Alan Waxman traces today's private credit risks to Glass-Steagall's 1999 repeal, which unleashed mergers including JPMorgan Chase and pushed investment banks like Goldman Sachs to lever up.
Waxman says the root cause of private credit stress is a behavior shift around 2018, when managers industrialized fundraising and deployment, lowering underwriting standards and accepting mismatched liabilities.
Waxman calls semi-liquid perpetual private BDCs a fiction, arguing managers must govern inflows and be upfront that these illiquid investments cannot offer quarterly liquidity.
Private credit's problem is behaviour, and investors can fix it
Waxman argues American finance is in its third system, which could be the best it has had. It worked until around 2018, when managers industrialised fundraising and deployment and sold illiquid assets to investors who expect liquidity. Mismatched liabilities are the old recipe for crisis, and he thinks investor discipline is the best remedy.
Takeaways
Private capital drifted into a factory model. Waxman says the system worked well until behaviour changed around 2018. Managers industrialised fundraising, then asset deployment, which pushed them to lower underwriting standards and accept mismatched liabilities.
Public valuations rewarded growth over discipline. Listed asset managers moved from 10 to 15 times fee-related earnings in the early 2010s to 15 to 20 in 2018, and now 25 to 30 or more. Separately managed accounts and wealth channels are symptoms of that behaviour.
Semi-liquid vehicles are a fiction. Perpetual private BDCs sell illiquid assets to investors who expect quarterly liquidity, so redemption requests exceed the 5% limit. Waxman says managers must govern inflows and state plainly that these are illiquid investments.
Leverage and mismatches underlie most crises. Waxman and O'Shaughnessy agree that mismatched assets and liabilities cause most crises, especially when retail money sits beside principal risk-taking. Waxman does not see the current stress as systemic, given its size and a healthy economy.
Markets should discipline managers, not heavy legislation. Waxman wants institutional investors to withhold capital from managers who change their business models, and fears heavy legislation would hurt competitiveness. Sixth Street, in direct lending since 2001, has zero dollars in perpetual private BDCs.
Sixth Street hires for learning and open architecture. Waxman says AI and software disruption will touch every industry, and firm-wide AI usage is high. Its ethos of facing the tiger means confronting problems head on together, which he applies to rapid change.
Three eras of American finance
System 1 ran from 1933 to 1999. After the 1929 crash and about 9,000 bank failures, Glass-Steagall separated commercial from investment banks. It was stable and conservative but grew less competitive as the world globalised.
European banks combined both businesses, Deutsche Bank bought Bankers Trust in 1998, and Citibank announced a merger with Travelers. Glass-Steagall was repealed in 1999 and mergers followed, including JPMorgan Chase.
System 2 ran to 2008. Investment banks had to lever up, helped by fixed income growing from about $7tn to $14tn. Waxman says repeal played some part in the crisis but was not the only cause.
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On this episode 2
Show 1
System 3 is the post-crisis era shaped by Basel III and Dodd-Frank in 2010. Private capital grew from about $2tn to $14-15tn, and private credit from $500bn to about $2tn.