“resurgence of shadow banking?”
There’s a whiff of 2008 in the air.
“Private Credit and the New World of Financial Risk,”
On July 15, 2007, the New York Times published an article titled “The richest of the rich, proud of a new Gilded Age.” The article was centered on a profile of Sanford Weill, CEO of Citigroup, who, like others in the financial industry, believed that they were leading America into a new era of prosperity — justifying their immense wealth — and that the government should scrap regulations that were getting in the way of financial innovation.
Exactly one year and two months later, Lehman Brothers failed, plunging the world into the worst financial crisis it had seen in more than 70 years. Many of the innovations of which Weill and others were so proud had, it turned out, created a system of poorly regulated financial institutions — so called “shadow banks” — that were exposed to a 21st-century version of the vast wave of bank runs in 1930 and 1931 that turned an ordinary recession into the Great Depression.
But the 2008 crisis was 17 years ago, and political support for the precautions introduced after 2008 has waned. The Treasury Department is moving to gut the Office of Financial Research, which monitors risks of financial crisis. There is once again a push to deregulate, to embrace financial innovations like crypto that arguably recreate the risks that brought the world economy to its knees in 2008. Shadow banking has had a major revival; by some measures, as I’ll explain, shadow banks are bigger relative to the financial system as they were when Lehman collapsed. And it’s only reasonable to worry about the possibility of a new financial crisis.
At the moment these worries are centered on private credit — lending by institutions that, unlike banks, are effectively shielded from public disclosure and regulation. What’s actually on their books?
After two lenders went bust last fall, Jamie Dimon, CEO of JPMorgan Chase, made waves with his comment that “When you see one cockroach, there are probably more.”
The good news is that providers of private credit aren’t banks, so that even if they turn out to have a lot of junk on their books it probably won’t have as much negative impact as bank losses in 1930 or shadow bank losses in 2008. But these companies aren’t exactly not banks either. And the rise of private credit is part of a broader growth in weakly regulated financial institutions that is making all of us who remember 2008 increasingly nervous.
So, today’s primer will be about private credit and the broader re-risking of the financial system. Beyond the paywall I will address the following:
1. How financial crises happen
2. The growth of private credit and other “non-bank financial intermediaries”
3. The risks from private credit
4. The big picture: Is it 2008 again?
The logic of financial crises
Financial crises — or, to use their older name, “panics” — were a regular feature of the U.S. economy before World War II. The Federal Reserve was created in a reaction to the Panic of 1907, in which J.P. Morgan rescued the banks from potential collapse: Everyone realized that you couldn’t count on there always being a J.P. Morgan around when you needed him, so an institutional equivalent was needed. Unfortunately, the Fed didn’t stop the mother of all panics, the immense banking crisis of 1930-31.
By 2008, however, many economists and policymakers considered such stories to be of mere historical interest. Bank runs, in which depositors raced to pull their funds from a bank they feared was on the edge of failure, were supposedly obsolete with depositors protected by deposit insurance, and in any case the risk of bank failure was supposed to be much lower thanks to regulations that limited risk-taking.
Then Lehman failed, and in the weeks that followed economists were wandering around muttering “Diamond-Dybvig” to themselves.
What? A seminal 1983 paper by Douglas Diamond and Phillip Dybvig — who won a Nobel prize in 2022 — laid out how bank runs can happen and spread through the economy. Their logic seemed obvious after the fact — why was a mathematical model necessary? — but that’s often true of breakthrough ideas in economics.
Diamond and Dybvig envisioned an institution that accepted deposits, which it promised to redeem with cash on demand even while investing most of that money in loans and other assets that could not be liquidated quickly except, possibly, at fire-sale prices.
Normally the disconnect between the liquidity of a bank’s liabilities and the illiquidity of its assets isn’t a problem, because only a small fraction of depositors will want to pull their money out on a given day. But if for whatever reason depositors come to fear that a bank will fail — possibly because other banks have failed recently — many will demand their money immediately. And this can become a self-fulfilling prophecy, because a bank trying to sell off its loans rapidly, at fire-sale prices, may well go bankrupt even if those loans were fundamentally sound.
That’s how the cascade of bank failures happened in the 1930s. But modern banks were supposed to be protected from such a fate because deposits are insured by the federal government.
What many economists more or less suddenly realized in the aftermath of Lehman’s fall was that the logic of bank runs, as laid out in Diamond-Dybvig, potentially applied to institutions that weren’t legally considered banks, and which didn’t accept conventional deposits. All that really matters, in terms of vulnerability to a crisis of confidence, is a mismatch between liquid liabilities and illiquid assets.
