ALL BOOMS END IN BUSTS, AND THE CURRENT BOOM IN PRIVATE CREDIT WILL BE NO DIFFERENT. BUT NOT ALL BUSTS ARE OF A SIMILAR SIZE.
Here, guest contributor Ben Hunt explains why he thinks the next economic and market downturn could weigh in at the heavier end of the scales.
BEN HUNT
is president and co-founder of Perscient, an AI research firm and software company that pioneered the use of language models and unstructured data analysis for investment strategies. In 2013, he launched Epsilon Theory, a newsletter and website that examines markets through the lens of narrative. Over 100,000 professional investors and allocators read Epsilon Theory for its fresh perspective and insights into market dynamics. In prior positions, Ben has managed a billion dollar hedge fund and served as chief strategist and chief risk officer for a $13 billion asset manager. He has a PhD from Harvard University, was a tenured political science professor and has co-founded three technology companies.
THE ETERNAL RHYME OF MARKETS IS THE CYCLE OF BOOM AND BUST – THE GOOD TIMES THAT BRING THE BAD TIMES THAT BRING THE GOOD TIMES, FOREVER AND EVER, AMEN.
The tempo of that rhyme may be slowed as capital markets take on a critical political importance, but the beat never stops. The amplitude of cycle peaks and cycle troughs may be shifted by new technologies, new politics and new demographics, but the peaking and the troughing never stops.
The question is not whether the boom today in global markets resulting from the financialization of private credit by alternative asset managers (the new, more kindly term for shadow banks) will end in a bust. Of course it will! The question is whether the bust will be a garden variety bear market or something more apocalyptic. Will it be limited to these alternative asset managers (many of which have arguably already endured a bear market in 2025) or something more far-reaching?
My baseline view is that this bust will be neither garden variety nor limited. Rather, the financialization of private credit and the insurance industry by shadow banks today is virtually an exact rhyme with the financialization of household credit and the mortgage industry by commercial banks 20 years ago, and the bust will similarly rhyme uncomfortably well with 2008.
The purpose of this note is twofold. First, I want to explain why this greater-than-garden-variety bust is my baseline view. To do that, I’ll need to explain why the current boom in private credit securitization by shadow bankers is such a close rhyme with the 2005-2008 boom in mortgage securitization by commercial bankers. Second, in the immortal words of Charlie Munger, I want to “invert, always invert!” and look closely at all the reasons why my harsh thesis could be wrong. To do that, I’ll need to set out a falsifiable path for the timing and catalysts my thesis requires. Because, when you have a negative view and you’re wrong on timing, you’re just wrong.
HOW IT STARTED
I’d argue there are four necessary and sufficient structural conditions for a financial boom to end in tears. All have built steadily over the past 15 years and are now in final boss form. All are crucial, but I’ve listed them in my impressionistic sense of development timing, from the earliest to the most recent. 1 Financial ‘innovation’ 2 Regulatory arbitrage, capture and myopia 3 Structuring complexity 4 Gearing for capital velocity
1 FINANCIAL ‘INNOVATION’
I’ve used quotation marks because innovation doesn’t really exist, at least not like innovation in any other field. All financial innovation, without exception, is either a new way to securitize something (to turn a thing, an idea, a process or a flow into a piece of paper that can be more easily traded than the original thing) or a new way to apply leverage to something (to use borrowed money to transact in it).
Leading up to the global financial crisis (GFC), financial innovation took the form of quant applications like the Gaussian copula. This (as Margot Robbie explained from her bathtub in The Big Short and as Felix Salmon explained in an only slightly less entertaining Wired magazine article1) ‘proved’ that a geographically diversified and properly structured portfolio of US residential mortgages had a much lower chance of meaningful defaults than was priced in by the mortgage coupons. That allowed AAA-rated securitizations of subprime or otherwise high credit risk mortgages.
Today, financial innovation takes the form of publicly traded vehicles like exchange-traded funds (ETFs) and business development companies (BDCs) that are chockful of private securities (mostly private credit), all marketed directly to retail investors. It takes the form of subsidiary or captive life insurers and reinsurers that fund their parent shadow bank’s securitizations not only through direct investment of insurance policy premia but also through debt issuance of funding agreement-backed securities and notes.2
2 REGULATORY ARBITRAGE, CAPTURE AND MYOPIA
These are the three ways financial institutions use the power of government to extend the boom times. But they also extend the depth of the bust.
