Why I Have Doubts About The “Next Global Financial Crisis”

"...even I don’t think they’re going to default in the next four weeks."

By James Hickman, Schiff Sovereign

It was the early 2000s, and poor Monty was down on his luck.

An aging, out-of-work game hunter and security guard, Monty had been unemployed for quite some time. Fortunately, he was getting by, but living off the generosity of a family in southern California who had taken him in. Without them Monty would have almost certainly been living on the street.

But things started to change for Monty on a fateful day when his host family received a letter in the mail from a local bank– addressed to Monty. They eagerly ripped open the letter to find that the bank had pre-approved old Monty for a substantial line of credit!

They all found this extraordinary… and not just because Monty had no job, no income, no assets (i.e. a classic “NINJA loan” from the early 2000s). What was particularly unique about this case is that Monty was a dog.

We’ve talked about this a lot over the years– but in case you’re too young to remember, the early 2000s was a decade in which anyone and everyone was able to borrow money.

The Federal Reserve had slashed interest rates to zero– which made borrowing look cheap… even free. And government policy was prompting banks to ignore all common sense and underwrite loans to anyone with a pulse… and occasionally some people without a pulse.

The stories covered in books like Michael Lewis’s The Big Short are hilarious– dead people, homeless people, unemployed people, prison inmates, canines and cats… they were wall approved for mortgages despite having no ability to make monthly payments.

There were so many loans being issued that the US mortgage market quickly ballooned to $11 trillion. Investment banks packaged up these dubious loans and dressed them up as special investment-grade bonds… and then the big Wall Street ratings agencies (like S&P, Fitch, etc.) slapped the highest quality “AAA” rating on them as if they were risk-free.

The whole system blew up in 2008, causing multiple financial institutions to collapse– triggering the Global Financial Crisis.

The warning signs were there all along. But very few people paid attention.

My friend and partner Peter Schiff was one of the few voices of reason who accurately predicted this crisis years before it actually happened; Peter used to go on live television and get laughed at by CNBC’s panel of ‘experts’. But in the end, Peter was right… and the whole system blew up.

It turns out that lending money to broke, unemployed people who cannot pay is a pretty stupid lending policy.

Now, you may have heard about new trouble emerging in the financial sector. And gee what else is new. Finance guys almost invariably find ways to generate short-term profits while creating long-term risk.

And the latest brewing financial crisis of the day is the so-called ‘private credit market’.

Private credit is what it sounds like– funds and investors (i.e. NOT banks) underwrite private loans to companies. This isn’t particularly controversial; private lending is one of the cornerstones of capitalism.

And usually these loans are asset-backed– just like a real estate mortgage– so the lender has collateral.

Private lending was initially brought on by the ultra-low interest rates of the pandemic era (when companies could borrow for 3%); and it also ballooned– estimated at roughly $3 trillion. That’s a pretty chunky number, even in the $30+ trillion US economy.

But, just like the subprime market in the years before the GFC kicked off, there are starting to be warning signs that private credit is cracking.

One of those– most notably– is that a major private lending fund (run by Blackstone, one of the world’s largest asset managers) has capped redemptions, i.e. they have limited the amount of money that investors can withdraw.

This is a pretty clear sign of strain. Perhaps not the proverbial canary in the coal mine… but it’s a big deal that an investment firm with the size and reputation of Blackstone isn’t letting its investors out of their fund.

(In fairness, the fund documents do stipulate redemption limits. But it’s pretty unusual for an asset manager to have to exercise this clause.)

Another sign of strain is that default rates are up dramatically. Fitch (the same guys who slapped AAA ratings on NINJA loans 20 years ago) estimated that roughly 10% of US private loans are in default. That’s a big number, and it could go a lot higher.

A key reason is that interest rates are MUCH higher today than when many of these loans were originally underwritten. So, any borrower that needs to refinance (which is likely the vast majority) will see a massive spike in monthly payments.

That will be unaffordable for a lot of borrowers, resulting in even higher defaults. Plus, general economic malaise could contribute to higher default rates too.

A chief concern about private credit is that many loans were like subprime “NINJA loans”, i.e. private loans that were way too big, issued to borrowers who were not creditworthy.

I doubt anyone will shed any tears that Blackstone might lose money in a bad deal. But there could be knock-on effects– specifically to banks.

I know the whole point of ‘private’ credit is that the loans are NOT issued by banks. But in a rather peculiar twist, banks often loan money to private credit funds, who in turn loan that same bank money to the final borrower. Strange, right?

Bottom line, banks are exposed.

A few prominent voices lately have been warning that this private credit fiasco has all the hallmarks of the early 2000s subprime bubble… and that the next GFC is upon us.

And there are definitely similarities. But a LOT of major differences too– most notably size. The private credit market is MUCH smaller than subprime was, and it’s difficult to see how those losses would take down the US financial system again, let alone the entire global economy.

But there are also significant existing risks in the banking sector– like rising defaults in traditional office and commercial loans, and mark-to-market losses in banks’ bond portfolios.

We’ve talked about this before– US financial institutions are collectively sitting on hundreds of billions of dollars in unrealized losses, and most of those losses ironically come from Treasury bonds. So, another ~$100+ billion hit from private credit could definitely hurt banks.

I’ve been looking at this pretty hard, but at the moment I don’t see some epic crisis emerging from private credit.

That said, one EASY Plan B option to safeguard your capital is to hold funds at Treasury Direct.

Through Treasury Direct, any US citizen is able to set up an account and hold virtually any amount of money through ultra-short-term T-bills; it’s like keeping your money in a 4-week certificate of deposit, but without any bank counterparty risk.

As we’ve discussed many times before, the US government is in pretty dire financial straits. But even I don’t think they’re going to default in the next four weeks.

So, this is a safer alternative to hold cash–and you can quickly link your Treasury Direct account to your bank for easy back & forth transfers.

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