Money from risky loans. What could go wrong?
Published: 02:01 PM,Jan 01,2025 | EDITED : 06:01 PM,Jan 01,2025
Sen. Sherrod Brown (D-Ohio), who is chair of the Senates banking committee and has warned that private credit funds operate in the shadows, talks to reporters on Capitol Hill in Washington. — New York Times
Maureen Farrell
In the fall of 2015, in the back booth of the retro Putnam Restaurant in Greenwich, Connecticut, Craig Packer, a partner at Goldman Sachs, sat across from Doug Ostrover and listened to an audacious pitch.
Ostrover, then 52, had recently left the investment colossus Blackstone and was mulling a dramatic midcareer effort to build a firm from scratch, one that would take on some of the biggest names in global finance. Quit your job, the billionaire financier told Packer, and join me.
As Packer, 48, later recalled, Ostrover wanted to create a firm that would lend money to highly indebted, risky businesses willing to pay hefty interest rates for fast cash. If it succeeded, the new enterprise and its founding partners could dominate a new financial playing field with the potential for huge profits.
Ostrover’s pitch (one he would also make to Marc Lipschultz, a two-decade veteran of KKR who would eventually become another founder of the nascent firm) was to leap into the business of “private credit,” a simple-sounding term that belies its complexity — and its risk.
The new venture would not be a bank but would operate almost like one — without the regulatory restrictions and government oversight that had made traditional banks skittish about this market. Unlike a bank, the firm would be amassing money not from individual depositors, whose savings are protected by the federal government and can be withdrawn at will, but from institutions like insurance companies and pension funds. Thus, the new firm would be legally permitted to finance tricky, highly speculative companies without reporting the details of such activities publicly.
During the next several months, Ostrover, Packer and Lipschultz agreed that the venture offered them a great opportunity — but only if they started at a gigantic scale, $10 billion or so. A bet that size would be a game-changing move in the world of private credit, where small, shady lending shops did backroom financing deals for even shadier fledgling companies.
Eventually, the three men raised $12 billion, undercutting their would-be competitors by promising big pension funds and others low investment fees if they backed the new firm.
Large investors — including Brown University’s endowments, New Jersey’s pension fund, Michael Dell’s investment firm and Iconiq Capital — were given stakes in the firm, essentially making them owners of the new enterprise.
Interest rates had been low since the 2007-08 financial crisis, so pension funds and other institutional investors were desperate to find ways to earn higher returns on their investments. The debt markets, Ostrover told prospective clients, were much stabler than stocks or commodities.
And the firm, then called Owl Rock Capital, took the unusual step of setting itself up with so-called permanent investor capital that it would hold even longer than a typical private equity fund, where investors tie up money for a few years or even a decade. This would allow it to make increasingly long-term loans. In return, clients were offered the prospect of far higher returns than they could earn with more conventional investments.
Nearly a decade after its founding, Blue Owl Capital — as the firm was renamed — is succeeding. The firm, which went public in 2021 through a merger, is one of the biggest private lenders on Wall Street, managing more than $235 billion of investors’ money.
Blue Owl has both caught and created a wave that has brought a change to Wall Street. Over the past few years, roughly $1.8 trillion has been raised by private credit investment firms, including rivals Ares and Apollo Global. That money has been lent to highly indebted companies in sectors like software, insurance and health care.
“We’re financing many of the same companies that used to go to the public markets,” Packer said.
Looking in from the outside are major banks like Goldman and JPMorgan Chase, whose executives now worry they are ceding lucrative financing to less-regulated rivals.
At a closed-door Goldman management committee meeting this summer, the top brass debated a hard truth: The investment bank was increasingly falling behind in private credit, namely in arranging big-ticket loans for corporations, because the newcomers were willing to give out the money at easier terms.
The partners decided they couldn’t ignore the frenzy; Goldman would continue to organize, for a fee, investment funds in which its clients can lend money alongside and in competition with private credit firms.
Other big players are also moving in. This month, BlackRock staked its claim with a deal to buy the private credit upstart HPS Investment Partners for $12 billion.
Already, the success of Blue Owl has brought mammoth riches to its founders. Blue Owl’s public arm, which trades on the New York Stock Exchange under the ticker “OWL,” was recently valued at $35 billion.
It can be a risky business, making loans to risky businesses. Consider the go-go junk bond era of the 1980s: Michael Milken’s Drexel Burnham Lambert helped fuel the era of corporate raiders and became the backbone of the private equity industry.
This worked until it didn’t. Milken went to jail for violating federal securities laws, Drexel went belly-up, and some of the companies financed with junk bonds eventually declared bankruptcy.
By the mid-2000s, Wall Street bankers had found yet another way to rake in billions through risky lending, this time with mortgages to borrowers with low credit scores. This fueled a rapid increase in mortgages, inflating home prices. The subprime mortgage bubble eventually burst, leading to a global financial crisis.
