald's,

3:57 they aren't going to alter their menu for you.

3:59 Extremely large banks just make more money by offering

4:02 standardized products that they can scale endlessly like mortgages,

4:05 credit cards, and non-bespoke lending.

4:07 Additionally, to play devil's advocate a bit,

4:09 heightened regulation in the wake of the GFC

4:11 has also made it much harder for traditional banks

4:13 to give out loans to companies unless they already

4:15 had a lot of assets in place of security.

4:18 In almost every economics textbook ever,

4:19 we are normally told that the role of banks is

4:22 to secure depositors money and use some of that liquidity

4:24 to lend to new businesses so that they have

4:26 the opportunity to go on and produce more value.

4:29 The reality is that this barely happens at all anymore.

4:31 And most bank lending has been directed towards mortgages, personal loans,

4:34 student loans, car loans, and lending to very large established companies.

4:38 So, this opened a hole in the market that was exploited by far

4:41 more flexible private lenders who could make a loan for pretty much anything.

4:45 The second major factor driving the unprecedented growth of the private credit

4:48 market has been the equally unprecedented growth of the private equity market.

4:51 Now, we have spoken a lot about the extremely complicated

4:54 debt structuring done by private equity firms on this channel before,

4:57 and I respect your time, so I will keep this brief.

5:00 And if you do want a refresher,

5:02 I'll leave a link to our old how private equity works video in the description.

5:05 But the basic rundown is that a fund will

5:07 raise money from investors and use that as effectively

5:09 a down payment to borrow more money to buy

5:12 a portfolio of private companies which will each get

5:14 to take out their own loans to pay

5:16 back the original fund which will use that money

5:18 as a further down payment for more debt to go

5:21 and buy more companies that will take on more debt.

5:23 This isn't even mentioning the secondary funds

5:26 or the managers of limited investors who

5:28 themselves often use their stake in a fund

5:30 as security for further personal lending.

5:32 The whole system relies on debt piled on debt piled on debt

5:35 to maximize leverage for higher potential returns and also to manage liquidity.

5:39 Private companies are notoriously hard to sell if

5:41 an investor wants to cash out of the fund.

5:44 So using debt instead of a sale

5:46 lets them facilitate those transactions within reason.

5:49 Now hopefully it should go without saying

5:51 that this whole thing is incredibly risky and the only

5:54 institutions that have really been willing to operate

5:56 in the space have been private credit funds.

5:57 And well, you have probably guessed by now that they raise money and take

6:01 on debt in much the same way as these private equity buyout funds do.

6:05 As investors in these funds saw that they

6:07 could make 20% returns every year on paper, more money piled in, which helped

6:11 to make those earlier investments look even better.

6:13 This system of debt on debt on debt on debt on debt on debt in a growing

6:18 market has generated some fantastic paper returns

6:20 and made private credit just as, if not more,

6:23 attractive than private equity itself.

6:24 And that's why the third thing that has allowed private credit

6:27 to grow so quickly is that unlike the private equity funds,

6:30 they don't need to go out and find individual businesses to invest in.

6:34 They can operate at a much larger scale by just building relationships

6:37 with a pool of existing funds and other companies that want to borrow money.

6:41 Recently, this lending has also extended to businesses

6:43 that want to build out data centers,

6:45 potentially exposing them to an additional market

6:47 bubble if there is a correction there.

6:49 So, these three factors allowed private lenders to fill the gap

6:52 in the market and make huge returns while growing at an unprecedented rate year.

6:55 But at a certain point, they ran out of good loans to write.

6:59 And now that interest rates are giving

7:01 the system the slightest hint of a reality check,

7:03 there are already rumors swirling about the Fed being forced to bail out

7:06 an industry that has again become too big to fail without anybody noticing.

7:10 So, it's time to learn how many works to find

7:13 out what happens if we don't bail them out.

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8:19 Okay, so the one thing that is important to note

8:22 as we start to explore how these good times came

8:25 undone is that the institutions putting these loans together are

8:28 fully aware that the lending they are doing is highly risky.

8:31 Because private lending is well private, market data is very hard to aggregate.

