The governor of the Bank of England, Andrew Bailey, has warned recent events in US private credit markets have worrying echoes of the sub-prime mortgage crisis that kicked off the global financial crash of 2008.
Appearing before a House of Lords committee, the governor said it was important to have the “drains up” and analyse the collapse of two leveraged US firms, First Brands and Tricolor, in case they are not isolated events but “the canary in the coalmine”.
“Are they telling us something more fundamental about the private finance, private asset, private credit, private equity sector, or are they telling us that in any of these worlds there will be idiosyncratic cases that go wrong?” he asked.
“I think that is still a very open question; it’s an open question in the US.”
He added: “I don’t want to sound too foreboding, but the added reason this question is important is if you go back to before the financial crisis when we were having this debate about sub-prime mortgages in the US, people were telling us, ‘No it’s too small to be systemic, it’s idiosyncratic’… That was the wrong call.”
Bailey said the complex nature of some of the financial engineering in use in the private credit markets gave cause for concern.
“We certainly are beginning to see, for instance what used to be called slicing and dicing and tranching of loan structures going on, and if you were involved before the financial crisis and during it, alarm bells start going off at that point,” he told peers.
“That stuff was a feature of the financial crisis, so that’s another reason why we’ve got to use these cases as another reason to have more drains up, frankly.”
Deputy Bank governor Sarah Breeden, appearing alongside Bailey, said the Bank would be carrying out a war game exercise in these markets, to test the linkages between private credit and other sectors.
She underlined some of the concerns about the private credit sector. “It’s about high leverage, it’s about opacity, it’s about complexity and it’s about weak underwriting standards.
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“Those are things that we were talking about in the abstract as a source of vulnerability in this bit of the financial system, and those appear to have been at play in the context of these two defaults.”
The collapse of car parts firm First Brands and auto lender Tricolor prompted concern on Wall Street, with the JP Morgan chief executive, Jamie Dimon, comparing them to “cockroaches”, and saying that more could emerge.
The International Monetary Fund’s global financial stability review last week highlighted concerns about the close connections between private credit markets and mainstream banks – and the IMF’s managing director, Kristalina Georgieva, said it was the issue that kept her awake at night.