To its detractors, private credit carries some of those same red flags. Officials at the International Monetary Fund (“could become a systematic risk”), at the Federal Reserve (“financial stability implications”) and on the Senate banking committee (“may pose hidden dangers”) have all chimed in with warnings.
Regulators have raised a number of potential issues. Chief among them is that the industry’s rapid growth has not been tested in a long market downturn — a financial crisis or a prolonged recession. It’s unclear how the companies they lend to would fare in a weak economy.
Even making a guess about what would happen, critics say, is difficult because of the opaqueness of the industry. While banks are required to publicly report the value of their loans, private credit firms are not.
Private credit’s boosters say their lending portfolios are well diversified and unlikely to sour all at once, and they rightly point out that everything thus far has gone smoothly. They say they report the health of their loans to their private investors, who have the right to examine their obligations in detail — and do.
But JPMorgan CEO Jamie Dimon has emerged as a vocal critic of private credit.
Last December, Dimon urged the senators to do something about the unregulated and swift growth of private credit. Regulators, he said, will be “unable to see the next brewing crisis,” because so much activity has moved outside the banking system. If these private loans run into trouble, he said, lenders will be unlikely to refinance them as banks do.
Dimon is not a disinterested party, of course. Firms like Blue Owl have been encroaching on JPMorgan’s business. To claw back at least part of this market, JPMorgan has also been hunting for a private credit shop to buy. So while Dimon may think private credit is dangerous, he still wants in.
But how long can the boom in private credit last? Practically everyone on Wall Street concedes that this moment is bound to dim as more lenders emerge to compete with one another for a finite number of loans. The question is whether it will cause a shakeout that could spill into the broader economy, with dire consequences.
Few influential voices in the financial world seem to have any immediate concerns.
Fed Chair Jerome Powell commented in May that, in private credit, “many of the lending structures are not subject to a run in the way that banks have traditionally been.” He added that because their funding largely came from backers with a long-term commitment, “it’s not obvious to me that at this point it’s a net loss to financial stability.” But regulators are increasingly on edge. The International Monetary Fund stated in April that the sector “has meaningful vulnerabilities, is opaque to stakeholders and is growing rapidly under limited prudential oversight.” Lipschultz pointed out that the government needed to rescue major banks in 2008 — and that his firm continued lending even at the nadir of the pandemic.
“Where have the problems been since the financial crisis?” Lipschultz asked and quickly answered his own question: “The banks.” — New York Times
In the fall of 2015, in the back booth of the retro Putnam Restaurant in Greenwich, Connecticut, Craig Packer, a partner at Goldman Sachs, sat across from Doug Ostrover and listened to an audacious pitch.
Ostrover, then 52, had recently left the investment colossus Blackstone and was mulling a dramatic midcareer effort to build a firm from scratch, one that would take on some of the biggest names in global finance. Quit your job, the billionaire financier told Packer, and join me.
As Packer, 48, later recalled, Ostrover wanted to create a firm that would lend money to highly indebted, risky businesses willing to pay hefty interest rates for fast cash. If it succeeded, the new enterprise and its founding partners could dominate a new financial playing field with the potential for huge profits.
Ostrover’s pitch (one he would also make to Marc Lipschultz, a two-decade veteran of KKR who would eventually become another founder of the nascent firm) was to leap into the business of “private credit,” a simple-sounding term that belies its complexity — and its risk.
The new venture would not be a bank but would operate almost like one — without the regulatory restrictions and government oversight that had made traditional banks skittish about this market. Unlike a bank, the firm would be amassing money not from individual depositors, whose savings are protected by the federal government and can be withdrawn at will, but from institutions like insurance companies and pension funds. Thus, the new firm would be legally permitted to finance tricky, highly speculative companies without reporting the details of such activities publicly.
During the next several months, Ostrover, Packer and Lipschultz agreed that the venture offered them a great opportunity — but only if they started at a gigantic scale, $10 billion or so. A bet that size would be a game-changing move in the world of private credit, where small, shady lending shops did backroom financing deals for even shadier fledgling companies.
Eventually, the three men raised $12 billion, undercutting their would-be competitors by promising big pension funds and others low investment fees if they backed the new firm.
Large investors — including Brown University’s endowments, New Jersey’s pension fund, Michael Dell’s investment firm and Iconiq Capital — were given stakes in the firm, essentially making them owners of the new enterprise.
Interest rates had been low since the 2007-08 financial crisis, so pension funds and other institutional investors were desperate to find ways to earn higher returns on their investments. The debt markets, Ostrover told prospective clients, were much stabler than stocks or commodities.