8:36 But according to information from PitchBook,

8:37 the average run-of-the-mill private credit loan for a small business with more

8:41 than $50 million in IBIDA was between S+ 500 and S+ 550.

8:45 Now, if you don't speak finance, bro,

8:48 that just means the risk-free rate plus 500 or 550 basis points or 5 to 5 1.5%.

8:54 At the moment, the secured overnight financing rate or sofur is around 3.7%.

8:58 Which means that the most basic loans are given

9:01 out at an interest rate of 8.7 to 9.2%.

9:04 Now there is a reason why they are quoted in such a confusing way.

9:08 But for now the point is that this is a high interest

9:12 rate that suggests a significant amount of risk and this is also

9:14 for a business maintaining 60% equity as a security which is kind

9:18 of like if you were putting a 60% down payment on a home loan.

9:22 Clearly it only gets riskier from here.

9:24 In their perspectus, Black Rockck's private credit arm acknowledged this risk,

9:27 but also pointed out that by lending to a large pool of businesses,

9:31 the individual credit risk would be mitigated and strong

9:34 overall returns could be maintained even in an uncertain market.

9:37 Now, that might sound concerningly familiar,

9:39 but with so much new capital rushing into the market,

9:42 private credit providers were happy to write

9:44 loans wherever they could find them.

9:46 So, then what went wrong?

9:48 Well, when this first started, private credit was genuinely a good idea.

9:51 The early funds filled a gap in the market for easy business credit that was

9:56 underserved and they were able to write

9:57 good loans to good companies with good terms.

10:00 But as investors piled into these funds,

10:02 the pool of capital they had to work with grew

10:05 faster than the pool of good borrowers they had to serve.

10:08 Private equity funds helped to fill that gap

10:10 because their buyout model relied on lots

10:13 of borrowing to generate strong returns or at the very

10:16 least pretend they were generating strong returns.

10:18 But these loans came with their own separate risks.

10:20 A lot of underlying problems in the private equity

10:23 market were paved over by new investors piling in.

10:25 This allowed funds to sell their portfolio companies to generate

10:28 cash flow and cover their debt until the point

10:31 where eventually the biggest buyer of the business is

10:34 sold by private equity firms became other private equity firms.

10:37 This is kind of like if property flippers

10:39 just flipped properties back and forth to one another.

10:42 So long as new property flippers kept entering the market,

10:45 everybody could pay off their mortgages.

10:47 But private equity has not been having a great time recently.

10:50 New fundraising is down and a lot of investors are trying to take their money

10:55 out only to realize that it's going to be a lot harder than putting it in.

10:59 This rush for liquidity in these illquid markets has

11:01 created problems up and down the debt supply line.

11:04 According to Fitch, defaults in private credit

11:06 reached their highest levels ever since January,

11:08 and we are still waiting on data from February.

11:11 Now, one little point to note is that this market is so new

11:14 and opaque that Fitch has only been tracking this data since mid 2024.

11:18 So, there is not that much historic context to go

11:21 off of, but it still isn't trending in the right direction.

11:24 The second problem is simply just rising interest rates.

11:27 Now, you might think that for a business

11:29 that generates returns by charging interest,

11:31 that higher rates would be a good thing.

11:33 But it's actually the opposite.

11:35 If investors can get a 5% return just

11:37 by sticking their money in a risk-free treasury,

11:40 that makes the highly risky 9% returns offered by the private credit

11:43 industry a little less enticing than when the margins were much wider.

11:47 Additionally, there is only so much interest these funds

11:49 can charge businesses before they start killing them.

11:52 Remember, the interest rate is a base rate plus a risk premium on top,

11:56 which means that if the Fed changes interest rates,

11:58 that gets automatically passed along to these businesses.

12:01 What's more is that as interest rates have increased,

12:03 they themselves have become a credit risk to the business.

12:06 The difference between paying $4 million in interest

12:08 on a loan and $8 million in interest

12:10 on the same loan could be enough to put a lot of firms out of business.

12:14 This is especially true for private equity structures that have

12:17 had several layers of debt built into the system.

12:20 Ironically, these credit lenders have had to account for the increased

12:23 risk of high interest rates by further raising interest rates.

12:27 Private credit funds are also hurt by interest rates on the other end as well.

