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- [00:02]
Jill Wiesenthal
Bonds are back and so is all the credit. PGIM Fixed Income's monthly podcast series. From the latest trends to long term perspectives, you'll get timely fixed income insights from leading economists, research analysts and investment professionals.
- [00:16]
Tracy Alloway
Whether you're new to bonds or a.
- [00:17]
Jill Wiesenthal
Seasoned investor, tune in to all the credit wherever you get your podcasts. This podcast is intended solely for professional investor use. Past performance is not a guarantee of future results.
- [00:31]
Matt Levine
Are you looking for a new podcast about stuff related to money?
- [00:35]
Tracy Alloway
Well, today's your lucky day.
- [00:37]
Matt Levine
I'm Matt Levine.
- [00:38]
Tracy Alloway
And I'm Katie Greifeld and we are.
- [00:40]
Katie Greifeld
The hosts of Money Stuff, the podcast. Every Friday we dive into the top.
- [00:45]
Matt Levine
Stories about Wall street finance and other stuff.
- [00:48]
Tracy Alloway
We have fun, we get weird and.
- [00:50]
Matt Levine
We want you to join us. You can listen to Money Stuff, the podcast on Apple Podcasts, Spotify or wherever you get your podcasts.
- [01:03]
Tracy Alloway
Bloomberg Audio Studios Podcasts Radio News.
- [01:19]
Jill Wiesenthal
Hello and welcome to another episode of the Odd Lots podcast. I'm Jill Wiesenthal.
- [01:24]
Tracy Alloway
And I'm Tracy Alloway.
- [01:25]
Jill Wiesenthal
Tracy, you know, we do all these episodes about private credit and obviously hedge funds, multistrategy hedge funds in particular lately. And of course it all sort of seems to be part of a bigger story of a bunch of things that used to happen inside banks no longer happening inside banks.
- [01:41]
Matt Levine
Right.
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Tracy Alloway
And this has been like a continual process ever since like the 2008 financial crisis. But even before that we had like big periods of bank disintermediation, which we talked about recently on that episode with Hugh Van Steenas.
- [01:56]
Jill Wiesenthal
Totally. There's a lot going on and not all of these trends date back to the financial crisis. But you know, this was obviously kind of an express goal, I think of the Dodd Frank regulations and just from my seat sitting here like, yeah, it seems pretty good. A bunch of risky stuff like multistrategy hedge funds, et cetera seems kind of risky. You can lose a lot of money in theory, lending to random middle market companies. Seems like you could lose a lot of money. It's like, yeah, it seems pretty good that it's not happening inside the banks and maybe that's good that it's not connected directly to deposit taking institutions. Yeah.
- [02:29]
Tracy Alloway
And I think given the increases we've seen in rates over the past couple of years, the fact that like nothing really broke or exploded in the private credit market seems like a good sign. But again, it's still relatively small and it is growing very rapidly. So I think there are more questions to be asking about this particular space.
- [02:50]
Jill Wiesenthal
Well, you brought up something recently on an episode of Synthetic Risk Transfers, where banks sort of offload some of their credit risk onto third party entities. And that's been really stuck in my head, which is, you know, okay, so these third party entities take the risk of the assets from the banks, but then that's an asset that can be levered up. And where do you get leverage? Presumably from a bank. And so I have this, like, sort of.
- [03:14]
Tracy Alloway
It's very circular, isn't it?
- [03:16]
Jill Wiesenthal
Yeah. And I just have this nagging thing in my head somewhere. It's like, okay, yeah, great, we moved it all off the banks. There's okay, we're not going to have another 2008, but what if in some way it still goes back to the banks and the risk still is there and it just sort of takes the loop out and then comes back, it.
- [03:33]
Tracy Alloway
Goes into prime brokerage instead of the balance sheet.
- [03:36]
Jill Wiesenthal
That's a good way to put it. And so I'm still like, yeah, things pretty good, but maybe there are still some reasons to be concerned. Can you ever. I guess maybe we could title this episode the can you ever really de risk the banking system?
- [03:49]
Tracy Alloway
That's a good one. Let's use that.
- [03:51]
Jill Wiesenthal
Okay. Well, I am really excited we have the perfect guest on today's show. Someone we've had on the podcast before and someone we've known and talked to for a long time. We are going to be speaking with Stephen Kelly, associate director of research at the Yale Program on Financial Stability. Steven, thank you so much for coming back on Outlaws.
