Moody’s rating agency warns of “systemic risk” in private credit
Stock markets continue to soar – Wall Street hit new highs this week – thanks to cheap money provided by the Fed and other central banks, but there are warnings of growing dangers in what is become an area of growth for the financial system.
Moody’s rating agency released a report that the $ 1 trillion private lending industry posed “systemic risks” due to its “explosive” growth.
“The rising tide of leverage sweeping a less regulated ‘gray area’ carries systemic risks,” he said. “Risks that go beyond the limelight of public investors and regulators can be difficult to quantify, even if they have broader economic consequences.”
The private credit market began to develop after the global financial crisis and its growth accelerated after the massive $ 4 trillion Fed intervention in response to the March 2020 crisis at the start of the pandemic. It has provided a source of profit for investors looking to increase their returns above those obtainable in the stock and bond markets.
Reporting on Moody’s findings, the Financial Time said the “debt buyout groups” had been “particularly active users of the industry, tightly weaving private equity and private credit into a debt-laden ecosystem.”
Moody’s head of leveraged finance research Christina Padgett said: “The business model of private equity is based on leverage. We have become accustomed to leveraging the institutional lending and bond market. Now we are seeing a higher degree of leverage among small businesses …. Right now it’s good because the interest rates are low, but it introduces a higher degree of risk for the future. “
Moody’s is not alone in warning about the heightened risks associated with private lending. In a report released earlier this month, S&P Global said private debt has become a “new frontier for yield-seeking credit investors” as the market has grown tenfold over the past decade.
“The growing investor base, lack of available data and the spread of debt across lending platforms make it difficult to know what the risk is in this market and who owns it.
“Expanding the investor base could lead to increased risk in the market if it results in volatile money flows in and out of the market,” he said.
Private credit is by no means the only potential source of instability.
In 2008, the epicenter of the financial crisis was the big banks and financial firms that were bailed out by the government with the supply of trillions of dollars of cheap money from the Fed. Regulations were introduced to strengthen their capital base, supposedly designed to prevent a recurrence of the financial crisis.
But there have been criticisms that deregulation introduced by Fed Chairman Jerome Powell has significantly weakened even these limited measures.
The criticisms were made public during a Senate Banking Committee hearing late last month when Massachusetts Democratic Senator Elizabeth Warren told Powell she would not support his nomination as Fed chair. , describing him as a “dangerous man”.
Warren said there were several instances where the Fed had relaxed financial regulations.
“Time and time again you have acted to make our banking system less secure. And that makes you a dangerous man to run the Fed, and that’s why I will oppose your re-appointment, ”she said.
Warren, who has described himself as a “capitalist to the bone,” is no adversary of finance capital and Wall Street. His support for stricter regulation stems from fears that another crisis of the magnitude of 2008, or perhaps even bigger, could lead to a deep economic crisis and the eruption of massive class social struggles. factory Girl.
Warren’s critiques received little support in the financial press at the time, and there is general support for Powell’s reappointment which is being discussed within the Biden administration.
But this week the Financial Time chose to publish an opinion piece by Dennis Kelleher, president of Better Markets, an advocacy group for tighter regulation and supervision of the banking and financial system.
Kelleher began by stating that Warren’s description of Powell was “correct” and that the deregulation he had supported over the past four years had “undermined the financial stability of the banking system,” bringing “the United States closer to the future. financial crises and taxpayer-funded bailouts. , as happened in 2008.
He said Powell’s actions weakened regulations covering five areas: capital requirements, supervisions, proprietary transactions, living wills to allow stricken banks to be settled safely and the amount liquid assets held by banks that are easy to sell.
Each of these rules had been considerably weakened, leaving the regulatory framework altered and “significantly reducing the resilience of banks”. Deregulation has also made it more difficult for “regulators and the public to know the real state of banks, making crisis planning and mitigation more difficult.”
He cited a dissenting opinion from Fed Governor Lael Brainard on stress test modifications that “gave the green light to big banks to significantly reduce their capital buffers.”
Banks with assets between $ 250 billion and $ 750 billion were no longer subject to the rules applicable to “systemically important banks” although some “are still large enough to cause systemic problems and contagion” and therefore “Have much less confidence than any major bank. can withstand a crisis.
He said the prohibitions on proprietary trading – where a bank engages in financial activity on its own account rather than getting a commission from a client – had been weakened, encouraging “the taking of risk and even gambling-like behavior “.
“Not only did the Powell Fed allow banks to engage in more of these types of activities directly, but they were also allowed to do more indirectly through investments in venture capital and loans, including some have proven to be unstable and dangerous. . “
At present, the vast accumulation of debt and financial assets is supported by ultra-low interest rates. But this regime is now under great pressure because inflation, far from being “transient”, as argued by Powell, is increasing at rates not seen since the 1970s.
The Fed seems almost certain to indicate that it will start cutting its asset purchases by $ 120 billion per month, possibly early next year, when it meets next week. Powell said that in his opinion it was “time to decrease. But he insisted that it was not time to raise rates because he is only too well aware that such a move could trigger a landslide on the mountain of fictitious capital and debts that Fed policies created.