Inside the $1 TRILLION Shadow Banking Bomb That’s About to Blow

There is a debate raging across Wall Street about what's happening right now, what's really happening right now in private credit and what it might mean moving forward. We've gotten past that initial stage, the initial shock, the tricolor, the first brands, the hedge fund redemptions, the cockroaches and the garbage lending. Okay, so now what? Well, to begin with, we can look at what banks are doing, but we're also still getting a number of warnings coming in from a lot of big names across the Right at the center of the storm is ratings agencies, again, not unlike 2008. Bond giant PIMCO's chief investment officer was the latest to warn about garbage lending and the high ratings that have been attached to it by questionable practices. And this comes from a firm which expects the economy to pick up next year too, though the CIO also added, quote, if you get into a period of economic softness, losses will go up and there'll likely be some disappointment. It's that quote disappointment that's the issue here. Flat beverage plus shadow banking equals the key ingredients for a lot more than just dissatisfied investors and big-time institutions. Even Bloomberg's editorial board wrote on Friday that regulative banks have been put on notice by these growing and more visible cracks deep in the shadows. The board adds it has all the similarities, not just dubious ratings on opaque and convoluted structures, but all the similarities to 2008 because of this framework that no one really knows and they don't know what the values are to the point that even government is stepping in by starting to ask questions and demand more information. That's really the issue here. And as I keep saying, the easy way to end this, to answer everyone's question, is to simply open the books. We don't need to see every last trade and transaction, but a thorough sampling and a legitimate honest audit would be enough to put to rest all the doubts that continue to swirl. And the reason they continue to swirl is we know there are legit reasons for all of these doubts. And the unwillingness and probably the inability of private credit providers to answer all these questions is really an answer unto itself. The one thing that we're missing, the one thing that we need everyone to provide, is the one thing that they don't have. That's information. And information, valuations, and the opacity of the system is a bad mix when it goes to the downside of the credit cycle, when flat beverage starts to emerge and makes more than just the real economy uncomfortable. We do have some information we can pull out, so we'll go over that on top of the continued debate and warnings about these credit market shadows. But keep in mind, back during the last credit bubble, you had bad mortgages given to struggling households that were buried into off-balance sheet debt arrangements that were funded by This time around, they're questionable loans to zombie companies primarily, plus securitized credit cards and auto lending in the same complicated arrangements, a lot of which is funded in wholesale markets like Repo. Similarities are easy to spot here, so already not starting out in the best way. And figuring out all this stuff is really worth isn't so easy, even in the best of times. These are not liquid markets for all these kinds of debts, nor do we have an answer for the true state of private credit portfolios. And that last one, that's a big stumbling block right now. All we really have are the reassurances from shadow bankers themselves that they're, of course, their portfolios are stout, they're solid, they are fundamentally sound. What else are they gonna say? So again, we're stuck at square one. I mean, after all, even the top central bankers at the Bank of England smelled the rat on that one. When bureaucrats like Andrew Bailey know the assurances from private credit providers are worthless, you really know what we're dealing with here. So our first problem is that shadow banks, whatever term you want to use here, non-depository financial institutions, the technical term, they're not required to disclose a whole lot. That's the key part in the latter term. They are not depositories. Since they aren't legally banks, they don't fall under the banking rules and regulations, including what they're supposed to disclose. Thus, the terms that private and shadow banks very much apply. Without any depositors, their investors are qualified individuals, either hedge fund investors or big institutions, including regulated banks who supply the leverage in these wholesale markets and other direct to the shadow bank lending. So absent disclosure requirements and mandated transparency, all we really have is shadow bankers' continued public confidence as far as the status of their credit portfolio. Sure, there are some published numbers about default rates and troubled loan estimates, but no one buys them. And we know for a fact they're understated by more questionable tactics and policies like things like selective defaults, which, I mean, we've talked about that before. But the first problem here is we don't know who these guys have really been lending to exactly and by how much. And that leads us into the second problem, which is how much is all of that actually legitimately honestly worth? Because you have to take into account macroeconomic consideration, financial