Fed ‘Forced To Act’ As Private Credit Bubble Collapses, Banks On Brink | Chris Whalen
Summary
Private Credit: Extensive discussion of rising redemption pressures, gated withdrawals, PIK interest, and potential default spikes with contagion risks to banks and alternative asset managers.
Banks Outlook: He warns weaker banks could face losses from bad paper while large banks remain pricey, expecting further deterioration as credit tightens and long-end yields rise.
Precious Metals: The guest is adding to gold and silver positions, citing medium-term strength after recent volatility and strong prior gains.
US Equities: Anticipates flows out of private credit back into public markets, supporting US equities due to limited global alternatives.
AI and Software: AI is accelerating layoffs and may render parts of the software sector vulnerable, with concerns about weak recoveries on software loans.
Housing Market: Policy moves to cut red tape help at the margin, but inflation and constrained supply drive affordability issues; builders cut prices and subsidize mortgages.
Treasury Yields: Expects long-term rates to eventually spike regardless of Fed moves, pressuring mortgages and corporate borrowers tied to the 7–10 year curve.
Key Companies Mentioned: Private credit and fintech names under pressure included ARES, KKR, OWL, APO, LC, AFRM, and JPM, with NLY and AGNC noted as income plays benefiting from a steeper curve.
Transcript
We're speaking on Wednesday, March 18th, and the Federal Reserve just announced its decision to keep rates steady. Uh the markets reacted by going down. Stock markets are down 1.3%. The S&P 500, that is, stock futures um ended the day in the red, gold down 3% on the day, Bitcoin down 4 1/2%. So, we'll discuss why markets reacted the way they did, what's next for policy, what's next for uh the markets, and why there have been a slew of headlines regarding private credit redemptions. Our next guest says that this is an area to watch. It's getting worse. Chris Whan joins us once more. He is the chairman of Whan Global Advisor. Good to see you again, Chris. Welcome back. >> Nice to see you, David. Thank you for inviting me. >> Thank you for coming back. I want to play for you this clip from the FOMC press conference. Take a look where we act together. There's been some debate about whether the Fed should look through the inflation that will come from higher oil prices stemming from the Middle East conflict. Is that the right approach at this juncture? And to what extent does the fact that inflation has been above target for roughly 5 years now influence the committee's thinking around this? >> So, uh, first let me say we're well aware of, um, the performance of inflation over the last few years and how a series of shocks have have interrupted progress that we've made over time. and uh that happened most recently with tariffs and then and now there will be some effects on inflation coming forward. Um the the thing that's really important that we see this year is progress uh on inflation through a reduction in goods inflation as the one-time effects on prices of tariffs go through the system, go through the economy. That's the main thing we're looking for going into this exercise. And we need to be seeing that uh to you know to sort of understand that we actually are making progress because on net we didn't make progress and if you look at total inflation sorry total core inflation it's about 3% and some big chunk of that between a half and 3/4 is actually tariffs. So we're looking for progress on that. The fact that they didn't uh lower rates or you know change uh the policy rate at all was well telegraphed by markets. But I'll just get you to react to what we heard uh just now and also to the broader uh question as to whether or not they should be lowering rates now despite oil going up. The unemployment rate is also going up. Chris, >> yeah, I think that's the key point, David. They they should be looking through this oil price hike because is it going to be solved tomorrow? No. uh we'll probably have elevated oil prices for the rest of this year. But the economy is slowing. The jobs numbers are down. There are other indicia of what people call the K-shaped economy, which is that most consumption is coming from the very top of the income stack and the rest of the economy is kind of flatted down slightly. I thought it was very interesting that the numbers from the ITA talking about foreign uh visitors to the United States show a dramatic decrease from just about all of our major trading partners. So, you know, we've been waiting for I think a downturn in this economy for a while. I think the Fed is too fixated on tariffs because, you know, Chairman Powell made a pretty specific statement about how much of inflation comes from tariffs, but how does he really know? That's one of these unknowable things, and I know the Fed estimates what the impact is, but they don't really know in in in specific terms. So, you know, I I think they should probably drop rates now because they're relatively high. If you look at where interest rates have been over the last 10 years, they're still relatively high compared to where we were. >> Do you recall that in 2008 the ECB, the European Central Bank raised rates to 4 and a half four 4.25% despite mounting pressure uh from the economy despite mounting financial risks brewing in July when they did that. But that was because oil was going up all throughout 2007 and 2008 up until that point. >> So this is the same thing that's happening right now. I'll let I'll let you just comment on whether or not the Fed is making a policy mistake by not reducing rates now in light of what may be happening to the economy. If you see any systemic shocks ahead, let's put it that way. >> I think the systemic aspect of this, David, is the simple fact that low rates coming out of CO and going back several years caused a lot of behaviors in the credit market that are turning out to be rather poorly uh chosen. specifically the private credit bubble and the way it's starting to collapse is part and parcel of uh a lack of investment opportunities. Why did people go into private credit? They didn't like hedge funds which marked the market every day mostly purchased public securities. So everybody thought, well, we'll go into private credit. We'll make more money and we don't have the noise from having to value the investments on a daily basis. This has turned out to be a disaster because the street said, "Well, we'll invite retail investors in and retail investors have no tolerance for a lack of liquidity or any signs of stress." And that's what you're seeing, not only in what we used to think of as private credit, but in things like consumer loans, which are purchased by some from some of the big p fintech firms like a firm and lending club and the rest of them. All of these are now under pressure. So, I think the Fed is going to be forced to act because the markets are under stress and we're going to see more of that as as time goes forward. The next shoe to drop will be the bank banks. The the dumber banks that didn't trade away some of their credit risk are in going to end up holding some very bad paper and they're going to have to take losses. >> So, that leads me to talk about um we're go to the next section which is about the labor market. So, we had discussed the labor market in our last interview. Um, and you said that at the time you didn't see a consumer recession in the numbers. Now, the last BLS uh jobs report came out and the economy lost 92,000 jobs, Chris. So, have you have you changed your outlook on the labor market? >> I think what's happened and and you know the answer to your question is yes, is that the advent of AI has given a lot of employers an excuse to cut headcount. Whether or not AI is actually going to take the place of those employees or not is another matter. But if you look at big employers, Federal Express, UPS, all across the board in tech, across the board in other industries, they're using the excuse of AI to cut back on headcount and that is rippling through the economy. So