Boom and bust. Fear and greed. Despite the advances in intelligence, both real and artificial, that shape our lives, financial decisions often boil down to raw human emotion. The cycle of financial markets is one of repetition—errors are repeated, bandwagons are jumped on, and boundaries are pushed until they break, leaving devastation in their wake.
The rise and fall of financial markets often share a common ingredient. During the ascent, terms like leverage and credit are used to gloss over potential dangers. However, when the inevitable collapse occurs, harsher words like debt and liabilities dominate the headlines. Every major stock market boom in the past fifty years has been driven by deregulation, lax credit standards, or financial innovations that bypass regulatory scrutiny.
In the aftermath of these collapses, investigations promise lessons learned. The 1980s’ decade of greed was fueled by financial deregulation, while the noughties’ boom was driven by a loosening of regulations, culminating in the Global Financial Crisis. Currently, a stock market frenzy centered around US-based technology companies is pulling global markets along, with valuations reaching unsustainable levels.
Private Credit: A Growing Threat
Recently, attention has shifted to private credit, the counterpart to private equity, and its potential to destabilize the financial system. JP Morgan Chase CEO Jamie Dimon, who survived the 2009 banking meltdown, recently issued a stark warning. “I probably shouldn’t say this, but when you see one cockroach, there are probably more. Everyone should be forewarned,” he stated.
His comments followed reports of troubles at US auto financing groups Tricolor Holdings and First Brands Group, which lent to sub-prime borrowers through private credit markets. These lending facilities operate outside traditional banking, raising funds from wealthy individuals and pension funds to extend loans to borrowers who don’t meet major banks’ credit standards.
While profitable during booms, these higher rates come with increased risk. The Reserve Bank reports that private credit quadrupled in the decade leading up to 2023, reaching $US2.1 trillion globally, and has since grown to $US3 trillion. Most of this growth has occurred in the US, with Europe quickly catching up.
“Non-bank lenders have played an increasingly large role in lending to risky companies, in part because some business lending has become more expensive for banks; regulatory reforms after the global financial crisis raised banks’ capital requirements,” noted a report last year.
Australia’s Private Credit Landscape
Australia, known for its substantial national savings pool through its compulsory superannuation system, has also seen a rise in private credit. The Australian Securities and Investment Commission (ASIC) has been investigating the $1 billion collapse of the First Guardian Master Fund and Shield Master Fund, highlighting sector vulnerabilities.
Approximately a quarter of Australia’s $4 trillion superannuation pool is self-managed and not protected by the Australian Prudential Regulatory Authority. Many self-managed super funds (SMSFs) and major funds have invested in private credit, attracted by the high returns.
Private credit operators now provide about 14% of loans to Australian corporations, with a significant portion directed towards commercial real estate, particularly property developers. Of the $200 billion raised in Australia, around half is funneled into real estate.
Property development is risky, with high upfront costs and long delays before returns are realized. Non-bank lenders have embraced developers, offering financing where traditional banks hesitate. Booming residential real estate has kept many developers afloat, but the specter of past collapses like Fincorp, Westpoint, and Australian Capital Reserve looms large.
Reviving Past Mistakes
ASIC recently released a report on private credit, signaling a strategy to gain insight into this expanding sector and raise standards. The report uncovered practices reminiscent of the debenture debacle nearly 20 years ago, including conflicts of interest, fee gouging, and hiding troubled loans.
These outsized returns often come from investors’ money. Loans to related parties and claims of protection by first mortgages over real estate, which often lack security, are prevalent. The report emphasizes that private credit has a role and, if properly monitored, could be beneficial.
However, lenders operating outside the banking system without oversight in a debt-laden world could trigger a shift from greed to fear. As the private credit market continues to grow, the need for regulation and transparency becomes increasingly urgent to prevent history from repeating itself.
