00:00I have to tell you guys, I didn't really know the phrase private credit about two months ago, and now
00:04I feel like it's like infiltrated everything in my feed.
00:08How bad is this? Do I need to care about Blue Owls? And why aren't you freaking out?
00:13So, yes, this is the problem with the financial sector becoming large and shadowy and not really big public companies,
00:22although technically Blue Owl is a public company.
00:25People don't really know what's going on, and private credit is this massive trillion-dollar asset class which has been
00:31very happy for many years making loans and getting interest payments.
00:36And this is basically just a loan you don't get from a bank, right?
00:39This is a loan that businesses borrow directly from the people with the money rather than going through an intermediary
00:45like a bank.
00:46A bank needs to fund itself through deposits or whatever, and these intermediaries have the cash.
00:51So, they just directly, if I'm a very rich person or an insurance company, I'll just lend money directly to
00:58private equity-backed companies, and they will take the money, and then they will pay me back over time.
01:03And it's just a bilateral relationship.
01:05There's nothing really systemically dangerous going on there, and that's why you haven't heard about it for the past two
01:11years.
01:13And now, over the past couple of months, you have heard about it because numbers have started going down rather
01:20than up, right?
01:20And so, there are worries, something, something, SaaS, something, something, cockroaches.
01:25People worry about, it's credit, right?
01:29Sometimes loans don't get repaid.
01:31Yeah.
01:31And people are realizing that there's credit risk in private credit, and so the values of those loans might be
01:37lower than 100 cents on the dollar.
01:39And that's it.
01:40That's the entire story.
01:42But because we haven't been paying attention for the past couple of years, and because we do have long enough
01:49memories to remember 2008, when things we hadn't been paying attention to wound up causing a massive financial crisis,
01:56we see, like, oh, my God, a trillion dollars here, and we haven't been paying attention, and prices are going
02:02down, and credit, and we're like, ah, is there going to be a financial crisis?
02:07And so, my thing is to just say, no, there is not going to be a financial crisis.
02:13There's all manner of things to worry about in this planet, but a financial crisis is not one of them.
02:18And why is that?
02:19Is it because it's confined to such a small space in the broader financial system?
02:24What gives you the confidence to say that despite people wringing their hands and worrying about cockroaches and other insects
02:29and vermin, this isn't going to be a big deal?
02:31So, there are two things that characterize credit crises.
02:35There are two things that characterize financial crises.
02:39One is when you have massive leverage, right?
02:41So, Lehman Brothers was 30 to 1 levered and that kind of thing.
02:44So, if you have all the subprime mortgages, you know, people would put down 4%, which is 25 to 1
02:51leverage.
02:52So, when you have massive leverage like that and you get a small decline in prices, people get wiped out,
02:58you get bankruptcies, and it's often people who are, you know, glameless, small individuals, and that's bad.
03:03The second thing that causes a financial crisis is when you have assets that people think are risk-free but
03:09turn out to have a bunch of risk in them.
03:12Bank deposits are a really good example of this.
03:15If I put a bunch of money in the bank, I'm like, that's money in the bank.
03:19That's safe.
03:19And then the bank goes bust and I don't have that money.
03:21That is a crisis.
03:22Or if I buy a bunch of AAA-rated CMBS in 2006, I buy that because it's AAA-rated.
03:31There's zero default risk.
03:32And then suddenly there's default risk.
03:34All hell breaks loose.
03:36Neither of those two things pertain to private credit.
03:41Private credit is credit.
03:42Everyone knows that there's credit risk.
03:44Everyone knows that there's default risk.
03:47So no one thinks that it's risk-free.
03:50And the amount of leverage in these things is small.
03:54It's like maximum two to one.
03:56But you've seen a little bit of panic.
03:58And the phrase I keep getting told is like retail investors are the problem.
04:01Like retail investors are panicking.
04:03Explain to us why that is and their caps at how much they can take out of some of these
04:08funds, right?
04:10So the general vibe, if you look at things like there's these animals called publicly traded BTCs, which you don't
04:18need to worry about too much.
04:19I'm on acronym overload.
04:21I'm learning as many as I can.
04:22But I'm not learning that one today.
04:23So don't learn that one.
04:25But the point is that if you look at the vibe in the markets, the vibe in the markets is
04:30that these private credit loans are worth less than 100 cents on the dollar right now because people are worried
04:35about default risk.
04:37And if you're a retail investor in private credit, and there are some, it's not a massive part of the
04:43private credit world, but it is a significant part of the private credit world.
04:46If you're a retail investor in private credit, in most of these vehicles, you have the ability to take your
04:52money out at 100 cents on the dollar.
04:54The market is telling you these things are worth 80 cents on the dollar.
04:58And your contract is saying you get to withdraw at 100 cents on the dollar.
05:02Even if you're not panicking, why would you not do that?
05:05You know, it's free money.
05:07So a whole bunch of perfectly rational, non-panicking investors are saying, yes, please, I'll put my name on the
05:14list to take money out at 100 cents on the dollar.
05:16The funds, because they are deliberately designed to be illiquid, say, look, we can only give you back in aggregate
05:24among all of the investors 5% of your money each quarter.
05:28So not everyone gets their money back.
05:30And then people start to panic.
05:32But this is a feature, not a bug.
05:34We have 30 seconds left.
05:35If this doesn't end with a bang, more so a whimper, what does that look like?
05:39If we don't get a crisis, how bad could this be?
05:43A few people lose, like institutional investors, lose money on some of their private credit investments.
05:50Small and medium-sized businesses lose access to an avenue of funding that they've had for the past few years.
05:58So you're just not that worried?
05:59You're not that worried.
06:00It's not going to be a crisis.
06:02All right.
06:02You heard it first.
06:03Felix Salmon, thank you very much.
06:06All right.
06:07You can read more about this story in the forecast newsletter.
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