Regulatory arbitrage is the selective use of different regulatory jurisdictions for commercial advantage. The best example of this in the lead up to the GFC was Lehman’s Repo 105 program. Mortgage-backed securities were sold off the bank’s books a couple of days before quarter end and repurchased as quickly after, all to mask the bank’s true risk profile in quarterly filings. This sort of window dressing is clearly illegal under both federal and state regulatory regimes in the US but arguably not so under UK law and was thus implemented by Lehman’s UK entity. Today, an example of regulatory arbitrage might be registering your captive reinsurer under Caymans jurisdiction (relatively lax) rather than Bermuda jurisdiction (relatively strict). Not surprisingly, Caymans registrations are booming across the shadow banking landscape.
Regulatory capture is financial institutions gaining commercial advantage by influencing the legislators who write financial laws, the regulators who enforce them, and the agency personnel who measure compliance with them. Both pre-GFC and today, the biggest bang for your buck can typically be found in capturing the ratings agencies which effectively price your debt securitizations, whether they are backed by a bucket of residential mortgages as in 2007 or by a bucket of corporate loans as now.
There is an enormous disparity in information, status and money between the parties here. If the financial institution runs into a firm or staffer who resists giving them the rating they need, they’ll find someone else who will.3
Regulatory myopia is the all too human tendency of regulators and legislators alike to fight the last war, to over-regulate whatever was deemed to have caused the last crisis and to under-regulate or ignore the proximate causes of the next crisis. After the GFC, every financial regulator on the planet focused its Eye of Sauron on commercial banks and their capitalization buffers and requirements, with the (very reasonable) goal of preventing commercial banks from ever again taking the sort of risks that might require their recapitalization with public funds. This left an enormous opportunity for financial institutions that were not commercial banks – like asset managers – to fill that void by making the loans commercial banks either could not or were not allowed to make, without maintaining the capital ratios and buffers regulators required of commercial banks. Put that together with the funding mechanism of captive insurance programs (which is more loosely regulated than bank deposit accounts) and voilà – private credit is born!
3 STRUCTURAL COMPLEXITY
The inevitable progression of any financial boom is greater and greater structural complexity. That’s because the primary source of commercial advantage as a financial market matures (remember, there is no actual technological innovation or intellectual property to be had here) comes through informational asymmetry. It is to your distinct advantage to know more than your counterparty about the system of obligations and controls that govern a set of transactions – and to make it more difficult for your counterparty to acquire that knowledge. You’re not lying to your counterparty; you’re just not going out of your way to show the full picture. Structural complexity is intentional, and the goal is to be as opaque and informationally asymmetric as possible.
Pre GFC, this structural complexity took the form of arcane tranching and retranching within a securitization, as well as securitizations of securitizations, and sometimes securitizations of securitizations of securitizations. More fundamentally, the entire enterprise of mortgage-backed securitizations was based on the premise that the note (the borrowed money) of a mortgage could be effectively severed from the collateral (the deed) backing the mortgage. When enough defaults occurred to force a reconnection of notes and deeds at scale, the entire enterprise collapsed under the weight of over-structured notes.
Today, structural complexity has all the securitizations of securitizations the pre-GFC period had, as well as all the tranching within securitizations. What’s different is the complexity around funding, particularly in the marriage of a structurally complex insurance world with a structurally complex asset management world. Imagine the Citi structured investment vehicles (SIVs) from 2005-2008 but also with reinsurance sidecars. We’ve gotten to the point where so many intentionally opaque ownership and debt structures intersect that no one, not even the household name sponsors of these deals, has a full view of the entire web. For example (and this specific example is more problematic for commercial bank lenders than the big boy alternative asset managers), here’s a set of debt structuring diagrams from the bankruptcy filings of auto parts distributor First Brands. They detail an $11 billion web of special purpose off-balance sheet entities funded by first lien, second lien and asset-based loans across dozens of senior and subordinated lenders, none of which were aware of the full extent of the lending web.