- [04:08]
Matt Levine
Great to be back. Sometimes you guys say literally the perfect guest. So I'm 0 for 2 on that. I've only gotten perfect guests. But why are you coming back?
- [04:16]
Tracy Alloway
We have people who complain about when we forget to the perfect guest, but you've kicked it up to another level and are complaining about not saying, oh, literally the perfect guest. This is a new era.
- [04:27]
Jill Wiesenthal
For what it's worth, I do not think that the word perfect does not actually need any adjectives. Right. Because either it's perfect or it's not. It's sort of like the word when people call something very unique. It's like, either it's unique, one of a kind, or it's not. So I wouldn't take that too.
- [04:42]
Matt Levine
I would agree with you.
- [04:43]
Jill Wiesenthal
I wouldn't take that too literally.
- [04:44]
Matt Levine
I would agree with you if you followed your own advice.
- [04:47]
Jill Wiesenthal
Okay, that's fair enough. Stephen Kelly, literally the perfect guest. Who made that correction? I just. Should I be. Like I said, everything seems fine, but are there reasons to think and we're going to get into specifics. So this is an incredibly broad question, but just conceptually, are there reasons to think about how these risks that migrate off of bank balance sheets find a way to migrate back onto them?
- [05:12]
Matt Levine
It's totally valid. I mean, this is part of the story of 2008, right, is there was this whole shadow banking sector and it looked like risk had moved, and really it hadn't. The banks brought everything back, first voluntarily and then involuntarily. So you're asking the exact right questions. The IMF is now asking these questions and citing odd lots. I don't know if you saw the recent Global Financial Stability Report.
- [05:34]
Tracy Alloway
I did not see that.
- [05:35]
Matt Levine
Citing. Tracy, on exactly this issue of. You talked about the synthetic risk transfers in your intro and this idea of, okay, but are the banks really funding it? I would say to the extent we're running risk through another balance sheet, the banks really are more protected, even if they are lending to a firm that's taking credit risk, because they do have that firm's capital and they have that firm's alleged skill at managing these risks. Part of the issue with all the financial crisis stuff was a lot of it was unfunded. We can get into synthetic risk transfers. And you had that great episode about how they're different and they're funded, but broadly. Joe. Yes, you're asking the right questions.
- [06:13]
Tracy Alloway
Wait, Okay, I have a very basic question. But what is actually happening in the financial system when someone puts money into private credit? So say I'm an investor and I'm going to invest, I don't know, a million dollars in some private credit fund. What happens to that million dollars?
- [06:32]
Matt Levine
Well, first, Tracy, you're probably taking the million dollars from an allocation towards junk bonds, investment grade credit. So that's step one. I mean, the idea of like private credit is taking all these loans from banks or it's eating the bank's lunch. We can put a pin in that for now and we should come back to that. So usually that's what's happening is this is an allocation away from whether it's other alternatives or other corporate credit. But the reality is this is deposits moving around the banking system. There's no, like, people talk about private credit like it's deposits leaving the banking system or it's, you know, deposits are going to non banks. But there is no shadow bank without a bank. Apollo has bank accounts, Blackstone has bank accounts. When you transfer money into them, they put it in their account and then it's lent on to whomever is receiving the credit. And so you're changing the nature of the aggregate deposit franchise to the extent deposits are moving to a different kind of actor. But deposits can't leave the banking system.
- [07:32]
Jill Wiesenthal
So just take it a little step further just to be clear. Okay, I sell some junk bonds. I decided to allocate a million dollars to an Apollo private credit fund. They lend the money. Is Apollo further leveraging that? Lending up to juice returns or how leveraged are these funds?