Thus Lehman was investing in mortgage-backed securities with money raised by issuing “repo”, basically one-day bonds. Repo isn’t exactly the same as bank deposits, but those buying it — for example, corporate treasurers — treated it as more or less equivalent, a place to park their cash with the expectation that it could be accessed on short notice. And because firms issuing repo were less regulated than conventional banks, they were able to offer a higher interest rate than their clients could get on bank deposits.
But when everyone lost confidence that money parked in repo would always be available on demand, Lehman and other financial institutions suffered the equivalent of a cascading wave of bank runs even though they weren’t banks in the conventional sense.
The 2008 crisis offered an object lesson in the risks created by shadow banking. But after retreating some-what in the years after the crisis, shadow banking in a variety of forms has staged a huge comeback. This comeback is essential background for understanding the furor over private credit.
The growth in “non-bank financial intermediaries”
A financial intermediary is any institution that invests using other people’s money. Banks accept deposits and then lend them out — and banks are still, as a group, the largest class of financial intermediaries. But the Financial Stability Board, an international body based in Basel, Switzerland, estimates that non-bank financial intermediaries now hold slightly more than half the world’s financial assets:
Many NFBIs are (financially) innocuous institutions like pension funds that probably don’t pose any significant risks to the system. But the board separates out a narrower measure that it poetically calls “the narrow measure of NBFI.” This is defined as “entities involved in credit intermediation activities that could give rise to bank-like vulnerabilities.” The share of these vulnerability-creating entities in assets fell substantially after the 2008 crisis but is now higher than ever:
This number does not include private credit, which doesn’t meet the board’s criteria, which were devised with a 2008-type crisis in mind. However, the board’s latest monitoring report acknowledges that private credit may indeed create vulnerabilities, and also that its growth is poorly measured.
More on private credit shortly. First, what should we make of the resurgence of shadow banking?
The price of financial stability is eternal vigilance. When crisis strikes, bailouts of failing financial institutions are, alas, the only wise course of action. Much as you may dislike shoveling money at banks or bank-like institutions that don’t deserve to be rescued, even if you believe that their actions brought on the crisis, denying them aid when panic strikes means deepening the crisis, inflicting huge punishment on workers and innocent businesses. So the money must flow.
But to limit both the need for and the size of bailouts, between crises one needs to regulate the institutions that might cause the next crisis. Thus banks and, since the post-2008 reforms, “systemically important” institutions are subject to extra capital requirements — basically forcing their owners to put substantial amounts of their own money at risk — limits on the kinds of investments they can make, and more.
However, financial regulation always leads to an arms race, as private-sector players try to find ways to avoid the regulations. Establish rules that limit risk-taking by banks, and people will create institutions that function like banks but don’t meet the traditional definition — e.g., issuing repo rather than accepting deposits.
For about 50 years after the 1930s — what Gary Gorton calls the “quiet period” — regulators mostly won that arms race. But then they began falling behind, for several reasons.
For one thing, there was a general rightward ideological tilt, the Reaganesque view that government is always the problem, never the solution. This view proved remarkably robust even in the face of the 2008 crisis, when the private sector obviously created the problem and emergency government action was the solution, the only reason we didn’t experience a full replay of the Great Depression.
Underlying the persistence of an anti-regulation mindset in the face of catastrophes was the Upton Sinclair principle: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” Even in the runup to 2008, and even more now, there are large financial rewards — campaign contributions, but also, these days, outright personal financial gain — for politicians who weaken regulation on financial institutions that may threaten financial stability.
Finally, financial players are very good at creating bright, shiny objects — new forms of finance that look great, at least for a while, both to investors and to politicians. Crypto is the most obvious example. Some investors are still buying Bitcoin and other tokens, even though they still have almost no legitimate use cases (although even before the war Iran made extensive use of crypto to evade Western sanctions, and is now accepting crypto payments from shippers who want to transit the Strait of Hormuz.)
And issuers of stablecoins — tokens whose value is pegged to existing currencies, normally the dollar — are, in effect, operating unregulated banks. But this reality is masked by techno razzle-dazzle.
The 2008 financial crisis caused a setback for shadow banking, both by making investors aware of the risks posed by financial products they don’t understand and by inspiring a round of new regulations. But by the mid-2010s both investor memories and the political will to rein in potentially destabilizing financial innovations were fading, and shadow banking in general was on the rise again.
The rise of private credit was part of this trend. And that’s the context in which we should think of it.
The risks posed by private credit
As Jared Bernstein notes, one good thing about private credit is that its name actually describes what it is. What happens with private credit is that investors entrust their money to managers who promise to lend it out in smart ways — typically loans to private businesses, that is, businesses that aren’t listed on the stock market.