again, you know, the upper 10, 15, 20% of income earners in this country are doing fine. consumption is increasing at the top and yet the bottom you know 50 60% are actually kind of stagnant and I do think we're in a bit of a stall economically and the revision on those jobs numbers was quite striking. Uh we may see more of that as we go forward through this year. >> Before we continue, I want to bring to your attention today's sponsor, Monetary Metals. Now most people think of gold as something you buy in store. Monetary Metals takes a different approach. Instead of just holding gold and waiting for price appreciation, you can earn a yield on it paid in physical ounces. Through their leasing platform, investors can earn up to 4% annually with yield paid monthly in ounces. That means your return is measured in gold, not just in currency terms. Rather than sitting idle while you pay storage costs, your gold generates income. The metal remains your asset and can be redeemed at any time. Thousands of investors are already earning monthly interest in gold through Monetary Metals. Visit monetary-medals.com/lin link in the description down below or scan the QR code here to learn more. I wonder if the weakening labor market has anything to do with this next story that I'm about to read you right now. Retail investors pulled billions from private credits uh credit private capitals credit gold mine. So the FT reported um on March 16, so 2 days ago, that wealthy investors have tried to pull more than $10 billion from the largest private credit funds this quarter alone. Managers including Blackstone, Black Rockck, Morgan Stanley, they've all had to limit withdrawals to about 70% of requests. Are we looking at different segments of the economy here? We've got wealthy, you know, private credit investors doing this while at the same time, the labor market, which reflects a broader American economy, is weakening. Are those two things related? tell us about what's going on. >> Well, they are related because many of those credit managers who put money into those funds represent all types of investors. You remember last year, David, just about every big retail firm on Wall Street was marketing private credit. Swiss banks, Vanguard, I mean all of them. And the reason they did this was they saw an opportunity to earn more fees. The problem is is that these investments were not suitable for these investors to borrow the term from US securities law. So you know we have a basic problem which is that this once you know once upon a time private credit was just for institutional investors big boys pensions endowments that sort of thing. And when it broadened out to include all types of qualified investors and then retail investors, you knew you were going to have a problem at some point because as soon as people think that their money is at risk, they run. You remember Silicon Valley Bank in 2023, 40% of the deposits walked out the door in 24 hours. So that's the kind of market we live live in today. Everybody's got a smartphone. They can all hit the button and say, "Give me my money back." And these firms who've had to gate their redemptions and say no are suffering big reputational damage. Whenever you have to say no to investors, they don't forget that for a while. So that's what's going on. >> This comes as a wave of headlines hit uh the news in the last couple weeks. Private credit redemptions have been going up. Um and uh like I mentioned, some of these fund managers have to have had to limit withdrawals. Uh, and you mentioned to me offline this situation has gotten worse in the last couple weeks. Tell us more. >> Well, it's start it's starting to spread to other asset classes. Private credit was mostly about funding uh various strategies around private companies, usually private equity portfolio companies. But you're starting to see pressure now on funds that were buying consumer loans, small business loans from some of the leading fintech plays, all of whom have seen their equities trade off dramatically. One of the more interesting ones was Lending Club. Last year, Lending Club was the best performing bank in the United States in the second half of the year. Now, it's down at the bottom of the 100 banks we track. uh and I think it just it gives you an indication of how much churn there is in the group and how much volatility there is in this group simply because of the change in perception on the part of investors about risk. So when you see people demanding their money back from a a fund which really doesn't have a terrible amount of risk in it, short-term paper, right? These are credit card receivables and similar sorts of things. It tells you that the contagion is spreading and that's my concern. I think we're going to see a wider uh exodus out of private credit funds and they're going to go back into the public markets. So, in a funny way, it's good for public markets, but it's probably not good for the private sponsors. >> How concerned should the uh regular consumer be? Uh I mean, this this could this could go bad. This could be another Lehman event, or it could just be a nothing burger. What do you sit? I I think it's mostly a nothing burger, but specific institutions are going to have some pain. There are some banks that I follow very closely who have been selling loan risk and buying the AAA tranches of CLOS's to hide and I think that's an effective strategy. There are other banks that haven't done that and I think you're going to find out who's dumb and who's not is what it comes down to. >> Why do you think bond markets aren't really pricing this risk in? So this is this is the um option adjusted spread from the Bank of America ICE index. It's been tickling it's been trickling up ever since the beginning of the year um for whole slew of reasons. But if you zoom out, if you take a look at actual crises and how they've behaved, how this index has behaved, we're nowhere near 2007. We're nowhere near um we're 2007208. We're nowhere near even near COVID. Um so it's you know high yield spreads are kind of muted right now. Why do you think that is? I think part of it is that there's nowhere else to go. You know, the markets have become desensitized to these macro shocks, even the war in Iran, you know, incredibly. Um, and so as a result, you don't see people reacting with fear in the way that they did say in 2020, which was other than 2008 was an amazing event. Uh, you really thought that the whole system was going to tip over at one point, but it hasn't happened. So, while oil prices have spiked well over $100, if you look at the US Treasury market, it's barely moved. And that's what's so interesting. Gold and silver have kind of traded off a bit over the past week, mostly because they had gone up so much. You know, at one point, silver was up 70% in the first three months of this year. That's quite extraordinary. So, it's a it's a time of volatility, but the volatility is muted as you just pointed out. Tell us about this piece that you wrote in uh IRA the institutional risk analyst risk concealed private credit PIK and the banks. Uh you published this piece on March 16th. You noted that according to uh KBW nearly 9% of private credit where private investment income is now being paid via payment in kind and you call that a stunning level for uh of default for the entire $2 trillion portfolio. So if a borrower cannot pay interest in cash and instead just adds more debt to what it already owes and the bank calls that a payment is that not is that not just another form of default with a different name I guess. >> Oh it is. Yeah very much. I think some banks have been playing a game here where they thought that the borrower somehow or another was going to uh be able to recover their situation and they would actually acrue the equity payments that they received as part of the principal amount owed which is not the way you should do it. Other banks have been more conservative and they essentially marked the loan as distressed and put it in the appropriate category. I think a number of lenders, banks and non-banks, uh, as well as some private equity