- [07:49]
Matt Levine
So what we're seeing is that they're increasingly. So it's pretty scarce so far. And that was part of the pitch. Right. It's like Apollo came along in 2022 when private credit was booming and said, hey, why haven't you guys thought of this? We have like one times leverage, two times leverage. That's generally sort of the space that it's in. But as we've sort of seen the market mature and the market grow, like there's a good reason to lever these things up if you're doing effectively bank credit, which sometimes they are. There's a reason banks are 10 times levered. Like that's the way the funding of the system works. And that provides a whole host of other benefits to the system. But there's also a cap on how much unlevered equity is out there. If you think about what the financial system exists to do, it's to create as many financial goods for us what we need deposits other kinds of savings on as little equity as possible. Equity is the scarce resource and it's the input to the financial system's manufacturing process. And so you cannot recreate 10x12x15x leverage from the banking system on 1, 2x leverage in private credit. And that's the limit to your fear, Joe. That's the limit of how big this thing can grow. And we're sort of seeing that a little bit is the bigger private credit grows relative to the economy. They're sort of nearing the kink on the funding curve as far as what amount of funding is willing to be locked up as long term assets. The fundamental idea that on demand par deposits can become locked up. Five year equity in a private credit fund is not real.
- [09:25]
Tracy Alloway
Hmm. Haven't we seen some private credit funds start to look at structures where investors can take their money out as well? Like instead of having the five year lockup periods, people can go in and out as they need.
- [09:37]
Matt Levine
Definitely. I mean, the long arc of financial history bends towards banks. And we've sort of seen private credit start to look more like banks. And one of the ways is these sort of interval funds or evergreen funds they're called. And basically these are just different types of structures that allow some amount of liquidity in the short term. And this is very, very marginal steps. It's gated, it's limited. It's gated after a certain percentage. It's limited by quarter. There's a certain time interval in which you can get it. It's not deposits yet, but that's one of the ways which funds have started to bend towards a banking model in addition to leverage.
- [10:14]
Jill Wiesenthal
By the way, just speaking of the history of finance is that entities try to make illiquid things a little bit more bank. Like there was a really interesting paper that came out recently from Tim Barker and Chris Hughes about the Penn Central bailout. And in there there was some talk about the history of CDs specifically and how at one point there was this really hard lockup on them. But then entities found ways to sort of you could liquidate and sell your right to that cd. So they always find a way to create liquidity out of illiquidity.
- [10:45]
Matt Levine
Yeah, you can tranch anything with cash flows, to paraphrase Robert De Niro and Meet the Parents. I mean, you can get anything out of that.
- [10:52]
Tracy Alloway
Speaking of tranching, I wanted to ask one more basic question, which is this term, retranching of risk in the financial system has come up a number of times. So Hugh Van Steenas used it in a recent episode. I'm pretty sure you've used it as well in your writing. Exactly what risk is being retrenched here? Like, give us an idea of what types of things end up in private credit. I imagine a lot of it is sort of middle market stuff. Stuff that, to your point earlier, would have been in the junk bond market or the leveraged loan market and is now going elsewhere.
- [11:25]
Matt Levine
Yeah, that's exactly right. I got this term from the gfc, the global financial crisis literature. I believe it originated with Gary Gordon and Andrew Metric, and they used it to describe increasing haircuts in 2008. So the idea that you have a AAA asset, you were haircutting at 1%, but now the market to resell that collateral is worse. You're more worried about your counterparty. And so you're going to haircut at 30%, you've sort of retranched what you've decided is AAA. And a lot of that was driven by market perception of risk as well as increased market demands for more capital. What we're seeing in the banking system is a little Bit of market demands and a little bit of regulatory demand. So obviously Basel III is looming next to the maturity wall and it's saying banks may have to have more capital. The other thing is investors, depositors are looking for a little more liquidity in banks than they were pre 2023. And frankly interest rate risk at a certain point becomes credit risk. And so when rates go to 5%, banks aren't really trying to be in the business of managing all the credit risk at 5% that they were avoiding at 0%. And so of that left tail and retranching by selling things out of the banking system is the aim. It's all those three things at once. And it makes sense for banks to lean then on prime brokerage and lending the senior layers of these funds.
- [12:53]
Tracy Alloway
Wait, this reminds me of something else I wanted to ask, which is I hear a lot about comparative advantages when it comes to private credit versus the banks in the sense that private credit might be better at managing certain loans. To your point about higher interest rates, is that true? And like, what does that comparative advantage actually look like? Does it just mean the analysts at private credit firms are like pouring over the paperwork more than a bank can?