And these are just the simplified diagrams.4
4 GEARING FOR CAPITAL VELOCITY
As the old saying goes, “Wall Street is in the moving business, not the storage business.” All financial institutions, from investment banks to commercial banks to shadow banks, evolve over a boom cycle to accelerate the pace at which capital moves through their balance sheets. No single position remains on the books for long, as far more money can be made with far less market risk by adopting a flow model for the enterprise.
Both pre GFC and today, the crucial strategic shifts of any lending institution to gear its operations for capital velocity are a) to acquire origination capabilities to bring loans onto the balance sheet and securitization capabilities to take loans off the balance sheet and b) to secure stable, captive funding sources so that there’s never a kink in the fuel lines (liquidity) required to transform originated loans into securitized loans.
The first part of this strategic imperative is why Morgan Stanley acquired mortgage originator Saxon Capital in 2006 and why Bank of America leapt at the opportunity to acquire Countrywide for what seemed a rock bottom price in 2008. It’s why Apollo acquired the securitized product origination and securitization business Atlas SP off the corpse of Credit Suisse in 2024.
The second part of this strategic imperative is why Bear Stearns failed. With the run on its prime brokerage business in early 2008, it didn’t have a stable, captive funding source. This is why commercial banks pay up to acquire deposits, why the US government guarantees commercial bank deposits and why the Fed provides limitless liquidity backstops to commercial banks through the standing repo facility. This is why alternative asset managers fully acquire and consolidate life insurers (Apollo-Athene 2021, KKR-Global Atlantic 2023, Brookfield-American Equity Life 2024) or partially acquire and control their investment decisions (Apollo-Athene 2009, Carlyle-Fortitude Re 2018, Ares-Aspida 2021, Blackstone-AIG Life 2021, Blue Owl-Kuvare 2024).
Gearing for capital velocity is typically the last development stage of a financial boom, and the creation of a ‘flow machine’ is where all the other stages come together. Financial innovation, regulatory influence, structural complexity, they all become focused on securing deeper funding sources as the flow machines require more and more fuel (fresh capital) to keep from sputtering. This is why alternative asset managers today are making such an all-out effort to convince investors, regulators and the public to allow them to tap directly into retail retirement accounts, in addition to expanding the portfolio risk transfers they’ve all implemented with public and private pension funds.
HOW IT'S GOING
These four necessary and sufficient conditions for a financial crisis – financial ‘innovation’, regulatory arbitrage, capture and myopia, structural complexity and gearing for capital velocity – are the wood and kindling for a bonfire. But without a match it won’t catch fire, and without a steady flow of oxygen it won’t burn. The structure for a financial conflagration is here today, but without a set of catalysts it can remain unlit for a very long time indeed, and without a feedback loop into the real economy it can smolder in sectoral underperformance rather than burn the whole market down. That’s what we need to explore next.
If you go by the headlines in the financial press, the primary risk to the alternative asset managers and their newly won credit empire must be on the AI infrastructure front. It feels like every other article is talking about a new datacenter and its funding, where every misstep hits the tech stocks and related financials hard. I think this fear is misplaced. At least for now. Yes, there is risk to both syndicated credit and private credit around AI infrastructure deals. But I don’t see how that manifests until late 2026 at the earliest, as political risk and project completion risk emerge around the midterm elections as part of a backlash against datacenter electricity consumption.5
Until that time, I don’t see what stops the AI infrastructure train. Big Tech is all-in and believes this is a winner-take-most market; strong cash flows are available to support future debt issuance. The White House desperately needs the positive GDP impact from the datacenter build-out (already a greater contributor to GDP growth than all consumer spending in the first half of 2025) and is similarly all-in through its recently announced Genesis Mission. We’re already seeing strong indications that a US Treasury backstop for AI datacenter debt is forthcoming, not to mention direct Department of Defense…er, War…allocations.
No, the catalysts for a major financial crisis aren’t coming from the AI bubble. They’re coming from the same source as in 2008, the same source that’s sparked every major financial crisis of the past century: the US consumer economy. The risks to the private credit world are in the loans they’ve made over the past ten years to consumer-facing companies, especially those facing the lower leg of the K-shaped economy.
The bankruptcies of auto lender Tricolor and First Brands last summer – both enmeshed in webs of fraud, both with billions in hidden debt, both directly facing the subprime consumer – are the canaries in this coal mine. They are the immediate catalysts for this greater-than-garden-variety bust, just as the Bear Stearns high yield funds were the immediate catalysts in 2007. Specifically, the Wall Street reaction to the Tricolor and First Brands bankruptcies has accelerated a consumer credit crunch and created a negative feedback loop into the real economy, just as Wall Street’s reaction to the Bear Stearns funds did.
