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The economist Hyman Minsky believed the financial system was prone to instability: tranquil conditions would inevitably give way to speculative excess. He observed that lengthy bull markets stoked complacency over risk. Recently, analysts have been debating whether private capital, where some of the greatest excesses have been evident, would soon meet their so-called “Minsky moment” — the point when the excess implodes. It has not happened, yet.
Minsky’s hypothesis could play out differently in more opaque private capital markets, which invest in equity, credit, real estate and other alternative assets that are not traded publicly. The industry has boomed since the global financial crisis. It stepped up as post-2008 regulatory reforms caused banks to pull back from riskier lending. Globally, assets under management have grown roughly fivefold since the crisis to over $11tn now. Blackstone, Apollo, KKR and Carlyle — the largest listed fund managers — hold over $2tn of that. Hundreds of new players have streamed in annually since the early 2010s too. Like other fast-growing corners of the financial world, the market was juiced by a decade of low interest rates which sparked a search for yield among investors and provided ample capital.
Rapid rate rises from the US Federal Reserve — and the possibility that they may stay higher for longer to tackle sticky inflation — have prompted suggestions that private markets will prove to be a house of cards. Howard Marks, co-founder of Oaktree Capital Management, recently warned that the roughly $1.5tn private credit segment — which lends to businesses — would be tested by tighter conditions and low growth. The competitive frenzy to sign loan deals in the period before rates soared has raised questions over the level of due diligence conducted by funds.
In time, higher rates could hurt the industry badly. Private equity — the business of buying, restructuring and selling firms — which makes up the bulk of the market, is becoming harder. Low interest rates had supported lofty valuations and funding, until now. On the credit side, floating-rate loans could become harder to service and, combined with low growth, drive corporate defaults.
A slow hiss, rather than a sudden pop, may be more likely. As low-rate deals are refinanced, debtors will feel the pinch over time. Private markets also remain popular. Some even suggest a “golden moment” is in store for private lending as banking turmoil leads to retrenchment by traditional credit providers and as rates look more attractive. A gradual deflating of some overleveraged segments of the market would be preferable to a Minsky-like crunch.
Either way, the growth of private markets is generally welcome. Free from the pressures of quarterly reporting, they allocate capital for years at a time and can support the economy when banks tighten up. Moreover, shifting risky lending away from banks — where funding demands instant liquidity — into long-term credit funds, pushes risk away from retail depositors and on to professional investors.
But the full risks are unknown. The sector has grown quickly and away from scrutiny. A more relaxed approach to valuations and due diligence might hide significant exposures. It is also unclear how interlinked the sector is with other markets and banks. And, growing retail investor interest means it is not just wealthy institutional clients shouldering the risk. Efforts to improve the monitoring of systemic risks in the sector, and to better assist investors in evaluating products, would be welcome.
The financial problems of recent months — in the UK pensions market, with Silicon Valley Bank’s niche business model, and the rate risks on bank balance sheets — have all been sitting in plain sight before they went pop. If the private capital bubble does burst, but does so with a hiss, that may further prove its worth.
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