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