Lizzie O'Leary (2:52)

At the time I worked for Bloomberg News covering economic policy in Washington and I remember the whispers that something was starting to go wrong in the mortgage market. We all know what happened next. The financial crisis. And now some 18 years later, I'm hearing little conversations and worries about something called the private credit market, a kind of financing that is very big in tech.

Tracy Alloway (3:20)

I think the vibes are actually very similar. And in fact, if we just look at this on a sort of behavioral Wall street basis, like let's pretend to be anthropologists of the financial industry at the moment, some of the behaviors you're seeing right now look very similar to what we saw in sort of 2007, 2008. So you have some pretty big funds who are saying we're not going to let investors pull out their money. They're allowed to do that. But the headlines are very similar to what we saw in, you know, 2007, 2008, with a few subprime funds back then. We're starting to see reports of private credit lenders having these sort of all hands on deck phone calls where they're trying to reassure their employees. We're starting to see major banks publish their exposure to private credit, which again, if you recall early 2008, you had a lot of big banks publishing their own exposure to subprime. So, you know, history doesn't necessarily repeat, but it definitely rhymes and it's rhyming right now.

Lizzie O'Leary (4:21)

Is it time to freak out?

Tracy Alloway (4:24)

Okay, so everyone is asking that question. I get frustrated when people talk about private credit and it's like, either it's a 2008 style financial crisis or it's not worth talking about at all. That's the wrong way to think about it, in my opinion. Like, even if you're not going to get a 2008 Redux. Exactly. And again, remember, 2008 was, you know, the worst financial crisis that we've ever had, basically. Certainly in modern times, even if you don't get that, it is definitely worth talking about private credit because it's this huge, fast growing industry. It's become more and more important to both banks and insurers. And I would argue everyone should care about what's going on with banks and insurers. And it's also become this really important engine of financing and credit to the wider economy. So if you think about the past few years, we had pretty high interest rates, like benchmark interest rates, than we've had in a very long time. We didn't really see a wave of bankruptcies from those additional financing costs. The US Economy kept growing. A lot of people would argue that's because you had this additional outlet from private credit which was extending financing to corporate America. So there are reasons to care about this even if we're not talking about a 2008 repeat.

Lizzie O'Leary (5:45)

Today on the show, a big financial engine of the tech industry is looking more and more uncertain. It's time to pay attention. I'm Lizzie o' Leary and you're listening to what Next? Tbd, a show about technology, power and how the future will be determined. Stick around. Foreign. What's it cost to invest with the Fidelity app?

Tracy Alloway (6:18)

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Lizzie O'Leary (6:25)

Hmm, that's music to my ears. I can only talk

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including risk of loss.

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Lizzie O'Leary (6:46)

so the words private credit like that makes sense, but I think a lot of people have no idea what the private credit market is. Let's do some private credit 101. What is it? How does it work?

Tracy Alloway (6:57)

Yeah, so it is totally fair to not totally understand what private credit actually is. So definitions are going to vary. Definitions of the size of the market certainly vary quite a lot. I've seen estimates like 1.3 trillion in size all the way up to more then 3 trillion, again just depending on how you account for it. But I think the other reason people are confused is because private credit kind of underwent a branding, a rebranding exercise very quietly. And I only just, just realized this myself like last year. But in the Aftermath of the 2008 financial crisis, we used to call private credit shadow banking. And I was a US Financial correspondent for the Financial Times at that time. And I remember writing all these headlines about, you know, shadow banking sector growing thanks to post 2008 banking regulation. That's what we called it. And the basic idea was that in the aftermath of 2008, policymakers did not want to see, you know, a repeat of that particular financial crisis. They did not want to be on the hook for bailing out banks yet again. It was very politically unpopular as you know. And so they designed these post crisis rules that basically made it more difficult for banks to engage in certain activities, including riskier lending. And so what happened, you know, 29 onwards is you had the slow migration of riskier lending outside of the banking system into other types of credit entities. And the one that springs to mind right now is something called a business development company, a bdc.

Lizzie O'Leary (8:31)

What is that?

