The Financial Product That Blew Up the Global Economy Is Back

As if the economy isn’t already in enough chaos, the banks are reviving credit default swaps. Hold on to your butts!

For anyone alive and aware in 2008, this weekend’s economic news probably sent them to the drug store to buy some Pepto Bismol. First, the Federal Reserve demanded that the nation’s biggest banks detail their exposure to the opaque, multitrillion-dollar private credit market. Then, almost simultaneously, word broke that some of those same banks are imminently launching a credit default swap index with S&P Global, targeting that same market.

For the past two months, we’ve watched America’s macroeconomic program quickly erode. President Donald Trump’s illegal war in Iran, which closed the Strait of Hormuz and marked the end of the Carter Doctrine era, cut off the supply of cheap oil from the Persian Gulf, raising inflation at a time when many have yet to see their pre-Covid purchasing power restored.

Another consequence of this shortage is that the U.S. Treasury is now desperately trying to finance a $1.9 trillion deficit without a large pool of captive foreign buyers, having failed to prepare for the crisis in which the United States now finds itself. China is dumping U.S. Treasuries at a rate not seen since the Global Financial Crisis, while stalwart buyers like Japan are seeing their bond yield rates creep up to their highest levels in 27 years.

All of that is structurally unhealthy for the U.S. macroeconomy, representing the rapid acceleration of a dynamic that has been playing out more slowly for the past six years. But the events of this weekend mark a shift that might be felt on a one-to-two-year horizon in the form of a liquidity crisis.

The Fed’s request that major banks detail their exposure to the private credit market should terrify risk assessors. When macroeconomists picked through the rubble of 2008, many landed on the conclusion that there had been a catastrophic mispricing of risk. The rating agencies continued to slap pristine AAA labels on toxic subprime mortgages, operating in a state of highly incentivized denial. But in 2008, regulators generally knew where those underlying assets were parked. The financial system was, in theory, visible.

The $2 trillion private credit market, by contrast, is a black box, grown in the regulatory shadows to facilitate high-risk corporate loans that traditional banks were forced to abandon  after the passage of Dodd-Frank. The recent limitations on withdrawals from many of these private funds tell us there’s a bank run taking place behind the velvet ropes, in the VIP section.

And if you’re interested in betting........

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