Will the bubble in private markets hiss or burst?

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The economist Hyman Minsky believed that the financial system was prone to instability: calm conditions would inevitably give way to speculative excess. He noted that prolonged bull markets stoked complacency about risk. Analysts recently they have been debating if private capital, where some of the biggest excesses have been evident, would soon reach the so-called “Minsky moment”, the point at which excess implodes. It hasn’t happened yet.

Minsky’s hypothesis might work differently in more opaque private equity markets, which invest in unlisted stocks, credit, real estate and other alternative assets. The industry has experienced a boom since the global financial crisis. It intensified when regulatory reforms after 2008 caused banks to withdraw from riskier lending. Globally, assets under management have grown approximately fivefold since the crisis to more than 11 trillion dollars now. Blackstone, Apollo, KKR and Carlyle, the largest ETF managers, have more than 2 trillion dollars of that. Hundreds of new players have been streamed annually since the early 2010s as well. Like other fast-growing corners of the financial world, the market was buoyed by a decade of low interest rates that sparked a search for yield among investors and provided ample capital.

Rapid rate hikes by the US Federal Reserve, and the possibility of them staying higher for longer to tackle sticky inflation, have given rise to suggestions that private markets will prove to be a castle of playing cards Howard Marks, co-founder of Oaktree Capital Management, recently warned that the roughly $1.5 trillion private credit segment, which lends to businesses, would be tested by tighter conditions and low growth. The competitive frenzy to sign loan deals in the period before rates soared has raised questions about the level of due diligence carried out by the funds.

Over time, the higher rates could seriously hurt the industry. Private equity, the business of buying, restructuring and selling companies, which makes up the bulk of the market, is getting more difficult. Low interest rates have supported high valuations and financing, until now. On the credit side, floating-rate loans could become more difficult to repay and, combined with low growth, drive corporate defaults.

A slow hiss, rather than a sudden pop, may be more likely. As low-rate deals are refinanced, borrowers will feel the pinch over time. Private markets also remain popular. Some even suggest a “golden moment” it is reserved for private loans, as banking turmoil leads to downsizing of traditional credit providers and rates look more attractive. A gradual disinflation of some overleveraged market segments would be preferable to a Minsky-like contraction.

Either way, the growth of private markets is generally welcome. Freed from the pressures of quarterly reports, they allocate capital for years and can support the economy when banks tighten. Also, steer risky loans away from banks, where financing demands instant liquidity — towards long-term credit funds, shifts risk from retail depositors to professional investors.

But the full risks are unknown. The sector has grown rapidly and far from scrutiny. A more relaxed approach to valuations and due diligence could hide significant exposures. It is also not clear how interrelated the sector is with other markets and banks. And, growing interest from retail investors means it’s not just wealthy institutional clients taking the risk. Efforts to improve monitoring of systemic risks in the sector and better assist investors in evaluating products would be welcome.

The financial woes of recent months – in the UK pension market, with Silicon Valley Bank’s niche business model and rate risks on bank balance sheets – have been in sight before they exploded. If the private equity bubble bursts, but does so with a hiss, that may further prove its value.