Such lending is effectively hidden from public view. Unlike banks, private credit companies don’t have to disclose their loans. Unlike listed companies, privately owned firms don’t have to disclose their finances. And unlike bonds, private loans don’t have to be disclosed to the Securities and Exchange Commission.
In effect, private loans are treated as interactions between consenting adults. The rest of us have no legal right, and, presumably, no need to know what took place.
Indeed, there are no official numbers on the size of private credit, although industry sources put it at something like $1.5 trillion. What’s clear is that it has grown explosively in recent years. Greg Ip had an eye-popping chart in the Wall Street Journal:
Why has private credit grown so rapidly? According to the industry’s boosters, they are filling a gap. Tighter regulation, the story goes, has inhibited bank lending to privately owned businesses, so that there were many opportunities for profitable lending being passed up; the private credit industry is taking advantage of these opportunities and allowing their investors to share in the gains.
An alternative, cynical story is that private credit is taking advantage of opacity — the lack of public information about their loans, the financial condition of borrowers, etc. — to lure in unwary investors, who don’t know that, as Jamie Dimon says, there are a lot of cockroaches they can’t see.
The truth is surely in between, although high-profile busts and other indicators are making the cockroach story look stronger.
But should those of us who aren’t investing in private credit care? Are these just interactions between consenting adults, and nobody else’s business?
Not quite. True, private credit firms aren’t doing what Lehman and other shadow banks did in the 2000s: issuing liabilities that were widely treated as equivalent to bank deposits, so that a collapse in confidence effectively disrupted the whole monetary system. In fact, private credit companies have relatively low leverage. That is, they’ve mostly sold shares rather than borrowing money, reducing the risk that they will default and start a credit-market chain reaction.
That said, as a 2025 Boston Fed paper showed, private credit companies have in fact borrowed large sums from banks, mostly in the form of revolving credit lines. This means that banks might suffer losses if private credit companies fail. But these loans are generally senior to credit companies’ other obligations, so bank losses will be minor unless private credit suffers very badly.
Possible blowback on banks aside, there’s another way in which private credit might hurt financial stability: the slightly money-like nature of investments in private credit funds. Investors who buy into these funds are normally offered the conditional right to redeem their investments — basically, to sell their shares back to the company — at intervals. So from the point of view of investors, these companies are slightly bank-like. Investors aren’t like depositors who can withdraw their money whenever they like, but they were led to believe that they were less committed than investors who just buy a company’s stock.
However, companies like Blue Owl, one of the industry’s biggest players, have rules allowing them to limit redemptions if too many people want their money at the same time. And Blue Owl, which lent a lot of money to software companies — which are threatened by AI — has invoked those limits for two of its funds. This news has, in turn, probably helped provoke an exodus from other funds by investors worried that they too may be locked in.
One way to think about this is that we’re witnessing a kind of slow-motion, low-key bank run on private lending.
So, can the problems in private credit lead to a full-scale financial crisis? No.
Despite its growth, private credit isn’t big enough to create an economy-wide crisis. The dollar value of private credit now appears similar to the value of subprime mortgages in 2008, but U.S. dollar GDP has more than doubled since then. Nor, although there may be cockroaches, we aren’t facing anything comparable to the collapse of the 2000s housing bubble. And private credit companies, unlike purchasers of mortgage-backed securities, aren’t mostly financed with short-term debt that can experience a full-scale bank run.
So private credit can’t by itself cause a financial crisis. The qualifier is important.
Is it 2008 again?
For those who remember 2008, arguments like the one I just made — that private credit may be troubled, but it’s not big enough to cause an overall financial crisis — sound a bit like famous last words. After all, similar arguments were made in 2007 about why we shouldn’t worry about the effects of the subprime crisis.
There are big differences between the two cases, and I still don’t think we’re looking at 2008-level disruptions. But one thing the mid-2000s and the past few years have in common is that the rise in financial risk isn’t just about one particular kind of investment. What we have instead is a general rise in risky financial behavior, brought on by a combination of lax regulation, amnesia about past crises, and Fear of Missing Out. You can see this state of mind in the huge rise and partial fall of Bitcoin, the gyrations of gold, waves of enthusiasm then disillusionment about AI-related stocks, and more.
Moreover, public policy is pushing ordinary Americans into taking on risks they don’t understand. It has moved to allow both crypto and private credit in 401ks. And whatever you think of either, they are not assets that middle-class families should be counting on for retirement.
While it’s important to get a handle on what is happening with private credit, it will only be truly destructive if problems with private credit are part of a broader story involving complacency and over-extension across financial market. The question is, how big is the overall story of overreach? Or to put it another way, how many cockroaches are there?