variables, a whole bunch of stuff to really come to a more solid conclusion about what are these credit portfolios truly worth in any real and meaningful sense. You know, the stuff that we're talking about here in this video, that's the reason why, for the first time, we're having a Eurodollar University live event this coming February 2026, President's Day weekend. And I'm going to talk about the signals in the Eurodollar system and all across the marketplace and try to navigate our way through it. But also we're going to have discussions about what can you do about it, things like distressed debt funds and distressed debt opportunities. So if you're a serious investor and this sounds like something you want to be a part of, there's a link in the description of this video where you can sign up to book a call and book your spot for Eurodollar University live. But you got to be, you got to hurry up here because we put this out to Eurodollar University members and subscribers and the response so far has been overwhelming. And we only have a limited number of spots available. So like I said, if you're interested in coming, joining us, joining me and a bunch of other people, experts and like-minded individuals, serious investors, February 2026, President's Day weekend, book your call at the link in the description. I do hope to see you there. It's going to be a lot of fun, a lot of stuff going on. Plus, we've got a lot to talk about. Like I said, link in the description to book your call. Now, it might sound strange we're talking about loans, but valuations are a huge headache anyway, even when they're actually transparent. If you remember back during the 2008 crisis, new bank regulations forced regulated banks to put out more disclosures on exactly what we're talking about right here. If you remember, there were things called level one assets, which had clearer market inputs, which meant banks had to put down what the market said for that category of assets, including the values of those securitized structures and the tranches of them, even that they still had interest in. And that became a huge problem in its own right when the markets themselves grew illiquid. Therefore, it led to the whole mark to market problem. But beyond level one, there's these level twos and level three assets, which the government rules said banks could use their own models to come up with values. But we're level three. It meant all sorts of just black box calculations. It got to the point where any bank that had a lot of level three assets found itself in trouble because no one had any faith in those black box calculations and the valuations that they spit out. That's the risk that we're kind of facing here. Not that private credit is that far down the rabbit hole of a potential crisis, just the same sort of difficulties with the added downside of no regulatory requirements whatsoever. It's almost as if the private credit space is itself level three, and we're supposed to just trust all the internal black box model values that private credit providers come up with, with all of these complex models that we have no idea what goes into them. And up until September, the entire industry and all these investors were perfectly fine with that. Everyone said, who cares? Economy's great. Jay Powell's a solid labor market. Therefore, no reason to suspect that numbers are anything but what the shadow bankers say they are. And this is where the flat beverage really changes everything. And that's where the Bloomberg editorial board warning, that's where it really picks up. Private credit exposures are opaque and increasingly convoluted. I don't know if they're increasingly convoluted. They've always been convoluted. With funds making loans backed by a wide range of esoteric collateral, even repackaging fund stakes into assets, which we saw before in the last crisis. A lack of public trading leads to loan volumes that are subjective and disputed. It can also lead to shocking meltdowns, as we talked about this before, too. Within weeks, BlackRock revised one loan's value to zero from 100 cents on the dollar. Those features create an extra risk if things go wrong. U.S. banks with the most exposure to non-bank financial institutions, or shadow banks, or private credit providers, whatever you want to call them, are also those most dependent on markets for their funding, according to the International Monetary Fund. One lesson of 2008, if investors aren't sure how exposed the bank might be to losses, best not to wait around to find out. That's a recipe for a financial crisis. Information asymmetry. So if or when markets and investors really begin to doubt both the models and the private credit providers' reassurances, that's when you got the problems. And we've already seen questionable practices and the cockroaches that have come up so far, which has only added to the mistrust that much more. In other words, if there are more troubled loans in these portfolios than we're already led to believe, that would have a huge impact on valuing them. How much losses should investors expect? Shadow bankers would tell us one thing, when in reality, it might be something very different. And in those frauds that have come out, what became clear in all of them was no one did their homework. Investors and funding suppliers just took everything on faith, whether the clatter was even there. Due diligence had