Echoes of 2007 In Mushrooming Private Credit Boom? | Patrick Perret-Green on Tricolor & First Brands Bankruptcy, Asian Disinflation, And Why U.K. Duration Looks Attractive
Timestamps are as accurate as they can be but may be slightly off. We encourage you to listen to the full context.
Podcast Summary
In this compelling episode of Monetary Matters, host Jack interviews Patrick Parrott Green of PPG Macro about concerning market developments and economic warning signs. Patrick highlights growing froth in markets, particularly around misclassified bank loans to non-bank financial institutions that have surged from 5% to 13% of total bank loans. (00:41) He draws parallels between current conditions and 2007, noting how real lending to the economy is stagnant while risky private credit markets have ballooned beyond the size of high-yield bond markets.
- Main Theme: The episode explores emerging systemic risks in financial markets, from private credit bubbles to AI capital expenditure booms, while examining global deflationary pressures and potential currency dynamics
Speakers
Patrick Parrott Green
Patrick Parrott Green is the founder of PPG Macro, a macroeconomic research and advisory firm. He is an economic historian by background and formerly worked as a rates trader at Citibank, running his own book on the rates trading desk. (25:26) Patrick specializes in global macro analysis, focusing on foreign exchange and interest rates for institutional clients including global macro hedge funds.
Jack (Host)
Jack is the host of Monetary Matters, a finance podcast that explores macroeconomic trends and market dynamics. He conducts in-depth interviews with financial professionals and has previously interviewed officials from major financial institutions including the Financial Stability Board and Federal Reserve personnel.
Key Takeaways
Bank Loan Misclassification Reveals Hidden Risks
Patrick discovered through Federal Reserve H.8 data that what appeared to be healthy commercial and industrial lending was actually misclassified loans to non-bank financial institutions. (00:41) These loans surged from under 5% of total bank loans in 2015-2016 to 13% currently, with a massive $290 billion upward revision occurring recently. This reveals that real lending to the productive economy is essentially flat, while risky lending to unregulated financial vehicles has exploded. The implications are significant because non-banks lack access to Federal Reserve liquidity facilities, making them vulnerable during stress periods when banks typically cut credit lines and increase charges.
Private Credit Markets Present Systemic Risk
The private credit market has grown larger than the high-yield bond market, yet operates with minimal regulatory oversight and transparency. (08:27) Recent defaults like Tricolor (an auto subprime lender to undocumented immigrants) and First Brands have exposed the poor due diligence standards, with major banks like JPMorgan and Barclays taking significant losses. Patrick draws parallels to CDO markets in 2006-2007, noting how rating agencies are now getting paid more to rate private credit deals, creating similar perverse incentives that contributed to the financial crisis.
AI Capital Expenditure Boom Shows Bubble Characteristics
The current AI investment wave exhibits classic bubble characteristics, with Patrick comparing it to 19th-century railway booms where massive debt was issued to build infrastructure that ultimately generated no profits. (27:24) While companies like Microsoft and Meta are spending enormous amounts on AI infrastructure, their free cash flow has collapsed. The fundamental question remains whether AI demand will be sufficient to justify these valuations and capital investments, especially given that building AI data centers happens quickly, concentrating massive capital expenditure in short timeframes.
Global Deflationary Forces Are Strengthening
Patrick identifies multiple deflationary pressures building globally, including nine consecutive quarters of deflation in China (the worst on record), collapsing producer prices in Taiwan and Thailand (down 5% year-over-year), and the euro's appreciation which historically reduces inflation by 0.5% over two years. (39:13) These deflationary forces are spreading while central banks, particularly the Fed, continue to focus on sticky inflation. This disconnect suggests that monetary policy may be inappropriately tight given the evolving global economic landscape.
Financial System Liquidity Concerns Echo 2019
Bank reserves have fallen to $3 trillion, representing only 9.7% of nominal GDP, approaching levels that caused problems in 2019. (16:56) The ratio of reserves to primary dealer repo is now 1:1, the highest since 2019 when the Fed was caught off-guard by repo market dysfunction. With the non-bank financial system much larger than in 2019 but still lacking access to Fed liquidity facilities, the adequacy of current reserve levels is questionable. Patrick notes that non-banks must rely on banks for funding, but banks typically restrict credit and raise charges during stress periods.
Statistics & Facts
- Non-bank lending has surged from less than 5% of total bank loans in 2015-2016 to 13% currently, with a recent $290 billion upward revision in Federal Reserve data. (00:41) This massive shift reveals that apparent commercial and industrial lending growth was actually misclassified lending to unregulated financial vehicles.
- Bank reserves have fallen to $3 trillion, representing only 9.7% of nominal GDP, with Fed officials previously suggesting the adequate level was 10-11% of GDP. (16:56) The ratio of reserves to primary dealer repo is now 1:1, matching problematic levels seen in 2019.
- China has experienced nine consecutive quarters of deflation, described as "the worst on record." (45:57) Producer prices in Taiwan and Thailand have collapsed to approximately minus 5% year-over-year, indicating deflationary pressures spreading throughout Asia.