funds are going to have to mark this paper down. You saw the announcement from JP Morgan. They've already started to do that. And the big concern I have is that for every dollar in bank loans to non-depository financial institutions, which is the fastest growing category in the industry, by the way, it's been doubledigit growth this year. There's $2 in unused credit. So, when you see the banks start to pull back those unused uh credit lines, that's when you know that we're really going to see a shake out in private credit. Uh we've had several disasters, most recently that UK uh uh mortgage firm MFS, which took down a lot of really smart people. It is quite astounding to see Blue Owl and Apollo and several others who are not at all uh the sort of uh professionals you would expect to get duped in this way uh take big losses. So, we're going to see more of that and it's part and parcel with the Fed keeping rates too low, too aggressive with monetary policy obviously and that contributed to a I think a sense that people could do whatever they wanted in terms of credit. But now credit's expensive. If you try and go out and issue paper in today's market, especially after the past week or two, David, uh you'll find that rates have risen a couple hundred basis points. Uh some of my clients were out in the market early in March trying to issue preferred and at first we were talking about 8%. Now we're talking about 12%. So that gives you a sense of how much the real market has moved even though the treasury market has been relatively stable although it has backed up a bit. >> This is another alarm bell. Chair of Swiss Private Cap Capital Group Partners Group sound alarm on private credit default rates. Uh we've got here the Partners Group chair uh Stefan Stefan Meister told the FT that private credit default rates could double from their recent average of 2.6% to above 5% in the coming years. UBS has modeled a tail risk event where private credit defaults could reach 14 to 15%. This is a tail risk event. Tail risk means it's not likely. However, uh where does it stop and what is a contagion risk of default rates going up? I would tell you David that the the probability of defaults going to his worst case scenario mid- teens or higher is actually higher simply because we're dealing with private markets where the sponsors have been responsible for telling us what the valuations are. We do not have independent uh opinions on what these assets are worth. And the sponsors are obviously conflicted. They don't want their schemes to fall apart because they're not going to be able to refinance them or sell them. You know, it's fascinating. There's probably 20% of all private equity companies in the United States today that are essentially illquid. And it's either they're paying in kind or they've been transitioned to what we call a continuation fund, which means that they can't be sold at the uh at the book value that the investor is carrying. So I think you're going to see a lot of markdowns in private assets this year and it's going to be quite painful. There are many private equity firms that are going to have to exit the industry because the losses that they've realized on their investments are so dramatic that they're not going to be able to raise money again. >> You said that ironically this might be good for equities as private credit flows back into the uh equities. Um, I'd like to point out that uh Blue Owl pulled out of the Oracle funding in December and the stock immediately dropped 5%. I'm not saying this is going to happen, but take a look at this article once more. Shares in US private private credit groups fell sharply on Thursday, extending a month monthsl long slide. Aries fell 6%, KKR fell 3.6%, Blue Owl lost 3%. If this continues, could we see a scenario in which private credit groups like Blue Owl maybe stop or slow down funding of of tech companies this year, which they need for capex, which by the way the market needs to go up. >> Yeah, very definitely. And particularly the software sector, there's a pervasive belief that the advent of AI is going to make a lot of software uh completely irrelevant. And so people have been dumping in the software, you know, in terms of investment allocations for years because they figured it was safe. They said, well, you know, new software, this is going to be the next big thing. And when you see the advent of AI, the layoffs that have come as a result, it really starts to make people wonder if software is not a more vulnerable sector than we've believed in the past. >> The other uh issue is, take a look at this. This is Apollo Group. Uh Apollo's um yeah top executive uh ZTO called out arrogance. This is from the Wall Street Journal. In private credits, private markets predicted that a private credit loan made a generic made to a generic small or midsize Joe Software company might recover 20 to 40 cents on the dollar. And he said Federal Reserve Chairman Powell is needing is needling President Trump with his inflation commentary. Okay. So, what do you think of this comment that um a software company loan might recover only 20 to 40 cents on the dollar? Uh, a senior executive at one of the biggest firms in the industry says the marks are all wrong. What does that tell you? Well, again, I think because these are private markets, David, and you don't have the benefit of a public discovery on a daily basis, you have to be very very critical of these marks. Um whereas in a public market you know to see that kind of a loss rate suggested is is very dramatic uh from a historical perspective but with private assets you don't know because the sponsors are all conflicted. That's why this has such a potential to be a mess, not just for banks, but for a lot of big investors, cuz there are a lot of endowments and pension funds that were depending on private equity as a source of income to cover operating expenses. The state of Oregon, for example, is a big mess because they put a lot of money into private equity and now they're forced to go out and borrow to cover their budget uh shortfall. And I think this is going to be a very familiar theme as we go forward this year. And again, ironically to your comment, people are going to go back into public equities. You know, we have more ETFs in this country than we do stocks. So there's not a lot of places to go. But that's one of the reasons I don't think the public equity market in the US is really going to trade off that much because where where do we go? Do we go out into emerging markets? Do we go into foreign currencies and hide there? There the other markets aren't big enough to absorb a real exodus from US financial markets. So, it's kind of a bit of an irony. >> What happens to bond yields once we do get a private credit shakeout? >> Oh, I think you could see them go up. You know, where the 10-year Treasury is now, you're already seeing elevated mortgage rates. Yeah. >> So, the little drop we had earlier in the year, we got below 6% on 30-year fixed mortgages. It's now well above six again. It's 6 and a quarter. In fact, this morning, >> uh, speaking of debt, let's move on from private credit to talk about um public debt for just a minute. The uh Congressional Budget Office is projecting that uh the deficit is going to continue widening and that interest payments on the debt itself is going to uh substantially widen to 2 trillion by the end of 2036 I believe or the end you know by the end of the decade and we're currently at just under 1 trillion. So that's doubling of interest payments alone. Now the interest payment on the debt alone right now is already greater than military spending uh barring the fact that Trump wants to you know expand that to 1.5 trillion. But the point is the the Federal Reserve or the Federal Government rather is going to be paying a lot more than interest payments over the next couple of years. What does that mean for fiscal policy? What does that mean for inflation? Well, we live in a kind of a delusionary uh age in the United States where members of both parties don't want to talk about this. You never hear anybody talk about