By Patrick Boyle
Last week, Goldman Sachs executives discussed the war in Iran with clients. Senior executive Kunal Sha acknowledged that some investors were simply glad to have something else to talk about besides software exposures and private credit. He called it "at least a distraction." But this isn't a distraction from reality—it's the reality itself.
Private credit has become a $1.8 trillion shadow banking system that global investors have been increasingly worried about for the past six months. The stock market tells the story: the world's biggest alternative asset managers have seen their share prices in freefall since early 2026. Blue Owl and Aries Management have plunged around 40%, while KKR, Blackstone, and Apollo have shed more than 25% of their market value.
How Private Credit Works
Private credit is essentially direct lending to mid-market companies often owned by private equity sponsors. Investors trade the ability to exit a position on a whim for higher yields and contracts tailored to borrowers' specific cash flow needs. The private equity firms that are the big borrowers tend to use significant leverage, meaning they aren't always the most creditworthy.
This ecosystem grew rapidly after 2008 when traditional banks, strangled by post-crisis capital requirements, were forced to retreat from riskier lending. For over a decade, this was hailed as a golden age for credit. Firms like Blackstone and KKR offered returns as high as 13% with almost no reported losses. Some funds advertised loss rates of less than one-tenth of 1%—a figure that would make most bank risk officers envious.
But as interest rates rose and parts of the economy began to cool, these golden returns started looking more like lead.
In February, Blue Owl was forced to block withdrawals from one of their funds as investors clamored to get out. The rapid expansion of private credit from a niche corner of finance into a $1.8 trillion behemoth is a direct result of the regulatory cleanup after the 2008 financial crisis. When regulators clamped down on bank balance sheets, forcing them to hold significantly more capital against risky loans, traditional banks decided that lending to sub-investment grade middle-market companies was simply too expensive.
This created a massive vacuum that the private capital industry was more than happy to fill.
"In an era of rock-bottom interest rates, pension funds and insurance companies were desperate for anything offering a decent return, and they were willing to trade liquidity for the double-digit coupons promised by private lenders."
The shift was so dramatic that the buyout barons of the 1980s largely reinvented themselves as alternative credit providers. KKR—the firm famous for the aggressive corporate raids chronicled in the book Barbarians at the Gate—now manages more credit assets than it does equity.
The Cockroach Problem
Financial problems rarely travel alone. On an analyst call last October, JP Morgan CEO Jamie Diamond noted that in credit markets, bad loans are often like cockroaches. When you see one, he said, there are probably more. Everyone should be forewarned.
The first real sightings of these credit cockroaches appeared late last year with the sudden collapses of First Brands Group and Triricolor. First Brands was an auto parts manufacturer that filed for bankruptcy owing roughly $10 billion. Its senior lenders only discovered the full extent of the company's debt during the bankruptcy filing. It turned out the business had been using its receivables—money it was supposedly owed by customers—to borrow from several different lenders at the same time.
The private credit industry was quick to defend itself, pointing out that these specific companies had actually borrowed from banks rather than private funds. But for many investors, the vibe shift was undeniable. After a decade of loose lending and fierce competition for deals, they worried that basic underwriting standards had weakened.
This leads us to the more recent case in the UK involving a mortgage lender called Market Financial Solutions or MFS. MFS recently collapsed amid allegations of fraud and double-pledging of collateral. What makes the MFS story so useful for investors is that warning signs were visible years ago to anyone who bothered to look.
One credit fund manager decided not to invest back in 2019 because the company was unable to provide simple answers to standard due-diligence questions. His real reason for passing, however, was what he called the watchtower ratio. He noticed that the founder of MFS wore a £200,000 Richard Mille watch while living in a house estimated to be worth only around twice that amount. If the founder's wrist was that leveraged, it suggested the success being projected was a performance—one likely being funded by the lenders themselves.
Despite these signals, several major institutions including Barclays and Jefferies handed over hundreds of millions of pounds to what is now described as a refinancing merry-go-round. The company was allegedly using new loans to pay off old ones, recycling debt to keep their default rates looking artificially low until the money finally ran out.
But the real story isn't just about colorful frauds. It's about the staggering amount of hidden distress across the entire $1.8 trillion market.
A recent study by Goldman Sachs Asset Management looked at 150 European companies that had hit a credit event since 2017. Only four of those 150 companies ever went through public bankruptcy. The other 146 were quiet handovers where the lender simply took the keys to the business to avoid the public spotlight.
When the industry advertises loss rates of less than one-tenth of 1%, you have to ask yourself: how is that possible in a world where public speculative-grade debt is currently defaulting at 4.5%?
The answer is that private credit is often just better at hiding its bruises.