And the firm, then called Owl Rock Capital, took the unusual step of setting itself up with so-called permanent investor capital that it would hold even longer than a typical private equity fund, where investors tie up money for a few years or even a decade. This would allow it to make increasingly long-term loans. In return, clients were offered the prospect of far higher returns than they could earn with more conventional investments.
Nearly a decade after its founding, Blue Owl Capital — as the firm was renamed — is succeeding. The firm, which went public in 2021 through a merger, is one of the biggest private lenders on Wall Street, managing more than $235 billion of investors’ money.
Blue Owl has both caught and created a wave that has brought a change to Wall Street. Over the past few years, roughly $1.8 trillion has been raised by private credit investment firms, including rivals Ares and Apollo Global. That money has been lent to highly indebted companies in sectors like software, insurance and health care.
“We’re financing many of the same companies that used to go to the public markets,” Packer said.
Looking in from the outside are major banks like Goldman and JPMorgan Chase, whose executives now worry they are ceding lucrative financing to less-regulated rivals.
At a closed-door Goldman management committee meeting this summer, the top brass debated a hard truth: The investment bank was increasingly falling behind in private credit, namely in arranging big-ticket loans for corporations, because the newcomers were willing to give out the money at easier terms.
The partners decided they couldn’t ignore the frenzy; Goldman would continue to organize, for a fee, investment funds in which its clients can lend money alongside and in competition with private credit firms.
Other big players are also moving in. This month, BlackRock staked its claim with a deal to buy the private credit upstart HPS Investment Partners for $12 billion.
Already, the success of Blue Owl has brought mammoth riches to its founders. Blue Owl’s public arm, which trades on the New York Stock Exchange under the ticker “OWL,” was recently valued at $35 billion.
It can be a risky business, making loans to risky businesses. Consider the go-go junk bond era of the 1980s: Michael Milken’s Drexel Burnham Lambert helped fuel the era of corporate raiders and became the backbone of the private equity industry.
This worked until it didn’t. Milken went to jail for violating federal securities laws, Drexel went belly-up, and some of the companies financed with junk bonds eventually declared bankruptcy.
By the mid-2000s, Wall Street bankers had found yet another way to rake in billions through risky lending, this time with mortgages to borrowers with low credit scores. This fueled a rapid increase in mortgages, inflating home prices. The subprime mortgage bubble eventually burst, leading to a global financial crisis.
To its detractors, private credit carries some of those same red flags. Officials at the International Monetary Fund (“could become a systematic risk”), at the Federal Reserve (“financial stability implications”) and on the Senate banking committee (“may pose hidden dangers”) have all chimed in with warnings.
Regulators have raised a number of potential issues. Chief among them is that the industry’s rapid growth has not been tested in a long market downturn — a financial crisis or a prolonged recession. It’s unclear how the companies they lend to would fare in a weak economy.
Even making a guess about what would happen, critics say, is difficult because of the opaqueness of the industry. While banks are required to publicly report the value of their loans, private credit firms are not.
Private credit’s boosters say their lending portfolios are well diversified and unlikely to sour all at once, and they rightly point out that everything thus far has gone smoothly. They say they report the health of their loans to their private investors, who have the right to examine their obligations in detail — and do.
But JPMorgan CEO Jamie Dimon has emerged as a vocal critic of private credit.
Last December, Dimon urged the senators to do something about the unregulated and swift growth of private credit. Regulators, he said, will be “unable to see the next brewing crisis,” because so much activity has moved outside the banking system. If these private loans run into trouble, he said, lenders will be unlikely to refinance them as banks do.
Dimon is not a disinterested party, of course. Firms like Blue Owl have been encroaching on JPMorgan’s business. To claw back at least part of this market, JPMorgan has also been hunting for a private credit shop to buy. So while Dimon may think private credit is dangerous, he still wants in.
But how long can the boom in private credit last? Practically everyone on Wall Street concedes that this moment is bound to dim as more lenders emerge to compete with one another for a finite number of loans. The question is whether it will cause a shakeout that could spill into the broader economy, with dire consequences.
Few influential voices in the financial world seem to have any immediate concerns.
Fed Chair Jerome Powell commented in May that, in private credit, “many of the lending structures are not subject to a run in the way that banks have traditionally been.” He added that because their funding largely came from backers with a long-term commitment, “it’s not obvious to me that at this point it’s a net loss to financial stability.” But regulators are increasingly on edge. The International Monetary Fund stated in April that the sector “has meaningful vulnerabilities, is opaque to stakeholders and is growing rapidly under limited prudential oversight.” Lipschultz pointed out that the government needed to rescue major banks in 2008 — and that his firm continued lending even at the nadir of the pandemic.
“Where have the problems been since the financial crisis?” Lipschultz asked and quickly answered his own question: “The banks.” — New York Times