the budget deficit. Uh I thought it was fascinating that Secretary of the Treasury Scott Besson said that the Fed was nowhere near returning to quantitative easing where they were buying a lot of Treasury bonds which is essentially monetizing the debt. But I think that's what's going to happen. the Fed is going to be forced to buy more and more Treasury debt to try and offset the trend that you just described and the result will be inflation because when the when the Fed buys Treasury uh securities, you grow the banking system. That's what happens and that growth translates almost immediately into asset price inflation. And that's kind of how we got to where we are today >> coming out of co when the Fed went and bought $7 trillion worth of Treasury securities and mortgage back securities. It grew the balance sheets of US banks dramatically. And even though those are kind of short-term assets, they don't really linger in the system very long, it still had a big effect on asset prices, David. And that's part of the reason you've seen the silliness in in private uh equity and private credit strategies. >> Speaking of uh strategies, last time you were on the show, um you told our audience to keep our powder dry, go shopping when things are cheap. Any such opportunities now, Chris? >> I'm still mostly focused on uh precious metals for my own portfolio and income. Uh I've been mostly out of US financials simply because I suspected they were going to trade off. You know last year after liberation day we had a great opportunity to trade US banks. I was in Schwab and American Express. >> Couple other names and we did very well. We also had a great trade in Fanny May and Freddy Mack last summer when people still thought they were going to be released from captivity but they're not. >> Yeah. So, I'm I I'm telling my readers to frankly be cautious. I've been putting whatever money I want to have in the fiat world into income producing stocks like Annalie and AGNC simply because they have safe assets and they benefit from a steep yield curve. Uh but mostly I'm adding to my positions in gold and silver because I think they're going to do very well over the medium term. Well, the financials have come off their highs by the order of 13% since January. >> Horribly. Look at the big guys. Look at JP Morgan. >> Yeah. >> Still two two times book value. So, it's not a crisis yet, but as credit deteriorates this year, I think the banks are going to trade off and there will be a point where they may be attractive. >> So, the banks aren't cheap yet is what you're saying. >> No. Yeah. Look at that chart. It tells you the story. Okay. Um, let's finally touch on a new executive order signed today by the White House removing regulatory barriers to affordable housing construction. I'll just read a few paragraphs from this. This came out uh this week. Uh, the American dream of home ownership depends on a dynamic housing market in which a varied inventory of new homes is built and renovated each year. layers of unnecessary regulatory barriers, slow permitting processes and owners mandates at all levels of government have delayed construction restrictions, development and driven up the cost of new housing. So this this executive order aims to uh remove some of the red tape that have been barriers and hurdles to uh construction and housing starts. Uh so you're right about mortgage finance every week. Uh will these orders have any material impact on actual housing starts? Uh not really. It It's helpful for them to do this. They also just modified uh the rules for um insurance for condominiums uh underwritten by Fanny May and Freddy Mack. And again, that's helpful. But the big driver of affordability problems, David, in the United States is inflation. If you look at the cost of building new housing in the United States, it just is prohibitive. Uh, I just sold my home in New York. It sold in 3 hours and I got an allcash bid $100,000 over the asking price. Why is that? Well, in New York State, we don't have a lot of new home construction. It's expensive. You have regulation and you also don't have a lot of property available. So, if you look at the New York metropolitan area, housing is only going up in price and you think, my god, how is that possible given the politics in New York? And the answer is there's no supply. That's really what's going on. So if you have a family and you want to move out of the city, uh you basically have to buy an existing home and it's a sellers market. >> Well, one of the um executive orders also targets institutional buyers basically uh blaming institutional buyers for buying up a bunch of housing units. And um first of all, can you just address that? Is is has that been a root problem of housing affordability? No, no. In fact, institutional investors have been a big help because they tend to focus on lower price housing that's built for rental. Um, you know, your typical builder is going to build a house for purchase because they're going to make more money. But I will tell you that most of the big home builders in the US have been cutting their prices for the past year simply because affordability has been so intense in terms of uh an obstacle to home ownership that they've had no choice but to cut their prices. They've also been subsidizing mortgages where they would push down the mortgage rate two and three points in order to incentivize a buyer. So I I think you know again inflation is the driver of this conversation. >> If the average American has most of their net worth tied up in housing and real estate >> and if we believe that the wealth effect has a considerable and material impact on consumer spending and demand then we should be concerned about the housing market. So should we be looking at the housing market as a potential indicator for slower demand? In other words, is the housing market in trouble right now? >> No. Housing is okay in terms of prices. The interesting thing is that the the median age of homeowners is much higher than it should be. And that's largely because they have the income. They are tending to to shelter in place rather than taking that equity out of the home and spending it. They are basically hunkered down. Many of them have low interest rate mortgages from the COVID period. I had a 3% mortgage that I'm about to prepay. So, I'm going to go in probably a six. And that may seem a little counterintuitive, but we want to move. So, eventually when people are forced to move, then those homes will come on the market. And the income, you know, I I bought this house I'm sitting in right now 5 years ago and I'm going to make almost 40% on the house. That's crazy. That illustrates the inflationary tendency in this market. >> What else are you watching when it comes to big risks facing investors right now? >> I think the bond market is a lagging indicator right now. Eventually, you're going to see interest rates, long-term interest rates spike regardless of what the Fed does. The Fed can't control the long end of the Treasury yield curve. And that's one of my big concerns because when that happens, the economy is going to slow down and you're going to see credit default activity in the corporate sector go up a lot because companies, you know, people who own office buildings and apartment buildings, they finance off the 7 to 10ear portion uh portion of the yield curve. And that's why it's so important. The Fed can't do much about that. They've tried uh like most central banks. They try and control the yield curve and it usually fails. Chris, thanks so much. Tell us where we can find you. I already mentioned the IRA. Um, but uh tell us where else. >> Well, as you said, I publish the institutional risk analyst. I also write a column for National Mortgage News. I'm active on X and LinkedIn under RC Whan and it's always a pleasure to talk to you, Dave. >> Okay. Always a pleasure to have you on the show, Chris. Thank you so much for coming back. Do follow Chris in the links down below and I'll see you next time. Take care for now, Chris. >> Thank you. >> Thank you for watching. Don't forget to like and subscribe.
