Should investors worry about a 2008-style shock?

BACK in the summer of 2008 – or just before the great financial crisis – two unsettling financial trends collided: oil prices surged to almost US$150 a barrel, and private funds holding sub-prime mortgages reported mounting losses.

Investors might now feel some deja vu. In March, the US-Israeli attack on Iran has caused the oil price to see-saw violently. And while it remains well below that 2008 peak – especially in inflation-adjusted terms – it could still climb, given the record scale of disruption.

Meanwhile, bad news is also tumbling out from the non-banking world, this time from private credit funds.

Never mind that regulators have repeatedly warned that the private credit sector seems overheated; or that banks such as JPMorgan are reducing exposures to this sphere, which contains “cockroaches”, that is, troubled loans, to cite Jamie Dimon, head of JPMorgan.

What is most unnerving is that multiple funds – ranging from those run by behemoths such as Morgan Stanley and BlackRock to specialists such as Blue Owl and Cliffwater – report that investors are trying to flee the funds.

That reflects fears that artificial intelligence (AI) will undermine the business model of software companies backed by private credit, even as the sector faces a US$40 billion redemption wall in 2028. However, the risks go well beyond AI, as the recent failure of UK lender MFS shows.

And while most private credit funds have rules that limit quarterly redemptions to 5 per cent of assets – enabling them to “gate” (prevent) excess outflows – the exodus echoes 2008. 

Hence why Kunal Shah, a top Goldman Sachs executive, told clients that some financiers were “just glad there’s something to talk about that isn’t software exposures and private credit” – the Iran war.

Or, even more bluntly, it is not just US President Donald Trump who might relish the focus on the war, which is a good distraction from the debate around the Epstein files.

Some financiers also have reason to avoid the spotlight. Doubly so, given that retail investors have flooded into private credit, with White House backing.

So, should investors worry about a 2008-style systemic shock? Probably not in the short term. One reason is that private credit is around US$2 trillion in size, so fairly small for the system as a whole.

Another is that the wider financial system seems better prepared for shocks – like surging oil prices – as Pablo Hernandez de Cos, head of the Bank for International Settlements, said in a thoughtful speech on Mar 4.

Most notably, he pointed out that banks’ Tier 1 capital ratios are now 14.3 per cent, against less than 10 per cent in 2011, while their share of high-quality liquid assets and stable funding has risen by 55 per cent and 40 per cent, respectively.

Moreover, since funds can slow investor outflows via gates, and do not need to revalue assets in a timely manner, they are not collapsing – yet.

The problem is more akin to a slow-moving cancer than a sudden heart attack. Or to use another metaphor: The private credit bubble is deflating with a long “hiss”, not a “pop”.

However, even if this is less immediately threatening, the medium-term risks are definitely rising.

When investors sense unrealised losses in the system, confidence tends to crumble; just look at what happened in 1990s Japan, when banks concealed their losses and it was hard for investors to exit.

And while private credit has boomed because regulators tightened controls on banks after 2008, leaving non-banks largely alone, the two remain connected.

“Banks are lenders, counterparties, service providers and, at times, backstops to non-bank entities,” noted Hernandez de Cos.

He lamented the “complex ecosystems of leverage, liquidity transformations and duration risk” beyond regulators’ control, which make private credit a potential channel of systemic risk.

Worse, the sector will become even more vulnerable if long-term rates rise – say, if the price of oil and other goods rises because the Strait of Hormuz stays shut.

And if a wider turmoil in bond markets then erupts, there is another risk that has received scant attention: global coordination, or the lack of it.

As Robert Hormats, a former economic official in the Obama administration, pointed out, after the 2008 crisis the Group of 20 leaders coordinated their policies to quell the shock. So, too, during the 1990s Asian financial crisis (at least among Western allies).

“The US took the lead and worked with other countries,” Hormats told me.

But, he noted, this coordination only works with trust. Trump has now shattered much of that. It is thus alarmingly unclear whether the White House could quell a cross-border panic today, particularly since its fiscal and monetary firepower is low.

Hopefully, this will not be tested. But the longer the Middle East turmoil grinds on, the more risks will rise.

Or to put it another way: The Iran war-private credit combination may not seem damaging enough to cause a global recession, but it could certainly spark financial tremors. Listen out for that long “hiss”. FINANCIAL TIMES