Remember what I said about the flow machines of late-stage financial boom cycles requiring more and more fuel in the form of funding capital to keep the machine running hot? If there’s any hiccup in the funding fuel lines – any hiccup at all – the entire machine can start to sputter and fail, which makes funders even more skittish about your firm. This is what happened to Bear Stearns in late 2007 and early 2008 as hedge funds pulled their prime brokerage accounts (its main source of funding), leading ultimately to Bear’s death. But it wasn’t only the Bear flow machine that seized up; a lot of others did, too. Which led to this 2008 doom loop (Figure 1) where the seized-up Wall Street machinery created more stress in the housing market, which led to greater nationwide price declines etc.
Figure 1 THE 2008 DOOM LOOP
The risk today is a similar doom loop (Figure 2), not from a nationwide decline in home prices that creates deep and unexpected losses for investors in securitizations like the Bear Stearns funds, but from the bankruptcy and default of companies like Tricolor and First Brands that create deep and unexpected losses in their web of debt securities.
Figure 2 THE 2026 DOOM LOOP?
I believe we are currently in the early stages of the bottom box of this loop, where the securitization engine has seized up for any sponsor or operating company facing consumers in the lower leg of the K-shaped economy, and where credit availability for those consumers is similarly in a deep freeze. I also believe that this credit and securitization freeze is spreading higher and higher up the consumer income ‘stack’, just as mortgage defaults were not contained in subprime in 2007 and 2008. Why do I believe this?
Figure 3 shows the October 2025 data from the NY Fed consumer credit access survey, which is updated every four months and goes back about a dozen years. Credit applications regardless of type (credit cards, auto loans, mortgages, mortgage refis) are being rejected at the highest rate (24.8%) since the survey started. Mortgage refi applications are being rejected at an especially high rate, north of 45%. These are not poor consumers; they are middle class and up homeowners. This is what a consumer credit freeze looks like – already! – in late 2025.
The US economy is the consumer, still – AI infrastructure notwithstanding – and credit is the oxygen the US consumer breathes. I believe we are currently in a polar vortex of a credit freeze to the bottom half of US income levels, with buy now pay later (BNPL) the only available credit for millions of American households. Now even BNPL credit availability is tightening, even as job losses in small/medium businesses spread and deportation policies create enormous stress in the bottom half of the consumer market.
If I’m right about these consumer-facing catalysts and the associated credit freeze feedback loop into the real economy, we should start to see another swath of defaults this spring. It will be harder for the Masters of the Private Credit Universe to claim that the next swath of defaults are one-off, idiosyncratic episodes, as they claimed with Tricolor and First Brands. We’ll also see another leg down in markets and another set of deep and unexpected losses in securitized loans, both syndicated (commercial banks) and private (shadow banks). At the same time, we’ll start to read stories about defaults spreading from subprime into higher and higher income brackets, and about consumers in the highest income brackets slowing their spending. Spreading and slowing – those will be the dominant narratives if I’m right about the path and severity of the private credit bust.
If I’m wrong, we’ll be reading about tax cuts and rebates. We’ll be reading about the resilient consumer. Financials, particularly alternative asset managers with exposure to subprime-facing companies, may underperform. But it won’t be contagious. It will be, at worst, a garden variety bear market, and you’ll be reading lots of stories about a mid-cycle slowdown.
Like many readers of this article, I lived through the (much) greater-than-garden-variety bust of 2008, and I wouldn’t wish that on anyone again. So I hope I’m wrong. But hope, as they say, is not a strategy, and we can’t wish away the cyclical nature of markets. All we can do is prepare. And listen for the rhymes. ⬤
1 Salmon (2009), Recipe for Disaster: The Formula That Killed Wall Street 2 Harris (2025), The niche debt tool at the heart of Apollo’s private credit machine 3 For an explanation of how the game is played today, see Harris, Healy, Nangle (2025), The new crop of ratings agencies behind the private credit boom 4 bondoro.com/first-brands-group 5 epsilontheory.com/world-war-ai
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