The Retail Problem
The smart money has clearly noticed this gap between reality and reporting, and they're already heading for the door. But as they exit, they're being replaced by a new group of investors who might not realize exactly what they're buying.
As the flood of money from pension funds and sovereign wealth funds began to dry up, the world's biggest alternative asset managers didn't just pack up and go home. Instead, they turned their attention to a much less sophisticated group: retail investors. This transition is often marketed as the democratization of finance—finally allowing the average saver to invest alongside the giants of Wall Street.
But insiders like hedge fund manager Boaz Weinstein describe it in much less noble terms. On the Money Stuff podcast, Weinstein noted that these private credit products are sold and not bought. Most individual investors don't call their financial advisors asking for a piece of an opaque middle-market software loan. The products are being pushed on them by their financial advisors who get paid a heavy commission.
The reason for the hard sell is simple. The commissions the financial adviser can earn are massive, especially compared to selling something simple like an ETF. Private credit vehicles often pay financial advisors upfront sales commissions as high as 3.5% and often pay ongoing annual servicing fees too. This creates a glaring conflict of interest. Your adviser isn't necessarily putting you into private credit because it's the best thing for your retirement. They may instead be doing it because it's the best thing for their own bottom line.
Weinstein went so far as to call the practice of putting retail clients into these illiquid products a scandal.
To understand how the retail products differ from the institutional funds we talked about earlier, we have to look at a specific type of vehicle called a Business Development Company or BDC. You can think of a BDC as a retail-friendly wrapper around these same types of private loans. These come in two main flavors.
First, there are publicly traded BDCs which trade on an exchange like a regular stock. You can buy or sell them whenever you want, but they have a habit of trading at a steep discount to the value of the loans they actually own. For example, FS KKR Capital has recently been trading at a 48% discount to its claimed book value. As Boaz Weinstein pointed out, when you see a public fund trading at 60 cents on the dollar while a private version of the same portfolio has been marketed at 100 cents, it's a fairly safe bet that one of these two prices is a work of fiction.
Then there are non-traded BDCs which are the ones marketed to individuals through financial advisors. These don't trade on an exchange. Instead, they're marketed as semi-liquid, typically offering investors the ability to exit on a quarterly basis. However, this liquidity comes with a significant catch: an industry standard cap that limits total redemptions to just 5% of the fund's net asset value each quarter.
It's important to understand that this 5% limit applies to the entire fund, not to your individual holding. In a quiet quarter when very few people want out, an individual could potentially cash out their entire stake. But the moment collective withdrawal requests hit that 5% ceiling, the fund manager pulls down the gate and starts rationing the available cash on a pro-rata basis.
This means that if everyone tries to leave at once, you only get a small fraction of your money back. As Antoine Gara described it on the Unhedged podcast last week, investors have to get in line for an amuse bouch of liquidity—a small taste of their cash while the rest is stuck behind the gate.
The fundamental mistake was believing that you could offer a little liquidity to retail investors in the first place. As Robert Armstrong has noted, liquidity is binary: it's either there when you need it or it never existed. Selling an illiquid asset to a retail audience under the guise of semi-liquidity was always going be problematic because you've set up a situation where the gates only stay open when no one's trying to walk through them.
This leads to what former Fed President Bill Dudley calls a dangerous adverse feedback loop. Once investors realize there's a limit on withdrawals, they have a greater incentive to always ask for the maximum amount possible just to get a spot in the queue. To meet these requests, the fund manager is often forced to sell their best, most liquid assets first to minimize realized losses.
This leaves the remaining investors stuck with the most problematic holdings—effectively the cockroaches we talked about earlier. It's a structural design flaw that can turn market jitters into an orderly spiral into the abyss, which really isn't what anyone wants.
The 401k Connection
The industry is currently facing this stress test just as they're on the cusp of their biggest victory yet: moving these products into 401k plans. Last year, an executive order was signed to make it easier for alternative assets like private credit to be offered in retirement accounts. The Department of Labor has begun the formal rulemaking process that will lead to a public comment period before finally giving a green light to 401k administrators to start investing in these products.
Proponents say this democratization gives average savers access to better returns. Though given that existing investors are currently fighting for an amuse bouch of liquidity, the timing might be considered inopportune.
To understand why fundraising for this asset class has suddenly hit a wall—even as the total market has swelled to a staggering $3 trillion—you have to look at what's really happening beneath the surface.
Bottom Line
The strongest part of this argument is its core observation: private credit's advertised loss rates don't match reality, and the gap between reported performance and actual defaults is widening. The industry's biggest vulnerability is structural design—it was never built for retail liquidity, yet it's being sold to everyday investors through their retirement accounts. What readers should watch for next is whether the Department of Labor's rulemaking on 401k investments in alternative assets goes forward—and if so, how quickly the promised returns turn into realized losses that retirees can no longer escape."}