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Private credit. We've probably been hearing this term more and more often in the news lately. It used to be a rather obscure corner of the financial world, but now it has become the center of attention. So, what's really going on ? Yes, after many years of quiet growth , this market is suddenly facing intense scrutiny and unpredictable fluctuations.
In today's analysis, we will delve deeper into this issue. To understand why this story is important, let's start with its scale. $2 trillion. This is a huge number, representing the scale of the direct lending market alone. And precisely because it's so large, any ripple can attract the attention of a great many people.
Okay, to understand the situation today, we have to step back a little to the past. The story of the origins of private credit will tell us how this industry came into being and grew. To put it simply, private credit is essentially lending that is not carried out by banks. Instead, large investment funds will lend money directly to companies.
They filled the void left by traditional banks, especially after the global financial crisis. And its fastest-growing form is called direct lending. This didn't happen overnight; it was an evolutionary process, beginning with the market's acceptance of riskier bonds in the 1970s, followed by the boom in debt-backed buyouts in the 1980s.
Each phase laid the foundation for the next. And then, the 2008 crisis created a huge gap, and direct lending quickly stepped in to fill it. And here's the really interesting part. Although this financial product may seem novel, the human behavior surrounding it follows a very old and almost predictable pattern.
This cycle almost always plays out this way . First, a new idea emerged, one that sounded very appealing. Those who joined early achieved great success. And that success, of course, attracted everyone else. As the crowd began to pour in, caution gradually disappeared. The standards have been lowered.
And finally, the harsh reality will emerge. So, what is the core psychological motivation behind the crowd participation phase ? It's envy. As the economist Charles Kindleberger once famously said. Nothing is more disturbing to one's peace of mind and judgment than seeing a friend become wealthy. This is one of the most powerful driving forces in the world of finance.
It can overwhelm even reason. This insightful quote from Warren Buffett perfectly illustrates how quality declines when a trend reaches its peak and capital flows in too quickly. The early pioneers already had the best deals. Then came the imitators. And ultimately, when too much money chases a handful of opportunities, those who arrive last often have to accept the worst conditions.
Okay, now let's apply that classic model to a very specific, very modern case that is causing tension in the private credit market today. Those are loans for software companies. The question is, why software? Ah, that's because revenue from subscription packages is considered very stable and predictable.
Unlike one-time sales, subscription packages generate a steady stream of monthly income. This makes software companies perfect candidates for taking on debt. As a result, there is a very high concentration of these loans in the private credit portfolio. This diagram illustrates the problem in a very visual way.
The direct lending market has a disproportionately high level of involvement in software debt. This figure reaches 20 to 30% of the market, significantly higher than other traditional credit markets. And then, the catalyst appeared. That 's AI. Artificial intelligence has the potential to render a lot of current software obsolete .
And that also means that the huge loans backing them could become much less valuable . Now, let's step back and look at the bigger picture. Because the risks emerging today seem to echo very familiar sounds from one of the most infamous collapses in history. Let's compare them. First, selling complex financial products to individual investors.
Secondly, the use of leverage to a high degree. And third, there is a dangerous imbalance between illiquid assets on the one hand and the potential for investors to want to withdraw their money immediately on the other. All three core elements of the 1929 market appear to be present in today's private credit instruments .
And this is probably the crucial point of it all. Technology changes, financial products change, but human nature remains the same . The tendency to forget the painful lessons of the past is the ultimate driving force behind cycles of boom and bust. We keep repeating the same mistakes because we always believe that this time will be different.
So where are we in this story? Today's analysis is not a doomsday prediction , but rather a description of a necessary phase in the market's evolution. It's important to emphasize that this can be a process of growing up, even if it may be painful. A new market is being tested for the first time. It must go through a complete cycle to weed out weak participants and strengthen the foundation for a more solid future.
And this is the biggest question left unanswered. Overall, this asset class is likely to survive and thrive, but for investors who entered at the peak of the euphoria with lax standards and underestimated risks, the road ahead could be very bumpy.
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