Tracy Alloway (8:33)

So it's basically an alternative lender. It's you know, a fund or a company that makes other loans. And the big important thing to realize about BDCs is they're not regulated banks, they are not deposit taking institutions. So if a BDC gets in trouble because it makes a bunch of bad loans, theoretically that's not going to reverberate around the financial system in the same way that we saw in 2008 when banks made a bunch of bad mortgages and then, you know, built additional leverage on top of that. And that was the thinking. The thinking was, well, we can't eliminate credit risk entirely from the financial system, but what we can do is hive it off to these non bank lenders, these shadow banks now called private credit. And that would help insulate us from any, you know, risk that might come about in future years. And so here we are in 2026 and shadow banking, slash private credit has grown enormously fast. So again, we're talking like 1.8 to maybe $3 trillion worth of credit. And that's something to emphasize here. Like this is an incredibly fast growing industry. It's actually again depending on the size of the market than the junk rated US bond market now. And the junk rated US bond market has been around since the 1970s. So here is something that has gotten bigger than another market that's been here for decades in just a few years.

Lizzie O'Leary (9:58)

I think that context is really helpful because you can say, oh my gosh, 1 trillion, 3 trillion, that's a lot of money. But also like if you look at US equity markets, we're talking 60 plus trillion. This is, this is big but not enormous.

Tracy Alloway (10:13)

Yeah, it's a drop in the bucket of like US financial assets overall. But again, I think the speed and the rate of growth is, is really worth highlighting here. It's been a phenomenally profitable business for a lot of the entities who have been engaging in this activity. And it's getting bigger. Right. So one thing worth mentioning here, again going back to why we should actually care about what private credit is doing, even if it's not necessarily going to lead to another 2008 style crisis, is we've just seen some of the rules around what can to people's 401ks loosened up to include alternative assets, which would be private credit.

Lizzie O'Leary (10:52)

So what is private credit useful for? Who wants this kind of different loan that's not a traditional bank loan, that maybe, you know, you're talking higher interest rates but complicated terms, different terms than you or I would take for a Very standard investment.

Tracy Alloway (11:08)

So you have it exactly right here. There are reasons that people would actually want to engage in a private credit deal on the part of investors. If you invest in private credit, you're generally looking at juicier yields, returns than you would necessarily see from the public market. If you're a company looking to borrow, you might want a deal, a financing arrangement that's more customizable, more suited to your particular business needs. And it's probably helpful here if I just talk a little bit about the difference between public and private credit markets. So in public markets you have loans and bonds, and we generally say they're syndicated out to the market. So there's a loan and you can sell it on to investors. The loan or the bond is usually rated by one of the big credit rating agencies people are familiar with.

Lizzie O'Leary (11:58)

It's a triple A, whatever, exactly like

Tracy Alloway (12:01)

Moody's, S and P, all those familiar names. And then that bond or loan gets traded in the open market. Now, it doesn't get traded as much as an equity, a stock, but it gets traded. So there's some price discovery there. You generally have a decent idea of how much that bond or loan is worth in the private credit market. You know, the clue is in the name. It's a private transaction between investors, you know, maybe a club of investors and a company. So it doesn't trade as much. You don't have as much transparency on the price. And often the deals are unrated. So you're not getting as much information from a sort of third party service about how the company is performing, what the balance sheet looks like. You have to do your own due diligence. And again, that's where you start to see some of the mistrust of this sector come in. A lot of people will have opinions on what the opinion of the credit rating agencies are worth anyway. But like in a lot of the private credit deals, you don't have any ratings at all.

Lizzie O'Leary (13:03)

Our show focuses on sort of tech and power and how these things come together. And private credit has been a pretty big deal in the tech industry. And I wonder if you could explain why this kind of financing is so appealing in technology.

Tracy Alloway (13:20)

Yeah, it's a really good question. So I would argue that, you know, tech is very attractive for investors in general. It's generally believed to be a growth area. And so a lot of investors naturally sort of migrate to that tech exposure. One thing that is true is once you start diving deeper into private credit overall and looking at what types of industries have actually seen the most Private credit activity or private credit lending. There's a lot of software. A lot, A lot of software. And this raises some interesting questions because now we are in the age of AI. We are in the age of Claude code. Claude code. There are a lot of people out there right now who think that that poses an existential threat to a lot of SaaS businesses.

Lizzie O'Leary (14:04)

Software as a service.

