When Edward Jenner inoculated an eight-year-old boy with cowpox in 1796, the principle was radical: Expose a healthy body to a mild, manageable version of harm, and it builds the defenses to survive something far worse. The cowpox patient never got smallpox. Markets work in much the same way.
The recent headlines on private credit have been alarming. More than $4.6 billion of investor capital is now trapped behind withdrawal limits, with investors having sought to pull roughly $13 billion from over a dozen such funds last quarter. Apollo Global Management Inc., Blackstone Inc., BlackRock Inc., Ares Management Corp., Blue Owl Capital Inc., Morgan Stanley and Cliffwater have all been caught in the crossfire. The private credit default rate hit 5.8% through January, according to a Fitch Ratings report, including extend-and-pretend events like maturity extensions and payment-in-kind, which while not legal defaults generally indicate severe financial stress.
This looks like a crisis. It isn’t — or at least it doesn’t have to be. In fact, if you squint past the panic, this moment may be exactly what a young, fast-growing and, until recently, largely untested market needed.
Private credit has expanded at a remarkable pace, ballooning to well over $2 trillion in assets in roughly a decade. It did so with little adversity. Borrowing costs were low, defaults were rare, and the semi-liquid structures used to sell these products to retail investors — quarterly redemptions capped at 5% of net asset value — attracted little scrutiny. The problems now surfacing were always latent. Better they surface now.
The instinct when seeing a gate slam shut is to panic. Investors who asked for their money back and received less than half of it in some cases are understandably aggrieved. But consider the alternative. Forced asset sales into an illiquid market would crater valuations, harm the investors who remained and potentially trigger the contagion that everyone fears. The redemption caps were there for a reason: Apollo, in a letter to shareholders, characterized the gates as an “intentional structural feature” designed to prevent a fire sale of illiquid loans that would harm long-term investors.
The gates also serve a useful disciplinary function. The surge in redemption requests — and the subsequent investor fury — will force private credit managers to think harder about who they lend to and borrow from, and on what terms. The weak hands will be flushed out. Good.
The weakest borrowers aren’t the only ones under a lens. The weakest managers are being exposed too. Investors burned by opaque valuations and sudden gates will remember. Future fundraising for firms that mismanage this moment will be harder. That means real pressure to underwrite better, price risk more honestly and communicate more transparently — all things the industry should have been doing anyway.
One of the deepest structural problems in private credit has been opacity. Unlike public bond markets, where prices are observable and move in real time, private credit has been priced largely at managers’ discretion, infrequently and with little external validation. That has allowed uncomfortable truths to stay hidden.
Apollo is trying to change this. The firm, which manages $938 billion, is preparing to start reporting the net asset values of its credit funds monthly, with the ultimate aim of having both daily NAVs and third-party valuations. It is also building a marketplace to deliver real-time prices, and Chief Executive Officer Marc Rowan has said managers need to make valuations more transparent to court a wider range of investors. Most recently, Apollo has partnered with Intercontinental Exchange Inc. to launch “ICE Private Credit Intelligence,” an initiative designed to bring the kind of standardized data infrastructure to private credit that public fixed income markets already enjoy.
All this is in pleasing contrast to the reaction of financial leaders in 2007. At the time, they displayed an irrational optimism and faith in their Maginot lines, deemed invincible, and felt no need to confront what was coming.
This year’s stress is happening while the sector is of moderate size and is not tightly coupled with the plumbing of the broader financial system. Banks have reduced their exposure to corporate lending in favor of private credit, but the linkages between the two sectors remain manageable. That gives us time to fix the structural flaws before they become systemic risks.
The situation is less like the sub-prime mortgage crisis of 2008 than junk bonds in the 1980s and structured credit in the early 2000s, where initial stress exposed genuine problems, triggered reforms and ultimately produced healthier markets. Private credit can follow that arc. The question is whether the industry and its regulators use this window to demand better standards or wait until the market is large enough to threaten the global financial system.
The pain is real. The panic is probably excessive. The private credit market, if it responds wisely, may look back on this turbulent quarter the way medicine looks back on Jenner’s cowpox experiment — not as the moment things fell apart, but as the controlled exposure that built the immunity to survive what came next.
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