12:31 Some funds take their investors money and borrow more money on top

12:34 of that to take advantage of the split between the low

12:37 interest rates they can borrow money on and the higher interest

12:39 rates they can charge the businesses they are lending money to.

12:42 As the rates that they can borrow money at has also increased,

12:45 it has led to tighter lending standards and higher interest rates.

12:48 It's also worth mentioning that while this is minimal

12:51 compared to the overall size of the private credit market,

12:53 this borrowing has mostly been done from regular banks.

12:56 So they are not completely isolated from this industry.

12:59 Again, the data on this is incredibly hard to come

13:01 by because most of these deals are not public record.

13:03 But according to a release from the Fed,

13:06 they noted lending commitments of $95 billion to private credit in Q4 of 2024,

13:10 a 12x increase over the decade before.

13:12 That is the most recent figure we have from the Fed themselves.

13:16 And this alone won't individually take out the banks.

13:19 Although even at this level,

13:20 the Fed did highlight it as potentially systemic risk to the banking system.

13:24 So not great, but within the last year alone,

13:28 that exposure has more than tripled.

13:30 Further analysis from the ratings agency Moody's found that today

13:34 bank exposure could be as high as $300 billion.

13:37 And even in a perfect economy,

13:39 that is major exposure to a highly risky asset class.

13:42 And well, yeah, the economy is also far from perfect.

13:45 The final big blow to private credit has been the turmoil

13:48 experienced by the primarily midsized companies they lend money to.

13:51 Jobs numbers have seen consistent downwards revisions for more than a year now.

13:55 And just last week, it was noted that we

13:57 had lost 92,000 jobs in the month before.

14:00 This indicates two things.

14:01 The first is that businesses are looking to cut costs where they can.

14:05 Market turmoil, increased interest rates,

14:07 and tariffs have been a major upset to regular business operations.

14:11 And if those businesses already have a lot of debt,

14:14 they have less capacity to absorb

14:15 these shocks without cutting expenses like staff.

14:17 But not only are these job losses a sign of trouble in the wider economy,

14:22 they could also be a cause of trouble within private credit.

14:26 Specifically, rising unemployment means fewer customers for exactly the types

14:29 of businesses that are typically laden with this kind of private debt.

14:32 And if they don't have customers, they don't have income,

14:35 which means a further feedback loop of layoffs and defaults.

14:38 So that's the current state of the private credit industry.

14:40 But if this really does come crashing down,

14:43 are we potentially looking at another global financial crisis here?

14:46 Again, we don't fully know exactly how much private

14:49 credit debt is floating around in the system because,

14:52 well, I know you are sick of hearing me say it by now, but it's private.

14:56 Morgan Stanley suggests that the total private credit market

14:59 was around $3 trillion at the start of 2025,

15:01 which would make it more than double the $1.3

15:04 trillion worth of subprime lending that was done in 2007.

15:07 Our economy is much larger overall today,

15:10 and our banking system is better capitalized.

15:12 But if these financial products saw the same kind of correction,

15:15 it could have a similar strain.

15:17 These loans are also not just financing houses.

15:20 They are financing businesses, which means services, inventory, and payroll.

15:23 All things that could impact productivity more

15:26 widely than just a simple home for closure.

15:28 Not that either outcome is pleasant.

15:30 It's also worth realizing that even if we

15:32 do go the bailout route for these, again, I have to reiterate, private lenders,

15:36 the government is not as healthy as it was in 2008.

15:39 Our debt is higher.

15:40 Inflation is already a problem.

15:42 And unlike the early 2000s, this debt didn't even let regular Americans

15:46 pretend they were rich for a little while.

15:47 Now, I just want to say that for the record,

15:50 I really genuinely hope I am wrong about this, but these concerns are

15:53 shared amongst basically all of the big names in finance at the moment.

15:56 And the only real reason why people aren't making a bigger deal about

15:59 it is because of everything else going on in the world at the moment.

16:02 But if you want to see the other side of this whole system,

16:04 go and watch this video next to find out the impact this debt is

16:07 already having on regular businesses as we

16:09 capped off a record year for corporate bankruptcies.

16:11 And don't forget to like and subscribe to keep on learning how money works.