- [13:18]
Matt Levine
I think that's right. And I know, I know Joe has rued the failure of the high touch banks in 2023. You know that banks that care about their customers are the ones that failed. But what that misses is that community banks didn't fail and those do the same thing and those don't have the attention of the market. And that's sort of part of the pitch of private credit as well, is like we're operating under less transparency again, we're seeing give on that as they sort of bend towards banks. But in theory this is just a product and they do have some ability. It's a smaller group, sometimes as small as one to work with the lenders. We've seen lower default rates out of private credit versus their competitors in leverage loans, but higher losses given default. So you can multiply those two things together and come up with some lesser loss. And in that case, you know, it makes sense to be allocated to private credit.
- [14:28]
Jill Wiesenthal
Direct lending has been one of the most dynamic areas of the private alternative space these last few years, having grown massively as a source of capital for.
- [14:36]
Tracy Alloway
Both corporate borrowers, but also financial sponsors that have kept going from strength to.
- [14:40]
Jill Wiesenthal
Strength and have needed that private capital to foster the growth that they've been experiencing for leading alternative investing insights.
- [14:49]
Tracy Alloway
Listen to speaking of alternatives from pgim.
- [14:55]
Katie Greifeld
Not everybody likes talking about money. Some people find it awkward. Sometimes they even find it a little embarrassing. I do not. I like talking about money, whether it's the boardroom, the newsroom, the trading floor. I've spent the last 30 years talking about money, writing about money and talking about it and writing about it a little bit more. I'm Marin Sums at Webb, and every week senior reporter John Stepek and I answer your questions about personal finance and we discuss the best strategies for making the most of your money. Listen in for the kind of insights and explanations everyone can use to help them make better saving and investment choices for themselves and their families. My question is whether you think maxing out my company Pension Match is enough for when it comes to saving for.
- [15:33]
Matt Levine
My pension, Should I attempt to pay.
- [15:36]
Tracy Alloway
My child's university fees and living costs? My partner and I have excess savings. So should we overpay on our mortgage or should we put the money into stocks?
- [15:45]
Katie Greifeld
From Bloomberg podcasts, tune into Marin Talks Money, follow Marin Talks Money on Apple podcasts, Spotify or wherever you listen.
- [15:54]
Jill Wiesenthal
You know what I realized a little earlier in the conversation is that I actually don't know the difference in what the shadow banks, the quote shadow banks were doing prior to 2008 and how their relationship with real banks was different than the current relationship. I mean, it's interesting because I remember one of the things that was going on, I think summer 2007 or summer 2008, there was a couple Bear Stearns hedge funds, just hedge funds that seemed like a really big deal, seemed to be systemically important. I think Citi had something maybe too. What was the nature of those shadow banks and how they actually connected to the regulated banks.
- [16:34]
Matt Levine
So the short version is that the nature of those is big banks with strong balance sheets like Bear Stearns and Citi put their name all over those shadow banks, but didn't actually have. They weren't funding them themselves. They weren't actually on the balance sheet of the banks. So when pressure came in 2007 and nobody knew this was going to be like a repeat of the Great Depression, Citi took all that stuff back on its balance sheet. To protect its reputation, Bear took one of those hedge funds on, back onto its balance sheet. These banks did not have to take on this risk. But they're going, okay, we're going to stand behind our name. We're going to stand behind our clients who thought they were buying a Bear Stearns or Citigroup product. And maybe that's a risk today, I don't know.
- [17:16]
Jill Wiesenthal
Yeah, well, I was Just going to ask, because you see these headlines right now, JP Morgan is going to get into private credit and so forth. And so I get the idea that this is going to be to be a separate funding vehicle, be like off balance sheet. Kind of sounds similar.
- [17:29]
Matt Levine
Yeah, I think that's totally a risk. Is there a world where, you know, Citigroup has to bail out its Apollo partnership because they put Citigroup's name all over it? Maybe, maybe.
- [17:40]
Tracy Alloway
Wait, that JP Morgan mention just reminded me of something. But a few years ago, well, actually more than a few years ago, maybe in like 2014 or something like that. I remember JP Morgan basically complaining that the prime brokerage business was a lot harder nowadays and like the margins were slimmer and stuff like that. I think that's what they said. And yet Fast forward to 2024 and it seems like prime brokerage is a moneymaker for the big banks, at least what happened there.