Fed ‘Forced To Act’ As Private Credit Bubble Collapses, Banks On Brink | Chris Whalen
Summary
Transcript
We're speaking on Wednesday, March 18th, and the Federal Reserve just announced its decision to keep rates steady. Uh the markets reacted by going down. Stock markets are down 1.3%. The S&P 500, that is, stock futures um ended the day in the red, gold down 3% on the day, Bitcoin down 4 1/2%. So, we'll discuss why markets reacted the way they did, what's next for policy, what's next for uh the markets, and why there have been a slew of headlines regarding private credit redemptions. Our next guest says that this is an area to watch. It's getting worse. Chris Whan joins us once more. He is the chairman of Whan Global Advisor. Good to see you again, Chris. Welcome back. >> Nice to see you, David. Thank you for inviting me. >> Thank you for coming back. I want to play for you this clip from the FOMC press conference. Take a look where we act together. There's been some debate about whether the Fed should look through the inflation that will come from higher oil prices stemming from the Middle East conflict. Is that the right approach at this juncture? And to what extent does the fact that inflation has been above target for roughly 5 years now influence the committee's thinking around this? >> So, uh, first let me say we're well aware of, um, the performance of inflation over the last few years and how a series of shocks have have interrupted progress that we've made over time. and uh that happened most recently with tariffs and then and now there will be some effects on inflation coming forward. Um the the thing that's really important that we see this year is progress uh on inflation through a reduction in goods inflation as the one-time effects on prices of tariffs go through the system, go through the economy. That's the main thing we're looking for going into this exercise. And we need to be seeing that uh to you know to sort of understand that we actually are making progress because on net we didn't make progress and if you look at total inflation sorry total core inflation it's about 3% and some big chunk of that between a half and 3/4 is actually tariffs. So we're looking for progress on that. The fact that they didn't uh lower rates or you know change uh the policy rate at all was well telegraphed by markets. But I'll just get you to react to what we heard uh just now and also to the broader uh question as to whether or not they should be lowering rates now despite oil going up. The unemployment rate is also going up. Chris, >> yeah, I think that's the key point, David. They they should be looking through this oil price hike because is it going to be solved tomorrow? No. uh we'll probably have elevated oil prices for the rest of this year. But the economy is slowing. The jobs numbers are down. There are other indicia of what people call the K-shaped economy, which is that most consumption is coming from the very top of the income stack and the rest of the economy is kind of flatted down slightly. I thought it was very interesting that the numbers from the ITA talking about foreign uh visitors to the United States show a dramatic decrease from just about all of our major trading partners. So, you know, we've been waiting for I think a downturn in this economy for a while. I think the Fed is too fixated on tariffs because, you know, Chairman Powell made a pretty specific statement about how much of inflation comes from tariffs, but how does he really know? That's one of these unknowable things, and I know the Fed estimates what the impact is, but they don't really know in in in specific terms. So, you know, I I think they should probably drop rates now because they're relatively high. If you look at where interest rates have been over the last 10 years, they're still relatively high compared to where we were. >> Do you recall that in 2008 the ECB, the European Central Bank raised rates to 4 and a half four 4.25% despite mounting pressure uh from the economy despite mounting financial risks brewing in July when they did that. But that was because oil was going up all throughout 2007 and 2008 up until that point. >> So this is the same thing that's happening right now. I'll let I'll let you just comment on whether or not the Fed is making a policy mistake by not reducing rates now in light of what may be happening to the economy. If you see any systemic shocks ahead, let's put it that way. >> I think the systemic aspect of this, David, is the simple fact that low rates coming out of CO and going back several years caused a lot of behaviors in the credit market that are turning out to be rather poorly uh chosen. specifically the private credit bubble and the way it's starting to collapse is part and parcel of uh a lack of investment opportunities. Why did people go into private credit? They didn't like hedge funds which marked the market every day mostly purchased public securities. So everybody thought, well, we'll go into private credit. We'll make more money and we don't have the noise from having to value the investments on a daily basis. This has turned out to be a disaster because the street said, "Well, we'll invite retail investors in and retail investors have no tolerance for a lack of liquidity or any signs of stress." And that's what you're seeing, not only in what we used to think of as private credit, but in things like consumer loans, which are purchased by some from some of the big p fintech firms like a firm and lending club and the rest of them. All of these are now under pressure. So, I think the Fed is going to be forced to act because the markets are under stress and we're going to see more of that as as time goes forward. The next shoe to drop will be the bank banks. The the dumber banks that didn't trade away some of their credit risk are in going to end up holding some very bad paper and they're going to have to take losses. >> So, that leads me to talk about um we're go to the next section which is about the labor market. So, we had discussed the labor market in our last interview. Um, and you said that at the time you didn't see a consumer recession in the numbers. Now, the last BLS uh jobs report came out and the economy lost 92,000 jobs, Chris. So, have you have you changed your outlook on the labor market? >> I think what's happened and and you know the answer to your question is yes, is that the advent of AI has given a lot of employers an excuse to cut headcount. Whether or not AI is actually going to take the place of those employees or not is another matter. But if you look at big employers, Federal Express, UPS, all across the board in tech, across the board in other industries, they're using the excuse of AI to cut back on headcount and that is rippling through the economy. So again, you know, the upper 10, 15, 20% of income earners in this country are doing fine. consumption is increasing at the top and yet the bottom you know 50 60% are actually kind of stagnant and I do think we're in a bit of a stall economically and the revision on those jobs numbers was quite striking. Uh we may see more of that as we go forward through this year. >> Before we continue, I want to bring to your attention today's sponsor, Monetary Metals. Now most people think of gold as something you buy in store. Monetary Metals takes a different approach. Instead of just holding gold and waiting for price appreciation, you can earn a yield on it paid in physical ounces. Through their leasing platform, investors can earn up to 4% annually with yield paid monthly in ounces. That means your return is measured in gold, not just in currency terms. Rather than sitting idle while you pay storage costs, your gold generates income. The metal remains your asset and can be redeemed at any time. Thousands