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John Walker's avatar

My favorite part of this whole thing comes after the securitization scheme blows up and the government (i.e. taxpayers) starts bailing out the banks that sold these bundles of bad debt to investors. Then the regulators meet and congress issues a 200 page report where they declare the resulting disaster was a big surprise that no one saw coming.

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Treeamigo's avatar

Private credit has its uses, particularly for mid-sized companies with limited leveragable working capital and due to market inefficiencies caused by post Dodd-Frank bank regulations (ie banks can’t lend as much to leveraged entities). The real business case for it, though, was the long-gone zero interest rate and QE era (now replaced by inflation and “normal” interest rates).

Unfortunately, some of the recent surge has been used to refinance maturing bank loans from the COVID bubble (zero rate) era. These companies and real estate projects are in deteriorating condition financially and likely could not attract bank credit without restructuring or a credit event. We certainly hope the sponsors don’t have a “I’ll lend to your bad credit if you lend to mine” mentality. This has been supposed, but seems unlikely to me (at least not so baldly) given the deep pockets, on-call legal teams and jury-friendly identities (eg teachers’ pension funds) of their limited partner investors. If things go south, lawsuits and discovery and prosecution will follow.

I love your anecdote about the sponsors saying “no thanks” to transparent secondary markets. That would kill the bogus sharpe ratios of the whole sector.

Famous last words, but I am not too worried about a PE/leveraged credit financial sector meltdown. Leverage is what kills. In the GFC it was deposit-taking banks buying “AAA” CDOs and ABS, arbitraging the inane Basel 2 capital rules and reaching for just a little bit more return in an ROA-challenged environment with compressed credit spreads, following on from Bernanke’s helicopter money.

Rich people and pension funds and endowments losing money? That shouldn’t cause massive financial contagion (though it might lead to sane repricing of risk assets generally) and cause tax hikes at the state levels. Economically would be more like the dot com crash than the GFC.

What should not happen (but probably will) is non-HNW/non-accredited retail investors being legally offered a slice of these portfolios.

Given public markets are shrinking relative to private, and given all of the PE and VC types backing political parties, inviting retail investors in to hold the bag seems likely, unfortunately. Will it be any more disastrous, though, than so many retail types being 100 pct invested in the allegedly “diversified” and “broad” SP500 index which is actually like putting 40 pct of everything you own into the 7-10 biggest tech stocks of the moment?

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