This is a slightly different kind of post than I usually do. And much longer. Some people might say "boring" or "too long" or "you're not fun anymore Chad" or "why would you do this, I trusted you." But bear with me here. You might walk away from this feeling like you accomplished something for the day. Or think wow I had no idea how much I love hearing this stuff.
There's Alcohol in That
If you have been paying attention to your morning institutional private credit publication, and I know most of you are, private credit is dealing with some not so private issues. Redemption freezes. Funds restricting withdrawals. Default rates climbing.
Have you ever watched a financial product blow up and thought "didn't we already do this?" I have. I'm watching it right now. I have learned that whatever Wall Street sells it's probably not something I want to be buying. Wall Street is not altruistic.
But here's the thing. None of this is new. Everyone loves to say "history doesn't repeat itself but it often rhymes." We've been rhyming the same verse for decades and nobody changes the song. And if you own private credit, private equity, or a non-traded REIT in your portfolio right now, you need to understand why that should make you uncomfortable.
The Ghost of 2008
Let me take you back to a product called auction rate securities. ARS for short. Unless you worked in finance in the mid-2000s you've probably never heard of them. That's by design. Wall Street has a short memory when it's convenient.
Here's how they worked. ARS were long-term bonds with 20 to 30 year maturities. But they were sold to investors as short-term, highly liquid, cash-like instruments. The trick was an auction mechanism that reset the interest rate every 7, 14, or 28 days. As long as the auctions kept working, you could get your money out whenever you wanted. It felt like a savings account that paid better than a CD.
By 2008 the ARS market had grown to over $330 billion. Retail investors and high-net-worth individuals were the biggest buyers. Their advisors told them it was safe. Liquid. Basically cash with a better yield.
Then in February 2008 the auctions stopped working. The big banks that had been backstopping the auctions with their own capital had some bigger issues with some sort of housing issue and then decided they couldn't afford to do it anymore. Within days, auctions were failing. Investors who thought they could access their money in a week found out they couldn't access it at all. Some had their holdings marked down 20% or more overnight. Modern day I have seen at least a dozen private credit managers take loans that were worth 100 cents on the dollar on Tuesday and mark them at 0 Wednesday morning.
The product that was sold as "basically cash" turned out to be a 30-year bond you couldn't sell.
Now Look at Private Credit
Private credit is a $1.8 trillion market as of today. It has been one of the hottest products for the last several years. Advisors have been putting clients into private credit funds, and business development companies (BDC's) so fast it would make you feel like a cartoon character getting hit in the head with a brick.
The pitch sounds familiar. "Institutional quality." "Diversified lending." "Steady income." "Low correlation to public markets." "This is how the big endowments invest."
Sound like a better option with better yield to you? It should. Because that's exactly how ARS were sold too.
Here's where it gets uncomfortable. The underlying loans in most private credit funds have terms of 3 to 7 years. But the funds themselves often offer quarterly redemption windows. That means you have illiquid assets stuffed inside a wrapper that promises liquidity. As long as more money is coming in than going out, it works fine. The moment that reverses, you have a problem.
We're at that moment right now.
Blue Owl, Blackstone, and BlackRock have all faced waves of withdrawal requests in recent weeks. Funds are restricting redemptions. Managers are scrambling to find ways to create liquidity that doesn't exist naturally in the underlying assets. Continuation vehicles. Secondaries markets. Financial engineering designed to make it look like everything is fine.
Good Thing It's Only 1.8 Trillion
Both products were sold to retail and high-net-worth investors as safe, yield-generating alternatives to boring old cash or bonds. Both promised better returns with "institutional" quality and the ability to get your money when you need it. The problem is that calling something liquid doesn't make it liquid. ARS were 30-year bonds masquerading as weekly liquid instruments. Private credit funds hold multi-year loans but offer quarterly redemption windows. In both cases, the liquidity promise only worked as long as nobody actually tested it. When people tested it, it broke.
Here's what kept the ARS market working for over 20 years. The big banks would step in as bidders of last resort every time an auction looked shaky. They did this quietly, consistently, and it gave everyone the impression that the system was bulletproof. Then one day they stopped showing up and the whole market froze overnight. Private credit managers have been running a similar play. Secondaries markets, NAV lending, continuation vehicles. Every tool in the box to manage redemptions and maintain the appearance of stability. The question nobody wants to answer is what happens when those tools stop working.
The disclosure problems are the same too. ARS investors didn't understand the penalty rate structures or what would happen if auctions failed. Their advisors didn't explain it because the auctions had never really failed before. Why worry about something that's never happened? Private credit investors today are in a similar spot. The DOJ has publicly warned about questionable valuation practices in private portfolios. The SEC is investigating the reliability of private credit ratings. Quarterly statements tell you a number but they don't tell you much about what's actually going on underneath.
And the retail investor got there last. This is the part that really gets me. With ARS, institutional money was already pulling back before retail investors even knew there was a problem. The same pattern is emerging in private credit. While sophisticated investors are looking for the exits, the industry has been pushing hard to get private credit into 401(k) plans and retail portfolios. When the product was only for institutions, the risks were contained. Now that retail is in, the risks are distributed to the people least equipped to understand them.
The Scale Problem
The ARS market was $330 billion when it froze. Private credit is $1.8 trillion. And unlike ARS, private credit is woven into the broader financial system in ways that most people don't appreciate. Banks fund private credit managers. Insurance companies are major investors. The connections run deep.
The headline default rate in private credit has been reported below 2% for years. That sounds reassuring until you dig into it. Once you account for selective defaults and what the industry politely calls "liability management exercises," the true default rate is reported to be closer to 5%. Partners Group, one of the largest private market firms in the world, has said default rates could double in the next few years.
The Question You Should Be Asking
If you own private credit, a non-traded REIT, or a private equity fund, ask yourself a few things.
Can I get to my money right now if I needed to?
Can my advisor explain in plain English what the underlying holdings are, what the current real value is, and what the total fee structure looks like? (more on this another time, I have a great story to tell)
If I asked for all of that in writing, how long would it take to get it? And would I be able to understand it? (I'm personally convinced that the individuals selling it don't understand it)
If the answers make you uncomfortable, they should.
There's Alcohol in That
I keep coming back to this scene from Landman. (highly recommend) Tommy tells the bartender he quit drinking but he'll stick with beer. The bartender just looks at him. "You know there's alcohol in that, right?"
A lot of investors think they're playing it safe because their advisor put them in "institutional quality" private credit, equity, real estate. They quit the commoner investments. Now they just own alternative investments because that's what sophisticated investors do.
But the risks didn't go away. They just got harder to see. The illiquidity is still there. The opacity is still there. The conflicts of interest are still there. And now that the market is under real stress for the first time, all of it is starting to surface.
If you own these products, I'm not saying panic. I'm saying pay attention. Not all private credit is bad, just like 2008, ARS didn't all go to 0, same thing with mortgages, but it sure isn't fun looking at a statement wondering what it's actually worth, and when you might be able to get your money back out.
There's alcohol in that.
But Chad why would you do this to me? Make me read all of this? It's because I love you.