clearly fallen by the wayside, and that's not a good sign that's going to add more trust back to the system. And that brings up the issue with ratings agencies, which I've talked about before too. These firms and their seals of approval exist for a couple of reasons, including being able to sell these debt structures to certain classes of buyers. But they also exist to essentially farm out that due diligence. Those shadow banks who don't need to or don't feel they need to do their own homework will hire a ratings agency and simply let them sample a portfolio of questionable quality and put a rating on the whole shebang. This is what PIMCO CIO was warning about that I was talking about in the introduction at the beginning of this video. Quote, it is very, very dangerous to assume something has an investment grade rating just because the ratings agencies assign a rating to it. There's been so much growth in lending to lower quality companies, that's gun lax garbage. And again, the last major cycle was lending to lower quality households. And I said at the beginning, this cycle has been largely about zombie companies and corporate credit, but also to a lot of households just not with mortgage collateral. It's not mortgage loans and housing collateral. Now it's consumer loans and zombie corporate loans and more of those types of junk debt. And PIMCO CIO then went on to add, PIMCO expects the US economy to strengthen in early 2026, thanks to AI related capital investment and the impact of the Trump administration's one big beautiful bill. And we need to realize here, there has almost never been a time when PIMCO didn't think the economy was strengthening, going all the way back to the days when Bill Gross's public comments were haunting the firm. But back to Iveson, he warned that credit losses could mount if growth weakens. Quote, if you get into a period of economic softness, losses will go up and there'll likely be some disappointment. And it all really could be a possibly brutal combination. You got questionable ratings from tainted agencies, worse than economic softness. We're really talking about flat beverage here. Plus, as the Bloomberg board said, throw in worries about valuations given the lack of information and you put all these things together and you really do have the basic ingredients for a financial crisis and maybe more if it spills over beyond into liquidity and shadow money again. And to that last point, valuations, private credit providers are doing themselves no favors. This has already come up in a different context, though you can see how it easily, easily applies to this environment where mistrust is still really starting to spark and to grow. We're starting to see the smoke come up from it. Go back to Bloomberg here. Stark divergences in how competing firms value private assets in their portfolios are drawing increasing attention from market participants, academics, and now the Department of Justice, according to Jay Clayton, who's the head of its Manhattan outpost. Quote, there are definitely some areas of concern for me in private markets. People should know that the financial regulators in the department are looking at those. But the rush to offer credit has started to show cracks this year amid mounting competition, not really, alleged frauds by borrowers, and a growing body of evidence fueling concerns that funds use varying methods to assign values to the assets that they hold and that these things are not always dependable. One recent academic paper referred to the apparent subjectivity of the numbers as mark to myth. Clayton says what he won't stand for is money managers cherry-picking prices that let them reap higher fees at the expense of their clients. And understand the parallels here. Yes, they might, you know, cherry-pick prices to get higher fees, you know, make the portfolios look bigger than they really are, but that works in the other direction too. If they're cherry-picking prices to hide losses and the public suspects that's the case, it's only going to fuel further mistrust. And one of these tactics is just shuffling assets back and forth between related funds. Back to the article here. An industry body representing fund clients has called the transactions, this shuffling back and forth, quote, inherently conflicted and pushed for clear guidelines and such deals. That hasn't slowed down a boom in continuation vehicles and they've increasingly appeared in private credit as well. But such asset shuffles may be ripe for abuse. Clayton said an area to watch for is marks on assets with no trading when things are moved around from vehicle to vehicle. If someone is moving a position from fund A to fund B and you can just name a price internally, an opportunity to pick a price that benefits the house over investors is pretty high. And so again, while that's a problem for valuations and maybe puffing up the value of the fund to raise higher fees or to create higher fees, in this context of questionable assets, talking about losses, what these illiquid structures might be worth, the temptation might be there with this tactic already in widespread use and maybe even widespread abuse. So again, we're seeing more ghosts of 2008. Now I'm not saying there's a repeat of that crisis, just human nature is human nature. There's a significant case to be made for concern because while private credit isn't as massive as the lead up