of investors are already earning monthly interest in gold through Monetary Metals. Visit monetary-medals.com/lin link in the description down below or scan the QR code here to learn more. I wonder if the weakening labor market has anything to do with this next story that I'm about to read you right now. Retail investors pulled billions from private credits uh credit private capitals credit gold mine. So the FT reported um on March 16, so 2 days ago, that wealthy investors have tried to pull more than $10 billion from the largest private credit funds this quarter alone. Managers including Blackstone, Black Rockck, Morgan Stanley, they've all had to limit withdrawals to about 70% of requests. Are we looking at different segments of the economy here? We've got wealthy, you know, private credit investors doing this while at the same time, the labor market, which reflects a broader American economy, is weakening. Are those two things related? tell us about what's going on. >> Well, they are related because many of those credit managers who put money into those funds represent all types of investors. You remember last year, David, just about every big retail firm on Wall Street was marketing private credit. Swiss banks, Vanguard, I mean all of them. And the reason they did this was they saw an opportunity to earn more fees. The problem is is that these investments were not suitable for these investors to borrow the term from US securities law. So you know we have a basic problem which is that this once you know once upon a time private credit was just for institutional investors big boys pensions endowments that sort of thing. And when it broadened out to include all types of qualified investors and then retail investors, you knew you were going to have a problem at some point because as soon as people think that their money is at risk, they run. You remember Silicon Valley Bank in 2023, 40% of the deposits walked out the door in 24 hours. So that's the kind of market we live live in today. Everybody's got a smartphone. They can all hit the button and say, "Give me my money back." And these firms who've had to gate their redemptions and say no are suffering big reputational damage. Whenever you have to say no to investors, they don't forget that for a while. So that's what's going on. >> This comes as a wave of headlines hit uh the news in the last couple weeks. Private credit redemptions have been going up. Um and uh like I mentioned, some of these fund managers have to have had to limit withdrawals. Uh, and you mentioned to me offline this situation has gotten worse in the last couple weeks. Tell us more. >> Well, it's start it's starting to spread to other asset classes. Private credit was mostly about funding uh various strategies around private companies, usually private equity portfolio companies. But you're starting to see pressure now on funds that were buying consumer loans, small business loans from some of the leading fintech plays, all of whom have seen their equities trade off dramatically. One of the more interesting ones was Lending Club. Last year, Lending Club was the best performing bank in the United States in the second half of the year. Now, it's down at the bottom of the 100 banks we track. uh and I think it just it gives you an indication of how much churn there is in the group and how much volatility there is in this group simply because of the change in perception on the part of investors about risk. So when you see people demanding their money back from a a fund which really doesn't have a terrible amount of risk in it, short-term paper, right? These are credit card receivables and similar sorts of things. It tells you that the contagion is spreading and that's my concern. I think we're going to see a wider uh exodus out of private credit funds and they're going to go back into the public markets. So, in a funny way, it's good for public markets, but it's probably not good for the private sponsors. >> How concerned should the uh regular consumer be? Uh I mean, this this could this could go bad. This could be another Lehman event, or it could just be a nothing burger. What do you sit? I I think it's mostly a nothing burger, but specific institutions are going to have some pain. There are some banks that I follow very closely who have been selling loan risk and buying the AAA tranches of CLOS's to hide and I think that's an effective strategy. There are other banks that haven't done that and I think you're going to find out who's dumb and who's not is what it comes down to. >> Why do you think bond markets aren't really pricing this risk in? So this is this is the um option adjusted spread from the Bank of America ICE index. It's been tickling it's been trickling up ever since the beginning of the year um for whole slew of reasons. But if you zoom out, if you take a look at actual crises and how they've behaved, how this index has behaved, we're nowhere near 2007. We're nowhere near um we're 2007208. We're nowhere near even near COVID. Um so it's you know high yield spreads are kind of muted right now. Why do you think that is? I think part of it is that there's nowhere else to go. You know, the markets have become desensitized to these macro shocks, even the war in Iran, you know, incredibly. Um, and so as a result, you don't see people reacting with fear in the way that they did say in 2020, which was other than 2008 was an amazing event. Uh, you really thought that the whole system was going to tip over at one point, but it hasn't happened. So, while oil prices have spiked well over $100, if you look at the US Treasury market, it's barely moved. And that's what's so interesting. Gold and silver have kind of traded off a bit over the past week, mostly because they had gone up so much. You know, at one point, silver was up 70% in the first three months of this year. That's quite extraordinary. So, it's a it's a time of volatility, but the volatility is muted as you just pointed out. Tell us about this piece that you wrote in uh IRA the institutional risk analyst risk concealed private credit PIK and the banks. Uh you published this piece on March 16th. You noted that according to uh KBW nearly 9% of private credit where private investment income is now being paid via payment in kind and you call that a stunning level for uh of default for the entire $2 trillion portfolio. So if a borrower cannot pay interest in cash and instead just adds more debt to what it already owes and the bank calls that a payment is that not is that not just another form of default with a different name I guess. >> Oh it is. Yeah very much. I think some banks have been playing a game here where they thought that the borrower somehow or another was going to uh be able to recover their situation and they would actually acrue the equity payments that they received as part of the principal amount owed which is not the way you should do it. Other banks have been more conservative and they essentially marked the loan as distressed and put it in the appropriate category. I think a number of lenders, banks and non-banks, uh, as well as some private equity funds are going to have to mark this paper down. You saw the announcement from JP Morgan. They've already started to do that. And the big concern I have is that for every dollar in bank loans to non-depository financial institutions, which is the fastest growing category in the industry, by the way, it's been doubledigit growth this year. There's $2 in unused credit. So, when you see the banks start to pull back those unused uh credit lines, that's when you know that we're really going to see a shake out in private credit. Uh we've had several disasters, most recently that UK uh uh mortgage firm MFS, which took down a lot of really smart people. It is quite