- [18:11]
Matt Levine
So part of it might just be the growth of private credit. I mean it has found a niche. I would think about it like a product. You know, like I said, it's got this middle market like you alluded to. It's sort of got a different model and there's no reason that shouldn't exist along the spectrum of bank deposits to 30 year locked up funding to fund Buried Treasure Expedition. It exists in that spectrum, which is kind of an academic answer, but it's true. I mean, Mark Rowan, CEO of Apollo recently had a comment. He said we'll get competed with like crazy and then what's the difference between public and private? And I think that's right. It arose as a product in the years. I mean it doubled between 2020 and 2023. We can talk about why. But now they have banking needs. Like I said, there's no shadow bank without a bank. And they have banking needs and hedge funds too.
- [19:00]
Jill Wiesenthal
So my takeaway so far from this conversation is that some of the questions we're asked is not that there's like some big looming risk out there or like, oh, this is a disaster waiting to happen. But mostly these are all like reasonable questions to be asking about where at some point risks could emerge or at least where regulators maybe want to think or try to get ahead of things. What tools or specific lines of inquiry have we seen from regulators or things regulators could do? If they're like, we want to monitor this and I know that's already you've written about this, but what are the specific mechanisms and questions and things they could do?
- [19:35]
Matt Levine
I mean, basically so far, what We've seen is they've just been really annoying to banks. That's a cost, right? If you talk about why the economics of private credit makes sense, some of it is that okay, the market demands a lot less capital for certain risks than banking regulators and there's some supervision attached to those capital regulations too. And so to the extent you're making supervision just more costly, it's annoying. And banks say whatever JPM, yeah, they're doing 10 billion of private credit on balance sheet. That's like they just found that in the couch cushions and they put out a press release so they can serve their clients. And this goes back to kind of what we were talking about earlier, about what the difference is between banks and private credit. Banks being more about managing a deposit franchise, private credit being more the lending side. But really we've seen from the bank of England, from the ecb, from the FSA in Japan, from the Fed, they're all starting to just probe banks about their exposure. They're lending to private credit funds and prime brokerage frankly. But that's step one, you hear regulators talk either one, we need more authority to regulate the non banking sector like banks. Or two, the conservative side is, let's be nicer with Basel 3 so you don't push all this stuff into private credit. The truth is always somewhere in the middle. Right now supervisors have just become more annoying.
- [20:57]
Tracy Alloway
That's a good way of putting it. Wait, I have a bunch of questions. Okay, one, have you noticed any substantial differences in supervisory approaches? Is the BOE doing something different to the Fed versus the boj? I know you said they're all in info collection mode at the moment, but, but like there must be some differences.
- [21:18]
Matt Levine
So generally this stuff goes better in foreign countries than it does in the us, particularly the bank of England. They have like a system wide stress test now where they simulate shocks in theory through like the whole financial system. They're big on macro prudential stuff over there in the U.S. like the fact that the FSOC, the Financial Stability Oversight Council hasn't designated BlackRock or its kin as systemically important under a Biden administration. It'll never happen. And I'm not saying they should have. I mean the idea is like they're not doing banking, they have no short term liabilities, blah blah, blah. But it just doesn't get that same reception abroad. So there's more. You know, I think it'll lean harder in Europe and elsewhere, but for right now the US is just kind of like poking at it in the Stress tests and in data collection.
- [22:08]
Jill Wiesenthal
By the way, you mentioned that one of the binding constraints in the financial system is how much money is just willing to be locked away on a permanent basis. This is really, though, where the role of insurers comes in, because this is money that people put into a pot and they theoretically expect to get all of it back, maybe at some point over the course of a lifetime, et cetera. But that really is a great source of cash for long term money. Can you talk a little bit more about how big that is?
- [22:35]
Matt Levine
Yeah, it's huge and growing. I think you're exactly right. That is sort of a sticky source of funds. And if you hear Apollo talk about their athene insurance unit, it sounds like it's basically unlimited. I mean, they'll say, like, our limit of new private credit is finding good things to invest in, not the source of funds. And so we may see a bifurcation across the system of like, do you have an insurer attached to yourself? I mean, this again goes back to sticky. Funny. Can you get bank leverage? Do you have an insurer attached to yourself? The other thing about insurance is that it still is a savings vehicle and so there still is a limit. Annuities aren't on demand.
