People seem eager to tell a story about private credit investments becoming a source of systemic risk in financial markets akin to mortgage-backed securities in 2008.
While the notion that private credit threatens the broader economy may conform to a predetermined narrative, that doesn’t make it true. In fact, the rise of private credit is a direct—and somewhat intentional—consequence of the post-financial crisis regulatory landscape, and there is no reason to think it poses a threat to financial stability.
One reason for this is that private credit actually represents a small proportion of the value in U.S. financial markets. The segment of private credit currently drawing the most attention—direct lending—is estimated to be roughly a $1 trillion market, or just three percent, of the $30 trillion U.S. economy. By contrast, the mortgage market exceeded $10 trillion ahead of the 2008 crisis when U.S. GDP was about $15 trillion.
In 2010, Dodd-Frank imposed strict lending constraints on banks that effectively pushed risk out of the banking system by making it more difficult for a wide variety of activities across the economy to obtain bank financing. This led to the growth of private credit over the subsequent 15 years, which was Dodd-Frank’s explicit intent.
It wasn’t the intent of Congress to impose an absolute reduction in the availability of credit in the economy; it just didn’t want banks to be on the hook for much of the lending. Private credit as we know it today, in effect, emerged as a complement to bank lending, diversifying lending sources and filling an important gap created by regulatory constraints.
The big difference between private credit and bank lending is that private credit is funded by large, sophisticated investors that commit capital for a defined, longer-term period. These investors face restrictions on drawing their funds before the end of the investment term. Bank depositors, on the other hand, can access their money on demand. This structure—where capital is committed for the duration of the investment—helps provide stability and allows private credit to function effectively as a source of long-term financing.
Any losses in private credit are also borne by investors, with no expectation for public support or that risks will be shifted to taxpayers. Since investors’ capital is committed for an extended period of time, private credit funds don’t have to sell assets at the first sign of trouble. These features don’t eliminate risk, but they help contain it—ensuring that stress remains with investors rather than cascading through the broader financial system.
If a bank experiences a steep reduction in deposits, it must begin liquidating its assets, which may include calling in loans. As we learned from the collapse of Silicon Valley Bank, deposit insurance alone isn’t enough to stanch bank runs when a significant proportion of depositors are above the insured limit.
These structural differences explain why many current and former policymakers do not view private credit as a systemic risk. Federal Reserve Chairman Jerome Powell has repeatedly emphasized that the core sources of financial instability come from leverage and runnable funding—features largely absent from private credit. Former Fed Vice Chairman Roger Ferguson and former New York Fed president William Dudley have made a similar point.
There are other reasons why private credit is unlikely to ignite any sort of financial crisis: While the total amount of private credit in the U.S. is approaching $3 trillion, it constitutes a small fraction of the $40 trillion in total nonfinancial debt in the U.S.
Further, there is considerable heterogeneity across private credit investments, unlike what occurred in 2008, where there was widespread and concentrated exposure to mortgage-backed securities. That diversity makes it unlikely that private credit valuations would move in lockstep across the industry.
It’s human nature to look for patterns and to try to analogize current conditions to previous events, but efforts to paint private credit as somehow akin to the toxic mortgage-backed securities in the 2000s and suggest that they present risks to the economy similar to what existed in 2007–2008 are misguided. These comparisons fundamentally misconstrue the nature of private credit and the condition of the U.S. economy and global financial markets.