astounding to see Blue Owl and Apollo and several others who are not at all uh the sort of uh professionals you would expect to get duped in this way uh take big losses. So, we're going to see more of that and it's part and parcel with the Fed keeping rates too low, too aggressive with monetary policy obviously and that contributed to a I think a sense that people could do whatever they wanted in terms of credit. But now credit's expensive. If you try and go out and issue paper in today's market, especially after the past week or two, David, uh you'll find that rates have risen a couple hundred basis points. Uh some of my clients were out in the market early in March trying to issue preferred and at first we were talking about 8%. Now we're talking about 12%. So that gives you a sense of how much the real market has moved even though the treasury market has been relatively stable although it has backed up a bit. >> This is another alarm bell. Chair of Swiss Private Cap Capital Group Partners Group sound alarm on private credit default rates. Uh we've got here the Partners Group chair uh Stefan Stefan Meister told the FT that private credit default rates could double from their recent average of 2.6% to above 5% in the coming years. UBS has modeled a tail risk event where private credit defaults could reach 14 to 15%. This is a tail risk event. Tail risk means it's not likely. However, uh where does it stop and what is a contagion risk of default rates going up? I would tell you David that the the probability of defaults going to his worst case scenario mid- teens or higher is actually higher simply because we're dealing with private markets where the sponsors have been responsible for telling us what the valuations are. We do not have independent uh opinions on what these assets are worth. And the sponsors are obviously conflicted. They don't want their schemes to fall apart because they're not going to be able to refinance them or sell them. You know, it's fascinating. There's probably 20% of all private equity companies in the United States today that are essentially illquid. And it's either they're paying in kind or they've been transitioned to what we call a continuation fund, which means that they can't be sold at the uh at the book value that the investor is carrying. So I think you're going to see a lot of markdowns in private assets this year and it's going to be quite painful. There are many private equity firms that are going to have to exit the industry because the losses that they've realized on their investments are so dramatic that they're not going to be able to raise money again. >> You said that ironically this might be good for equities as private credit flows back into the uh equities. Um, I'd like to point out that uh Blue Owl pulled out of the Oracle funding in December and the stock immediately dropped 5%. I'm not saying this is going to happen, but take a look at this article once more. Shares in US private private credit groups fell sharply on Thursday, extending a month monthsl long slide. Aries fell 6%, KKR fell 3.6%, Blue Owl lost 3%. If this continues, could we see a scenario in which private credit groups like Blue Owl maybe stop or slow down funding of of tech companies this year, which they need for capex, which by the way the market needs to go up. >> Yeah, very definitely. And particularly the software sector, there's a pervasive belief that the advent of AI is going to make a lot of software uh completely irrelevant. And so people have been dumping in the software, you know, in terms of investment allocations for years because they figured it was safe. They said, well, you know, new software, this is going to be the next big thing. And when you see the advent of AI, the layoffs that have come as a result, it really starts to make people wonder if software is not a more vulnerable sector than we've believed in the past. >> The other uh issue is, take a look at this. This is Apollo Group. Uh Apollo's um yeah top executive uh ZTO called out arrogance. This is from the Wall Street Journal. In private credits, private markets predicted that a private credit loan made a generic made to a generic small or midsize Joe Software company might recover 20 to 40 cents on the dollar. And he said Federal Reserve Chairman Powell is needing is needling President Trump with his inflation commentary. Okay. So, what do you think of this comment that um a software company loan might recover only 20 to 40 cents on the dollar? Uh, a senior executive at one of the biggest firms in the industry says the marks are all wrong. What does that tell you? Well, again, I think because these are private markets, David, and you don't have the benefit of a public discovery on a daily basis, you have to be very very critical of these marks. Um whereas in a public market you know to see that kind of a loss rate suggested is is very dramatic uh from a historical perspective but with private assets you don't know because the sponsors are all conflicted. That's why this has such a potential to be a mess, not just for banks, but for a lot of big investors, cuz there are a lot of endowments and pension funds that were depending on private equity as a source of income to cover operating expenses. The state of Oregon, for example, is a big mess because they put a lot of money into private equity and now they're forced to go out and borrow to cover their budget uh shortfall. And I think this is going to be a very familiar theme as we go forward this year. And again, ironically to your comment, people are going to go back into public equities. You know, we have more ETFs in this country than we do stocks. So there's not a lot of places to go. But that's one of the reasons I don't think the public equity market in the US is really going to trade off that much because where where do we go? Do we go out into emerging markets? Do we go into foreign currencies and hide there? There the other markets aren't big enough to absorb a real exodus from US financial markets. So, it's kind of a bit of an irony. >> What happens to bond yields once we do get a private credit shakeout? >> Oh, I think you could see them go up. You know, where the 10-year Treasury is now, you're already seeing elevated mortgage rates. Yeah. >> So, the little drop we had earlier in the year, we got below 6% on 30-year fixed mortgages. It's now well above six again. It's 6 and a quarter. In fact, this morning, >> uh, speaking of debt, let's move on from private credit to talk about um public debt for just a minute. The uh Congressional Budget Office is projecting that uh the deficit is going to continue widening and that interest payments on the debt itself is going to uh substantially widen to 2 trillion by the end of 2036 I believe or the end you know by the end of the decade and we're currently at just under 1 trillion. So that's doubling of interest payments alone. Now the interest payment on the debt alone right now is already greater than military spending uh barring the fact that Trump wants to you know expand that to 1.5 trillion. But the point is the the Federal Reserve or the Federal Government rather is going to be paying a lot more than interest payments over the next couple of years. What does that mean for fiscal policy? What does that mean for inflation? Well, we live in a kind of a delusionary uh age in the United States where members of both parties don't want to talk about this. You never hear anybody talk about the budget deficit. Uh I thought it was fascinating that Secretary of the Treasury Scott Besson said that the Fed was nowhere near returning to quantitative easing where they were buying a lot of Treasury bonds which is essentially monetizing the debt. But I think that's what's going to happen. the Fed is going to be forced to buy