- [23:14]
Jill Wiesenthal
They try to layer in stuff so that it looks more and more like an investment over time. It looks more and more like a mutual fund or something like that. So even there, the other question. So we're talking about the distribution of risk across various entities. What about, and I kind of think this might be a core question from an investor perspective of, I guess, the distribution of profitability. And when you look at the profits that come out of prime brokerage units and banks, how do those stack up compared to the profits of traditional banking? And is there a risk that making risky loans, setting aside the risk part, is a profitable business? And does that ultimately impair over time how much money what we call banks can make?
- [23:56]
Tracy Alloway
Good question.
- [23:57]
Matt Levine
I think not. And it goes back to the limit of funding in private credit.
- [24:02]
Jill Wiesenthal
Okay.
- [24:02]
Matt Levine
Like take Covid, for example. In the two weeks after the pandemic really hit in March 2020, banks increased their business loans by 25%. Half a trillion dollars, two weeks. They didn't go to market and issue equity. They didn't go find investors. They are able to create deposits at a keystroke. And that's always going to be the advantage of banks. And so, like I said, private credit, we're seeing them sort of get closer and closer to this kink on their funding curve where all of a sudden the long term wealth lockup sources are scarcer and frankly we're seeing this a little bit. Fundraising is falling in private credit and we're seeing more institutional investors say we're at our alternatives allocation and now it's all the big push is retail. And again, talk about looking more like a bank. That was one of private credit's original promises to us as well. It's like, oh, this is different. This is just safe institutional investors. Now everyone's after the retail money. How can we make a retail vehicle? How can we Tap private credit ETFs?
- [25:04]
Tracy Alloway
They are moving into ETFs, which again is another good example of putting a liquid wrapper on a bunch of illiquid assets.
- [25:11]
Matt Levine
Right. That was the other thing is, oh, private credit doesn't mark to market. Once you have an ETF and we've seen a bunch of banks and non banks start to build out their secondary trading desks for private credit. I mean, it goes back to what Mark Rowan said eventually. What's the difference between public and private?
- [25:26]
Tracy Alloway
Just to go back to something you touched on earlier, do you get the sense that regulatory attitudes towards private credit and banks and the relationship there are starting to change in the sense that Joe and I have talked a lot about how in the Aftermath of the 2008 financial crisis, there were deliberate efforts to shift risk into the shadow banking system. Does it feel like maybe there's some change in the vibes, the regulatory vibes now?
- [25:58]
Matt Levine
Not yet. I think regulators are looking for sure. It's a matter of do they find something? I mean, you talked about this on the episode with Hugh Tracy, how when you ask a private credit investor, you say like, oh, are you guys eating the bank's lunch now? And they sort of wax and wane and they say, well, it's an ecosystem and we're partners. And then they go in the bathroom and scream in the mirror at how embarrassing that is. It goes back to them needing the banks for one and two. I think everyone's sort of happy with the status quo. The question is the direction of travel and that's where the risks are.
- [26:32]
Jill Wiesenthal
I'm just really fascinated by this idea of the kink and the funding curve for private credit, because I'm trying to reconcile that with this idea that at least from Apollo, via all the money that they have for their athene insurance vehicle, it sounds like there's still plenty of money and that they don't need to go out to retail, that they don't need to make ETFs that they just have to find more good deals to employ all of the premiums they're collecting from insurance.
- [26:56]
Matt Levine
Yeah, I think, like I said, we may see some kind of bifurcation. I mean, there's a question about how popular annuities remain and if rates go lower and all that stuff, and I don't have a view on that. What we see from other private credit lenders is they're chasing retail money now because institutional investors are full on private equity, which isn't giving them their money back. They have hedge fund allocations, they have venture capital allocations, and they say, hey, we're full on alternatives now. Insurance is definitely a space where more money can come and more diversification because it is so sticky and long term. But there's a limit to that and it may be that to the partners go the spoils for insurers.
- [27:33]
Jill Wiesenthal
Tracy, I don't understand. Why doesn't every investing firm have an insurer? I mean, this is like Bernie. Sure. Hathaway.
- [27:39]
Matt Levine
Right.
- [27:39]
Jill Wiesenthal
They just collect all those premiums and they have all this money that they can invest. It seems like such a big advantage to have an insurer. And I know various hedge funds they have. Their reinsurance thing is kind of similar. Seems like such a huge advantage.
