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What a contrast a Friday afternoon can bring. Throughout the week, Wall Street remained in a celebratory atmosphere: record peaks for major U.S. blue-chip stocks, technology shares rising on the Nasdaq, and widespread optimism. However, just before the New York Stock Exchange closed, the news arrived: the trade conflict with China was intensifying once more. In reaction to new export restrictions from Beijing, the U.S. intended to impose a 100%special tax on all goods coming from China, which President Donald Trump stated would be "in addition to all the other tariffs they are already paying."
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The event triggered a sudden, short-lived fear. Stock markets in the U.S. and Asia dropped, with billions of dollars disappearing within hours in the volatile cryptocurrency sector. It was as though the president's restless message had lit a fire in a dry field. During the weekend, Trump attempted to calm the situation, as he typically does following his explosive statements, posting on Truth Social, "Don't worry about China!"
However, the moment of fear in the markets exposed a more profound concern that was spreading across trading floors from New York to Singapore. What if the next trigger—a Trump-related message, a significant corporate collapse, or a new conflict—sets off something much more severe? In 2008, the spark was the downfall of Lehman Brothers, and the resulting fire led to the most severe recession of recent history.
Dimon’s warning
Experienced voices are now sounding an alarm about a comparable danger. Jamie Dimon, who leads JPMorgan Chase, the biggest U.S. bank, recently stated that investors are“systematically underestimating” today’s dangersHe estimates the chance of a major market crash in the near future at 30%. This would merely be the beginning of the issues.
In recent years, a steadily increasing risk has been developing almost unnoticed within global finance. Insiders refer to it as "private credit," and it could trigger a chain reaction during the next financial shock, causing financial institutions, companies, pension funds, and insurers to collapse, and endangering economic stability across entire nations. Private credit, as Dimon warned at an event in Miami, is one of the most dangerous issues confronting the world economy. At 69, after a careerspend time dealing with emergencies, he is familiar with the area.
Challenges frequently follow a similar sequence. They are typically preceded by a strong sense of assurance.
Challenges frequently follow a similar sequence. They are often preceded by excessive optimism as underlying dangers accumulate unnoticed. In 2008, the collapse of Lehman Brothers triggered a worldwide financial collapse, with the problem being the trading of unstable mortgage-backed securities that became nearly worthless overnight. During the Asian crisis between 1997 and 1998, banks and businesses in developing markets took on debt in dollars until the U.S. dollar strengthened, revealing the hidden currency risk. The European debt crisis from 2010 to 2012 highlighted how some nations had become deeply indebted beneath the attractive appearance of a single currency and the illusion of uniform creditworthiness.
The subject remains the same. Perils exist in the darkness, developing within systems that neither monitors nor financiers completely understand. Following this is the collapse.
Private credit involves lending that occurs outside of traditional banking institutions. This concept is not new. For a long time, private investors and funds have been offering loans directly to businesses, without the involvement of a bank or a publicly traded bond.
What has changed is the magnitude. The Bank for International Settlements (BIS) based in Geneva estimates that private credit was approximately $100 billion in 2010. It has now reached nearly $2.2 trillion. Even the BIS is not entirely sure, despite its connections with central banks, as these loans are not required to be disclosed.
Financial institutions assume the responsibilities previously held by banks
The experts who control this industry credit their swift ascent to the regulations implemented after 2008. To prevent another Lehman Brothers-style collapse, regulators increased the difficulty and expense of bank lending. Officials in the United States and the European Union promised that problematic loans on bank balance sheets would not once again push the economy into turmoil. Banks were required to maintain significant reserves for every loan.
As banks retreated, other entities stepped in. Companies such as Blackstone, Apollo, and Ares introduced debt funds. In contrast to banks,they encounter limited transparency obligations, yet they now fund complete acquisitions, corporate investments, and infrastructure developments. Much that was once typical banking activity is now handled by them.
Could private credit be the spark that ignites the next market surge? This concern is becoming more widespread. Allianz CEO Oliver Bäte recently stated to CNBC that the rapid expansion of private credit resembles the conditions leading up to the 2008 systemic collapse. "At some point, an event will occur, and the question will be whether the system can withstand it."
Earlier this week, Andrew Bailey, the head of the Bank of England, sent a letter to G20 finance ministers convening in Washington, expressing concerns that the global system is "susceptible to disruptions" and highlighting private credit as a major threat. Bailey also leads the Financial Stability Board, an international organization that includes finance departments, central banks, and regulators.
The Millennium Fund, one of the globe's biggest hedge funds, is currently facing billions in losses.