more and more Treasury debt to try and offset the trend that you just described and the result will be inflation because when the when the Fed buys Treasury uh securities, you grow the banking system. That's what happens and that growth translates almost immediately into asset price inflation. And that's kind of how we got to where we are today >> coming out of co when the Fed went and bought $7 trillion worth of Treasury securities and mortgage back securities. It grew the balance sheets of US banks dramatically. And even though those are kind of short-term assets, they don't really linger in the system very long, it still had a big effect on asset prices, David. And that's part of the reason you've seen the silliness in in private uh equity and private credit strategies. >> Speaking of uh strategies, last time you were on the show, um you told our audience to keep our powder dry, go shopping when things are cheap. Any such opportunities now, Chris? >> I'm still mostly focused on uh precious metals for my own portfolio and income. Uh I've been mostly out of US financials simply because I suspected they were going to trade off. You know last year after liberation day we had a great opportunity to trade US banks. I was in Schwab and American Express. >> Couple other names and we did very well. We also had a great trade in Fanny May and Freddy Mack last summer when people still thought they were going to be released from captivity but they're not. >> Yeah. So, I'm I I'm telling my readers to frankly be cautious. I've been putting whatever money I want to have in the fiat world into income producing stocks like Annalie and AGNC simply because they have safe assets and they benefit from a steep yield curve. Uh but mostly I'm adding to my positions in gold and silver because I think they're going to do very well over the medium term. Well, the financials have come off their highs by the order of 13% since January. >> Horribly. Look at the big guys. Look at JP Morgan. >> Yeah. >> Still two two times book value. So, it's not a crisis yet, but as credit deteriorates this year, I think the banks are going to trade off and there will be a point where they may be attractive. >> So, the banks aren't cheap yet is what you're saying. >> No. Yeah. Look at that chart. It tells you the story. Okay. Um, let's finally touch on a new executive order signed today by the White House removing regulatory barriers to affordable housing construction. I'll just read a few paragraphs from this. This came out uh this week. Uh, the American dream of home ownership depends on a dynamic housing market in which a varied inventory of new homes is built and renovated each year. layers of unnecessary regulatory barriers, slow permitting processes and owners mandates at all levels of government have delayed construction restrictions, development and driven up the cost of new housing. So this this executive order aims to uh remove some of the red tape that have been barriers and hurdles to uh construction and housing starts. Uh so you're right about mortgage finance every week. Uh will these orders have any material impact on actual housing starts? Uh not really. It It's helpful for them to do this. They also just modified uh the rules for um insurance for condominiums uh underwritten by Fanny May and Freddy Mack. And again, that's helpful. But the big driver of affordability problems, David, in the United States is inflation. If you look at the cost of building new housing in the United States, it just is prohibitive. Uh, I just sold my home in New York. It sold in 3 hours and I got an allcash bid $100,000 over the asking price. Why is that? Well, in New York State, we don't have a lot of new home construction. It's expensive. You have regulation and you also don't have a lot of property available. So, if you look at the New York metropolitan area, housing is only going up in price and you think, my god, how is that possible given the politics in New York? And the answer is there's no supply. That's really what's going on. So if you have a family and you want to move out of the city, uh you basically have to buy an existing home and it's a sellers market. >> Well, one of the um executive orders also targets institutional buyers basically uh blaming institutional buyers for buying up a bunch of housing units. And um first of all, can you just address that? Is is has that been a root problem of housing affordability? No, no. In fact, institutional investors have been a big help because they tend to focus on lower price housing that's built for rental. Um, you know, your typical builder is going to build a house for purchase because they're going to make more money. But I will tell you that most of the big home builders in the US have been cutting their prices for the past year simply because affordability has been so intense in terms of uh an obstacle to home ownership that they've had no choice but to cut their prices. They've also been subsidizing mortgages where they would push down the mortgage rate two and three points in order to incentivize a buyer. So I I think you know again inflation is the driver of this conversation. >> If the average American has most of their net worth tied up in housing and real estate >> and if we believe that the wealth effect has a considerable and material impact on consumer spending and demand then we should be concerned about the housing market. So should we be looking at the housing market as a potential indicator for slower demand? In other words, is the housing market in trouble right now? >> No. Housing is okay in terms of prices. The interesting thing is that the the median age of homeowners is much higher than it should be. And that's largely because they have the income. They are tending to to shelter in place rather than taking that equity out of the home and spending it. They are basically hunkered down. Many of them have low interest rate mortgages from the COVID period. I had a 3% mortgage that I'm about to prepay. So, I'm going to go in probably a six. And that may seem a little counterintuitive, but we want to move. So, eventually when people are forced to move, then those homes will come on the market. And the income, you know, I I bought this house I'm sitting in right now 5 years ago and I'm going to make almost 40% on the house. That's crazy. That illustrates the inflationary tendency in this market. >> What else are you watching when it comes to big risks facing investors right now? >> I think the bond market is a lagging indicator right now. Eventually, you're going to see interest rates, long-term interest rates spike regardless of what the Fed does. The Fed can't control the long end of the Treasury yield curve. And that's one of my big concerns because when that happens, the economy is going to slow down and you're going to see credit default activity in the corporate sector go up a lot because companies, you know, people who own office buildings and apartment buildings, they finance off the 7 to 10ear portion uh portion of the yield curve. And that's why it's so important. The Fed can't do much about that. They've tried uh like most central banks. They try and control the yield curve and it usually fails. Chris, thanks so much. Tell us where we can find you. I already mentioned the IRA. Um, but uh tell us where else. >> Well, as you said, I publish the institutional risk analyst. I also write a column for National Mortgage News. I'm active on X and LinkedIn under RC Whan and it's always a pleasure to talk to you, Dave. >> Okay. Always a pleasure to have you on the show, Chris. Thank you so much for coming back. Do follow Chris in the links down below and I'll see you next time. Take care for now, Chris. >> Thank you. >> Thank you for watching. Don't forget to like and subscribe.