Tracy Alloway (14:06)

Exactly. This idea that, you know, I, I might have a piece of software that I have dedicated customers to, but someone out there can use Claude code to basically replicate that entire service and absolutely demolish my business model in the space of weeks, potentially. So that's where a lot of the concern around private credit has come from. This idea that, well, a big chunk of it is actually two software companies because they were a big part of, of the US economy. They still are a big part of the US economy, but now they're a big part of the US economy with a large question mark over their future. And so that's where we started to see some of the anxieties over private credit actually erupt. One of the worries right now with private credit and software is that we're talking about software companies with a lot of intangible assets. It's basically just, you know, I guess, some computers, some engineers, server space and, and a brand. And so if those really start to fail, private cred investors won't necessarily have a lot of hard assets that they can tap to try to make up their losses. So there's some nuance here.

Lizzie O'Leary (15:12)

One of the kind of dorky things that I wanted to ask you about is how to value these things and how their valuation gets looked at on, you know, a balance sheet or someone's portfolio, because it's different than a lot of other assets. And that has added to some of this worry. Could you explain that part of it?

Tracy Alloway (15:35)

Yeah. So this goes back to the difference between public versus private loans and bonds. And if you think I'm going to go one step higher and talk about the stock market right now, but, you know, if you want to know the value of a Tesla share, you can look it up pretty easily. It's trading, you know, hundreds, thousands, possibly millions of times per day. And there's a live price quote that tells you exactly how much that thing would sell for. If you were to go into the market right now and actually try to unload some of your exposure with private credit, that's not really the case. Okay. Again, these things do not trade on a regular basis, if at all. And so what tends to happen when it comes to valuations is if you are a private credit fund, you have all of these private assets on your book. You hire a third party pricing service provider, experts in pricing, and they're going to look at that particular private loan or private bond on a probably quarterly basis and they're going to try to triangulate from other, you know, figures, other external signs, how much they think that bond or loan is actually worth at that particular moment in time. Obviously, people tend to get a little bit nervous about that. The idea being, well, you know, the market probably moves faster than on a quarterly basis. And so if you're doing this on a quarterly lag, it might mean that the marks are falling behind reality. What it also means is that if everyone were to try to sell their private credit at once and basically head for the exits at once, it is very unlikely that they're actually going to be able to crystallize the marks that are currently on their books.

Lizzie O'Leary (17:22)

After the break. The AI industry has been doing some funky financing too. Could we be headed for a combination of private credit AI debt doomsday scenario? So what we have seen recently is that some people want to take their money out. What has that done?

Tracy Alloway (17:53)

So we've had a bunch of headlines about private credit funds basically saying that they're limiting the amount of money that investors in their fund can take out. And the reaction that you tend to get when you see those headlines, there are a lot of private credit bros out there who will say, well, obviously this is the way the funds are supposed to work. If you read the prospectus for the fund, if you read the documentation, it says right there that the manager is allowed to limit redemptions as they see fit. And again, there's some reasonable, you know, intent behind doing this. And the intent is basically trying to stop the scenario that I just described to you, which is everyone heading for the exits all at once and the fund having to liquidate at basically fire sale emergency prices. So the idea is, well, if you can kind of create an orderly exit from the fund, if you can manage the outflows, then the fund doesn't have to sell as much at depressed prices when everyone's panicking. And it can kind of manage its way through a down cycle in the credit market. That all seems very reasonable, but it doesn't really stop the fundamental thing that is happening here, which is you have a lot of investors who are worried about getting out at the moment and maybe private credit funds will be able to manage their way through the cycle. But also it's A very different environment to how those funds have been operating for the past four or five years. You know, you think, again, private credit was a huge success story on Wall Street. It was all inflows, it was all investors looking for additional yield. Now the tide is turning. And so people, again, are getting pretty nervous because this is something that private credit hasn't really had to deal with before.

Lizzie O'Leary (19:37)

There's this other aspect of this that I wanted to ask you about, which is slightly different, where many of the companies that are big in the AI boom are also selling their debt largely so that they can get more money without having to dilute their stock by selling it. How much is that tied to the overall credit worry? It just feels like there's a lot of debt going around.

Tracy Alloway (20:02)

Yeah. So this is where I start to get a little bit concerned is the sort of interconnectedness of all of this happening at the same time. And Richard Bookstaber actually wrote a great piece in, I think it was the New York Times recently talking about this idea that, well, you know, AI is basically driving the US economy at the moment, or has been for the past year or so for a while. Yeah. If you start to break down some of what we've seen in US gdp, a lot of that is just going into building the infrastructure data centers needed for AI. And a lot of that financing is coming from various parts of the credit market. Now, it might be a bank loan, but it might also be a private financing deal. It might be a securitization of data center cash flows. And so the worry to me is if you start to see some doubts about the hyperscaler build, I guess at the same time that you're seeing doubts about the credit market. And this is kind of setting aside everything that's happening with the Iran situation and the overall stock market. But you. You have a chance here for a lot to unravel all at once. And that, like, that to me is kind of concerning.

