The Vault

Last week, several press reports slammed synthetic credit risk transfers (CRTs) on grounds that the biggest U.S. bank in this sector which is of course the biggest global bank ever – JPMorgan – is creating new and serious risks when it scores SCRTs.  It’s easy to assume that anything “synthetic” is more dangerous than the “natural” way a bank absorbs credit risk, but this is simply not the case as a whole lot of financial crises make all too clear.  SCRTs are a rare example of a complex structured deal that gives the issuing bank a safe, sound way to reduce its capital requirements.  Regulatory arbitrage, yes, regulatory evasion, no.  The real risk SCRTs actually pose lies in the way some banks are using “natural” credit – i.e., loans – to lever up SCRT investors in ways dangerous to everyone but the SCRT issuer.

Let me explain.  FedFin laid out how SCRTs work in a September 2023 report following conditional FRB approval of the first of these deals since the great financial crisis.  One of the hard-learned GFC lessons was that structured financial instruments can be toxic due to opacity to regulators, counterparties, and even bank sponsors.  Given this, the regulator’s SCRT okay has several significant strings attached.

Most importantly, the bank making use of the credit-linked notes (CLNs) usual in these deals must issue the notes via a bankruptcy-remote vehicle and get cash or like-kind collateral to enjoy any regulatory-capital offset.  In short – and this is very short …

Jamie Dimon recently said that there will be “hell to pay” when private credit gets the comeuppance common to businesses engaged in a race to the bottom.  But, who’ll pay it?  If the $1.7 trillion sector isn’t as systemic as many fear, then hell will be paid by institutional investors and, downstream, the policy-holders and pensioners who depend on them.  But, there’s more.  Typically, Wall Street opens high-return products to retail investors only when there’s so much to go around that pricing no longer reflects risk.  As smart money stands back, retail investors are enticed in order to, as one bank CEO memorably said in 2008, keep dancing until the music stops.  As we learned yet again the hard way in 2020, hell paid by retail investors can quickly turn into hell paid by taxpayers.

Last week’s news brought an announcement that one large adviser has opened a new fund for higher net-worth clients able to put $100,000 in funds comprised largely of private-credit assets.  So far, this is just one group of funds, but so far isn’t all that long and it’s very likely that growing fears about private-credit risk among institutional investors will open the retail spigot for private-equity lenders which still have loads of high-risk they hope to move into the waiting hands of a sector less learned about opacity and manifold conflicts of interest.

Despite growing alarm about private credit from both global regulators and institutional investors, the Fed’s most recent financial stability report essentially ignores …

Deciding against finalizing a proposal to require a registry from nonbanks of their contractual terms,  the CFPB has instead issued a circular – i.e., a de facto rulemaking – telling both banks and nonbanks and their service providers that contractual terms and conditions may not require consumers to waive rights to which they are entitled under applicable state or federal law or which the Bureau believes likely to be “unenforceable.”  The scope of Bureau actions remains to be seen, but it has established a ….

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