Back in 2007, just before the global financial crisis, Chuck Prince, then the ill-starred head of Citigroup, famously told the FT that “as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
Or in plain English: when an asset class is booming, competitive pressures force financiers to keep peddling deals — even if they fear the bubble will burst.
It is a mantra that might haunt Jamie Dimon, head of JPMorgan, right now. In recent months, Dimon has repeatedly warned about risks lurking in private credit, which has recently had such a “meteoric rise”, to cite the Boston Federal Reserve, that it has been one of the fastest-growing finance sectors.
Dimon has noted that while there are plenty of good deals, bad ones exist too — and credit ratings are so unreliable that the sector is creating a potential “recipe for a financial crisis”.
“I’ve seen a couple of these deals that were rated by a rating agency. And . . . it shocked me what they got rated,” he observed. “It reminds me a little bit of mortgages [before the GFC].” Then this month he doubled down, suggesting we “may have seen peak private credit”.
But this year JPMorgan has also raised its allocation to private credit from $10bn to $50bn The reason? Its rivals are rushing into this space, as US President Donald Trump seeks to open the asset class to pension funds and retail investors. The financial “dancing” is intensifying.
So what should investors conclude? The first point to stress is that there are sound reasons why some investors might want to diversify their portfolios into private credit, since it has historically been a well-performing asset class with fairly stable returns (albeit high fees).
There are also good reasons why the sector exists. Post-crisis regulatory reforms have curbed bank lending in the past decades, and tariff uncertainties have damped lending again this year. However, a decade of ultra-loose monetary policy has left the system awash with liquidity, some of which has gone to private capital funds.
It is thus no surprise that when Meta recently decided to raise finance for artificial intelligence investments it looked at private credit — even though it can easily issue bonds. “Push” and “pull” factors are both at work in this boom, which has driven the global sector to almost $2tn in size, of which roughly three-quarters is in North America.
However, what concerns some observers is that the sheer speed of this rise evokes nasty historical comparisons. After all, history is full of examples of new(ish) financial products that have expanded at breakneck speed, delivered big profits for early smart-money players, but then produced large losses when retail money or unsophisticated institutional investors finally rushed in.
That happened with derivatives, leveraged loans and ESG assets. So, too, with subprime mortgage products. (I will never forget watching suave Wall Street financiers selling subprime securities to badly dressed German and Japanese regional bank managers at a securitisation summit in June 2007; it was a good sign the bubble was about to burst.)
And what makes these historical comparisons doubly unnerving is that private credit deals are typically bespoke and opaque, as their name suggests.
On a macro level, that leaves entities like the IMF and the Financial Stability Board worried about the threats of excessive, concealed leverage. On a micro level, it suggest there may be some ticking time bombs in the portfolios. And while patient capital (like sovereign wealth funds) can weather such shocks, retail investors and pensioners usually expect regular and reliable returns. Or to cite Dimon again: “There could be hell to pay . . . when the shit hits the fan” since “retail clients tend to circle the block and call their senators and congressmen” if losses erupt.
Financiers at groups such as Morningstar think problems like these can be mitigated, for example by creating mechanisms to guarantee regular payouts and pooling credits to hedge risks. And the beauty of opening the sector to retail investors, they note, is that this process of “democratisation” could force it to become more transparent and credible — and cut fees.
One hopes so: it is hard to argue against the idea that the “democratisation” of finance is a good thing — especially if it shares the returns more widely, and enables a sector to become more mature and transparent.
However, there is another lesson from history that Wall Street should heed: when other sectors have been forced to clean up their standards in the past, this has almost invariably occurred after, not before, a big crisis hits. Painful losses are what usually sparks reform.
Maybe private credit can buck this trend — and reform itself before, not after, a bubble bursts. But this will probably only happen if institutions such as JPMorgan and BlackRock campaign for change. Don’t expect the Trump team to protect investors without such strong pressure; caveat emptor is now the mantra of the day. Anyone entering the private credit dance should be warned.