Lizzie O'Leary (21:17)

I mean, we just saw one of OpenAI's data centers canceled because it couldn't reach terms with Oracle. Like, there is nervousness in that kind of funding. Ouroboros. I never pronounced that word correctly.

Tracy Alloway (21:29)

Ouroboros. Yeah, it's a good word. It's a good word to describe it. Yeah.

Lizzie O'Leary (21:32)

So if you add to that the other things that you just mentioned, gas prices are rising, the stock market is bouncing around every other day based on what the President says, and we don't know what's going to happen in Iran. How does the Trump administration look at the private credit market, does it say this is not our problem, Wall Street's got this or e this might be something that bleeds over into the rest of the economy.

Tracy Alloway (22:02)

Yeah. So I think there's a world where the Trump administration can kind of wash its hands of private credit and say, you know what, this is not a systemic issue. This is something that lies outside the banking system. But again, I would argue that there two things to worry about in that context. So number one is something I talked about earlier, which is this idea that private credit, because it's grown so fast, especially in recent years, has basically been this additional spigot for the U.S. economy. You know, if you're maybe a smaller medium sized business looking for financing in an era of higher rates, private credit could be your go to in some situations. So if the private credit spigot gets shut off suddenly you have a bunch of companies that might find it more diffic to get loans. The other potential concern, and this is where we start to see shades of 2008, is it is not entirely clear how much exposure some of the banks actually have to the private credit system. And the reason I say that is because even though we talked earlier about banks not wanting or not being able to extend as much risky credit in the aftermath of 2008 because of all those new rules, they have still managed to find a way to have a piece of the private credit pie.

Lizzie O'Leary (23:22)

I thought they weren't supposed to do that because of Dodd Frank.

Tracy Alloway (23:25)

Yeah. So it's kind of weird and I've been describing the relationship between banks and private credit as frenemies because they're basically competing for the same business, but they're also partnering up in order to do it. So actually a Moody's report hit my inbox saying that bank exposure to non depository financial institutions, so private credit shadow banks, non banks is now 1.4 trillion, which is up from like basically nothing. So that would be about 10% of total loan exposure in the deposit taking banking system versus like maybe 1 or 2% like 10 years ago. So there is exposure there. And the concern is that if you have a bunch of banks who are basically lending to non banks who are lending to riskier credits, that that's going to come back into deposit taking, you know, realm which is exactly what post financial crisis rules were meant to eliminate. The other vector where this could become kind of systemic is one of the big buyers of private credit has been insurance companies and insurers and banks are where, you know, if you're a regulator or a policymaker in the Trump administration, you probably should start getting a little bit nervous.

Lizzie O'Leary (24:45)

Are they doing that at all? After all, they've had an extremely deregulatory push in this administration.

Tracy Alloway (24:52)

Yeah, it's hard for me to judge. Right. Like, this is not necessarily the most transparent administration of all time. The headlines I've seen so far, we have had one of the insurance regulators say that they are going to take a harder look at some of the unrated private credit sitting on insurer balance sheets and they could potentially require insurers to hold more capital against that private credit. Again, that was a change that was announced fairly recently. So we haven't actually seen much action on that front. The action that we have seen is in the deregulatory bent, as you describe it, which is, well, let's allow in retail investors, mom and Pop, to have access to private credit and alternative assets in their 401ks if they want to.

Lizzie O'Leary (25:40)

Okay, so this is where I was going with this because I think if you are not someone who follows the markets or who is particularly interested in this, this might sound confusing. But as you have mentioned, the Department of Labor recently released this proposed rule that would allow alternative assets like private credit to be in Americans retirement accounts. And that to me is like a, hey, even if all of this stuff makes your head spin, you maybe should pay attention to this because suddenly if it's in your retirement account and we have a big problem, that's an everybody problem.

