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Stress in the private credit market could trigger “psychological contagion” and contribute to a wider credit crunch, Federal Reserve officials warned, according to an interview with Bloomberg News published Sunday (May 3).
In the interview, Barr said that direct connections between banks and private credit do not yet appear “super worrisome.” However, he pointed to other areas of concern, including the insurance industry’s ties to private lenders.
Barr also warned that market sentiment could worsen if investors interpret private credit problems as signs of broader corporate stress. “Then you also have the problem of kind of psychological contagion,” he said. “People might look at private credit, and instead of saying, ‘This is an idiosyncratic problem, these were high risk loans, the rest of the corporate sector is different,’ they might say, ‘Wow, there seem to be cracks in our corporate sector. Maybe over here in the corporate bond market, there are also cracks.’ Then you could have a credit pullback, and that could lead to more financial strain,” he added.
Bloomberg noted that Barr has repeatedly warned about growing risks in the financial system, including the $1.8 trillion private credit market. The report said investors withdrew about $5 billion earlier this year as redemption demands increased for funds with limited liquidity.
Wall Street banks that have expanded into private lending have also warned about potential future troubles, while remaining optimistic about the overall health of the asset class, Bloomberg reported.
Among the banking figures expressing concerns about private credit is JPMorgan Chase CEO Jamie Dimon. During a speech last week, Dimon said the large number of companies in the sector means not all borrowers will perform well in a downturn. “Some of them ‘may be brilliant, but I guarantee you not all 1,000 of them are,’” Dimon said. He added that underwriting standards and the long absence of a credit recession could make a downturn more severe than many expect: “So in my view, because of that and the underwriting standards, we haven’t had a credit recession in so long, so when we have one it will be worse than people think.”
Separately, PYMNTS highlighted that private credit is an asset class that largely sits outside the transparency standards applied to traditional banking or public debt markets. It said loans are typically held in private portfolios and valued internally by the funds that originate them, a structure that can mask deteriorating credit conditions until stress becomes difficult to ignore.
“The overarching concern may not herald an imminent crisis, but the structure of the market could amplify shocks if credit conditions deteriorate,” PYMNTS said.
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