- [27:49]
Tracy Alloway
Like you should have suggested, Joe, we should have a sales pitch, a deck.
- [27:54]
Jill Wiesenthal
Like, why would you be an investor without an insurance company? I don't really get it.
- [27:57]
Tracy Alloway
The one thing I was thinking about, though, is just going back to this lack of deals point. It kind of feels like if you can't put your money in good deals, like if you can't get a big enough volume of those deals, then the temptation is presumably to try to eke out more returns from the ones you do get and apply leverage. And that's again, like, where some of the risk could come from. That's not a question, that's just a point. I will continue on.
- [28:22]
Jill Wiesenthal
Is that correct?
- [28:24]
Tracy Alloway
One thing I wanted to ask is, you're obviously focused on the financial stability aspect of all of this, but I feel like there's been some macro impact from private credit as well. And if you think about, you know, financial stability is tied very much to fundamental economics, and if the economy is good, then probably you're not going to see a bunch of banks blowing up and that sort of thing. But what are you watching in terms of, like, the real world impact of private credit?
- [28:53]
Matt Levine
So there's absolutely a risk. It's almost a trope now to say, like, this stuff has not seen a downturn Private credit has not seen a downturn and I don't know what's going to happen to it in a downturn either. So sorry, that's a terrible answer. But there obviously is like a credit crisis type risk to this in the same way there is for leverage lending, which has held up well in the past. That's maybe a good analogy. I think part of this you talk about stability. Private credit was really there to offset the bank's hung loans problem in 2022. So rates go from 0 to 5. Banks are sitting on ton on billions of dollars of hung loans, most famously Twitter. And they're in the news again. Talk about the benefits of being private. Everybody knew Morgan Stanley had that Twitter loan. Private credit was really there to take a lot of deals and they did a lot of refinancings in 2023. That problem is worked through on the bank side. And now we're seeing the banks come back and we're seeing private credit do payment in kind. Modifications do extend and pretend type things. The longer part of hire for longer. It goes back to what I said about interest rate risk becoming credit risk. We're seeing that in private credit. In that sense, it's nice that we have these two side by side systems that can cushion each other, but as we've seen, they're increasingly becoming one.
- [30:13]
Jill Wiesenthal
I have one last question that has nothing to do actually with private credit, but I figure you're here and I think you might have some thoughts on this topic. We did an episode probably about two months or so ago about stablecoins and we saw recently Stripe made a $1.1 billion acquisition of a stablecoin company. There are some, I think, issues related to financial stability related to stablecoins. Because anytime you have asset or a product that's pegged one to one against the dollar, we can talk about money markets all the time. But I actually have a separate question than financial stability related to stablecoins. Do you, as a researcher in how the financial system works, take them seriously as something that will be important for payments in the financial system going forward?
- [31:02]
Matt Levine
I'm going to hit you with another trope, which is that I think the tech is good, the product is not. I think this is another area where the big banks will win. I mean, it'll be a stable coin technology. But like now we don't actually experience ACH versus Fedwire versus whatever else. It'll be that it's the right technology. But the ultimate question is payment in what? And you don't want the answer of that question to be usdc, you want it to be a deposit.
- [31:32]
Jill Wiesenthal
I mean I guess my thinking is I actually buy kind of the argument from the stablecoin advocates that it solves a lot of problems with tech interoperability that you will never get a sort of blockchain type solution from all the big banks working together because of lack of trust or whatever it else. I buy that, but I guess to your point specifically, I don't know how big ultimately that demand will be. Especially since as you pointed away, for most payments in most of the world these things are pretty abstracted away. I don't want to jump to conclusions because I know there are underdeveloped banking systems but for much of the world, for much of the wealthy world, a lot of these problems are completely seem abstracted away.
- [32:20]
Matt Levine
The other challenge is to go find a bunch of safe assets to invest in. You know, if you're replacing trillions of dollars of payments, you have to go find a bunch of safe assets. And that's why we run this through banks, because they don't have to find safe assets. They can back deposits with mortgages.
- [32:33]
Jill Wiesenthal
Stephen Kelly, thank you so much for coming on avat. That was great. You answered a bunch of questions. I think that at least in my head had been lingering for a long time.
- [32:40]
Matt Levine
Thanks guys.