Why are the alerts becoming more intense now? A preliminary example has emerged, the failure of a company that depended heavily on private loans, which has taken form to some of the most alarming concerns.
The case centers around First Brands, a manufacturer of automotive parts located in Ohio. Previously, it was not well-known outside of its industry. However, at the end of September, the company declared bankruptcy, revealing the identities of its major creditors. Millennium, one of the largest hedge funds globally, is now facing significant financial losses connected to First Brands. The connection between a producer of wiper blades and fuel filters and the powerful figures on Wall Street. Private credit.
The most typical method for these loans operates in the following manner. A financial company secures funds from investors and then provides them to businesses such as First Brands. Nevertheless, to enhance profits,the creditor performs a different actionIt acquires extra funds for itself and then lends that money out again, frequently including unique terms that traditional banks would not provide. For instance, there is a type of loan where the borrower does not make regular interest payments. Instead, the accumulated interest is incorporated into the principal amount. This method is known as payment in kind, or PIK. This approach carries significant risk since creditors might not have a clear understanding of the borrower's ability to repay over an extended period. As per the credit analysis company Lincoln International, PIK is present in approximately 12% of private credit transactions.
First Brands was established in 2013 by Patrick James, a young business leader who started acquiring companies following his graduation, including Westfalia Automotive, a German manufacturer of trailer hitches based in North Rhine Westphalia. He obtained his funding from multiple private lending companies, which were willing to provide additional loans repeatedly. Eventually, the company's total debt climbed to at least $11 billion, while its yearly revenue stood at $4 billion, resulting in a dangerously high debt-to-income ratio. According to Goldman Sachs, First Brands paid interest rates as high as 30% on certain credit lines.
A dangerous chain reaction
Eleven billion dollars seems insignificant compared to the size of Wall Street, but the Ohio case continues to cause concern. How did several lenders provide such large amounts to the same borrower? Did they neglect to assess the risks adequately? There is also discussion about whether the company used the same collateral for multiple creditors. "If you spot one cockroach, there are likely more," said JPMorgan's Dimon during an analyst conference on Tuesday. Everyone should take this as a warning.
What occurs if private credit lenders become more cautious, adjust their risk assessments, demand repayment of loans, and stop offering new credit? This is how the most hazardous chain reactions begin. Companies suddenly find themselves unable to refinance, leading to failures, which in turn cause additional losses.
It has also become evident that numerous banks, constrained by the post-crisis regulatory framework, contributed to the growth of private credit. A complication in the capital rules made this possible. When a bank provides a loan to a company, it is required to hold significant reserves for possible losses. However, when it lends to another financial institution, the required reserves are much lower, approximately one-fifth of that amount. In reality, this meansit can provide five times as muchif the counterparty is a private credit fund.
The bankruptcy of First Brands affected not just private credit firms. UBS, Switzerland's leading bank, and Jefferies, a New York-based investment bank, were also impacted. They did not lend directly to the auto parts company but instead funneled money through private credit structures.
Pension funds, insurance companies, sovereign wealth funds, private investment vehicles, and ETFs have also entered the market.
Claudia Buch, who oversees banking regulation at the European Central Bank, expressed concerns in June regarding the limited openness in this area of finance, stating, "since banks' involvement in private markets can create risks to their financial stability and cash flow that are not sufficiently addressed by current risk management frameworks." Her worry probably stems from the fact that major domestic banks like UBS are engaged in these activities.
Pension funds, insurance companies, national wealth funds, private investment vehicles, and ETFs have also entered the scene.After the 2008 crisis, private equity groups appeared as saviors for certain life insurers. With central banks lowering interest rates, how could insurers meet the returns outlined in their contracts? Private credit funds were able to produce approximately nine percent annually. As of now, according to Moody’s, roughly one third of the $6 trillion managed by U.S. life insurers is invested in private credit, with a significant portion held in offshore locations like Bermuda.
With a large amount of money circulating, numerous private credit companies have increased their debt. Over the last 15 years, the proportion of borrowed funds relative to equity has risen from a dangerous 30% to a concerning 90%, according to the Bank for International Settlements. Meanwhile, an increasing number of these lenders' clients are struggling with heavy debt. By the end of 2024, over 40% of companies utilizing private credit had negative cash flow, indicating that their expenses surpassed their revenue, as reported by the International Monetary Fund.The flint is in position.
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This piece was initially published onHealthy urvivalIt was translated and adapted by the Healthy Survival Partnership in collaboration withDIE ZEIT.
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