Tracy Alloway (26:19)

Absolutely. And a lot of people are going to see that headline about the proposed change and think that, well, this sounds like retail is exit liquidity. Right. This sounds like a bunch of professional investors in private credit are now looking for someone to shift this stuff onto. And one of the things that you will hear from private credit experts all the time is, oh, it's not that the asset class is inherently risky, it's that you have to do your due diligence. You're talking about these customized deals between a single or club of lenders and a particular company. They're not being rated, they're not being put out into the overall market for other investors to judge. And so it's really up to the lender to figure out if they're doing a smart deal. It is very hard as a sort of ordinary investor, mom and Pop is the classic example, to figure out whether or not, you know, something that is actually as opaque as private credit is actually being, you know, well managed and with deal terms that are favorable to the lender. Like the idea that someone with a 401k is going to be able to have very good insight into whatever private credit is getting stuffed into their retirement portfolio. I think is. Is very difficult to argue.

Lizzie O'Leary (27:36)

I have this really strong memory from 2008 that, like, I think about all the time. It was when Congress passed the. The initial TARP proposal. I don't even think they passed it, but they came out with a proposal. And I was sitting on the floor holding my little microphone right next to Ben Bernanke, and I could see that his hands were shaking. And I didn't really know that much about this at the time because I had just started covering, but I had this moment of realizing, oh my God, the Fed chairman's hands are shaking. This seems bad, but what made it bad was that it was so systemic, that it was so interconnected. And I guess my biggest question for you is, how interconnected is the private credit market? Is it Ben Bernanke's hands shake or is it some companies fail and it sucks for them, but we're okay?

Tracy Alloway (28:29)

So I think this is exactly the question to be asking right now, and I'm gonna tell you right away, I do not have the exact answer. I'm not sure anyone does at the moment. But again, like, that is why the regulators should be looking into this and why, even if their hands aren't necessarily sh. Just yet, their hands should be very busy, you know, typing and looking up interconnections and exposure and leverage built upon leverage within the financial system. There are some, like, little hints of areas that I would be worried about. So I mentioned that the banks have been lending to private credit entities in this sort of roundabout way, and that there is exposure there in a way that we didn't have before. One of the ways the banks have managed that exposure is they've been striking something called a synthetic risk transfer, where they basically ensure some of their credit exposure in the market by striking a deal with other investors. And again, like, you covered the financial crisis, if you hear the word synthetic risk transfer.

Lizzie O'Leary (29:30)

Yes, yes. I start thinking synthetic cdo and I'm like, that's. That was bad. It was really bad.

Tracy Alloway (29:36)

Exactly. And there are some estimates floating around for, like, how big those deals actually are in the market. And again, they're not, like, they're not numbers that would immediately set alarm bells ringing. But again, in two, 2008, a lot of these interconnections weren't clear at that time either. Right. Like, we had to kind of figure out that there were subprime mortgages and people had built derivatives on top of subprime mortgages, and then people had used subprime mortgages as collateral in the interbank lending system, the repo market. And it's hard to figure those things out. Like all of those markets tend to be very, very opaque. And once you add private credit in the mix and then try to figure out what's going on with private cred being used as collateral in the repo market, it just becomes very, very difficult to untangle. So I would be surprised. Maybe this is me projecting some hopefulness on the situation. But regulators should be looking at this right now. They should be trying to figure out what those exposure figures and those interconnections actually look like. We're probably not at these sort of foothills of a 2008 style financial crisis. But again, that doesn't mean that you should shouldn't think about it. It doesn't mean that you shouldn't worry about it. This is an important part of the financial system. It's a fast growing part of Wall street and it's an important source of financing for corporate America. And we should really be trying to understand how it all works.

Lizzie O'Leary (31:05)

And I would imagine if you are running an AI company right now, you should be thinking pretty hard about this stuff.

Tracy Alloway (31:10)

Absolutely.

Lizzie O'Leary (31:14)

Tracy Alloway, thank you so much for coming on.

Tracy Alloway (31:17)

Thank you so much for having me. It was fun to reminisce about the 2008 financial crisis.

Lizzie O'Leary (31:26)

Tracee Alloway is a co host of the Odd Lots podcast. All right, that is it for our show today. What Next TBD is produced by Patrick Fort and edited by Evan Campbell. Paige Osborne is the senior supervising producer for what Next and what Next tbd. Mia Lo Bell is the executive producer here at Slate. TBD is part of the larger what Next family. And we'll be back on Sunday with an experiment in vibe coding. I'm Lizzie o'. Leary. Thanks so much for listening.