- [32:54]
Jill Wiesenthal
Stephen is so good. He's so clear.
- [32:56]
Tracy Alloway
Yes he is. It's always good to catch up with him. I mean I do think like the circular nature of the leverage is obviously a concern. Again like we're talking about relatively small volumes right now but it feels like it could become problematic at some point.
- [33:14]
Jill Wiesenthal
It's interesting, I kind of forget when I think about 2008 and 2009, how much of those first like tremors I guess of the crisis were literally, you know, non banks. And I think, you know, people never talk about those Bear Stearns hedge funds that blew up.
- [33:31]
Tracy Alloway
Yeah, that was the start but that.
- [33:32]
Jill Wiesenthal
Was like really kind of. I mean there was the quant quake, what was that? Late 2006 and that was sort of freaked the market out a little bit. But then it was really like those Bear Stearns hedge funds. And then you mentioned the City one and just this idea that they had these banks, they had these off balance sheet vehicles probably for many of the reasons that the same reasons that shadow banks or private credit or multi strategy hedge funds exist today, less capital intensive vehicles and then they felt the need to bring them on maybe for reputational reasons. I think that's a really interesting history that gets forgotten about no, you're absolutely right.
- [34:06]
Tracy Alloway
And money market funds as well, when they broke the buck. You know, the other thing I was thinking about was just this idea of again, liquid wrappers on illiquid assets. And I kind of think like the ultimate expression of shadow banking has to be someone putting an ETF wrapper on, like private credit.
- [34:24]
Jill Wiesenthal
It's so perfect. They always find a way to do that. They always find a way to like, we're going to get the liquidity premium and then we're going to still give you the liquidity. I think one of the most important points that Steven makes, and I've heard him make it before, is just this idea that the key scarcity in the financial system is cash that's willing to be locked up, cash that's willing to not be sold at an instant or in a demand deposit. There is therefore then this natural constraint on how much, say a private credit firm could take away from the banking system. Because in the end, banks, as we know, as you mentioned, are very levered. How do you recreate that leverage? How do you satisfy the financing demands of the real economy given this constraint in locked up capital? I think it's just a really important concept to keep in mind.
- [35:14]
Tracy Alloway
Yeah. All right, well, shall we leave it there?
- [35:17]
Jill Wiesenthal
Let's leave it there.
- [35:18]
Tracy Alloway
This has been another episode of the Odd Thoughts podcast. I'm Tracy Allowait. You can follow me raceyalloway and I'm Jill Wiesenthal.
- [35:25]
Jill Wiesenthal
You can follow me at the Stalwart, follow Stephen Kelly at Stephen Kelly 49. Follow our producers Carmen Rodriguez at carmenarman, Dashiell Bennett at Dashbot and Kel Brooks at Kale Brooks. Thank you to our producer Moses Andam. For more Odd Lots content, go to bloomberg.comoddlods where we have transcripts, a blog and a new daily newsletter. And you can chat about all of these topics 24. 7 in our Discord Discord ggodlauds and.
- [35:51]
Tracy Alloway
If you enjoy Odd Lots, if you like it when we ask questions about private credit, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. You'll also get access to our new daily newsletter. All you need to do is go to Apple Podcasts and find the Bloomberg channel there and follow the instructions. Thanks for listening.
- [36:51]
Katie Greifeld
Not everybody likes talking about money. Some people find it awkward. Sometimes they even find it a little embarrassing. I do not. I like talking about money. Whether it's the boardroom the newsroom, the trading floor. I've spent the last 30 years talking about money, writing about money and talking about it and writing about it a little bit more. I'm Meryn Zumzet Webb, and every week senior reporter John Stepek and I answer your questions about personal finance, and we discuss the best strategies for making the most of your money. Listen in for the kind of insights and explanations everyone can use to help them make better saving and investment choices for themselves and their families. My question is whether you think maxing out my company Pension Match is enough for when it comes to saving for.
- [37:29]
Matt Levine
My pension, should I attempt to pay.
- [37:32]
Tracy Alloway
My child's university fees and living costs? My partner and I have excess savings, so should we overpay on our mortgage or should we put the money into stocks?
- [37:41]
Katie Greifeld
From Bloomberg podcasts, tune into Marin Talks Money, Follow Marin Talks Money on Apple Podcasts, Spotify or wherever you listen.