to the last crisis was, it is still significant. It's significant enough to create havoc and cause lasting damage in money, finance, and most of all, most of all, once again, the real economy. These kinds of obviously questionable valuation practices aren't doing the industry any favors, especially right now. So you get the sense that everything Wall Street comes up with from black box models to trading tactics to ratings assigned by agencies that Wall Street itself pays for, the real purpose of all of it isn't to provide information, it's to not provide information. It's to create the impression of reassurance in lieu of anything useful. Don't worry, we've got it all covered. Look at all this stuff that we have to show you. But when you scratch the surface, you don't need to go too far to begin doubting whether all that's really true. So what we're looking for, what we're doing here is when all of these things, valuation problems, the investing public's view on potential for losses, the lack of forthright information, when all of that might combine to create a small backlash that could then lead to a self-reinforcing cycle where it's no longer really about values and credit portfolios, it gets to be about a lot bigger things like markets and industries. So that's why we're watching all of these various factors and developments, cockroaches and garbage lending, and all these warnings from across the credit market space itself, not from private credit providers. They're still saying, hey, everything's fine, fundamentally sound. And then you put all that together in the macroeconomic context. As PIMCO CIO himself admitted, you get to some economic softening and suddenly the entire profile for the whole thing shifts. Well, that's what's been going on over the last couple months. The marketplace, the overall marketplace, public comment, all of it. Hedge fund investors, they can sense that shift and people are getting quite a little antsy about it. So one indirect clue that we can turn to is the regulated banking sector, because banks are maybe one step removed from shadow banks. And while we shouldn't trust that they've done their due diligence either, as we've seen in these frauds, banks do have leverage, pun intended, to get more information than certainly we can. And going by the Federal Reserve's H8 statistics on regulated bank holdings, what we see is they have yet to pull back completely from lending to non-depository financial institutions. Loans to shadow banking continue to grow, though the rate has slowed down a little bit more recently. This suggests that bankers are at the very least rethinking some of their shadow banking exposures and future exposures, though they aren't ready yet to simply pull up stakes and exit the space entirely. So maybe that's an early stage down cycle signal, though if you're an optimist on the space or the economy overall, you could argue, and many do right now, there isn't really enough here to be worried about. So maybe this is just a whole bunch of one-offs and a few bad cases, but no widespread proof that private credit is heading for some kind of major reckoning and then major damage beyond it. But then you balance that optimistic take out against really the real economy, but also Jamie Dimon's cockroaches, Gunlak's garbage, Pimco's hit on ratings, and even the Bloomberg editorial board's caution over valuations, the lack of information, and there really does seem to be quite a bit of smoke building up from the shadow banking world, even if it's not yet at an overwhelming amount. So that might be, as I said, that this is all just early. For most people, cockroaches and collateral fraud just showed up a couple of months ago, and we have to keep in mind credit cycles are processes just like economic cycles. And that's another thing, flat beverage isn't all that flat just yet, as we've been pointing out all summer. Make it flatter, like the Pimco guy was saying, and then suddenly we really see pressure, we really see demands on private credit, then the crisis ingredients really start to get mixed up in the bowl. So you see what I mean here? There is enough smoke, it's not an overwhelming amount, it doesn't say, hey this thing is falling apart, this is crashing right now, but there are enough problems and there are enough ingredients for future problems that we do need to be careful, we do need to scrutinize what's taking place, and we need to keep a very cautious eye on all of these various pieces as they might get closer and closer together to combining. I mean, we've got the cockroaches so far, and most of the common thread in each one was about the lack of care and information. It's not really about the collateral so much as it's been about everything bad that you would have expected at the end stage of a credit cycle. And then all of those habits compound the problem given the shadow part of shadow credit. There are genuine reasons to be asking hard questions that up until recently no one had any interest in raising. Again, diamonds, cockroaches, gun lats garbage, Pimco on ratings, Bloomberg editorial board, valuations and information, even the government is throwing up red flags on valuations. If all this smoke really is from a credit cycle downturn fire, the reason it isn't massively building up is only because, as I said, it's still early in the process. Flat beverages isn't even all that flat. Just like at ADP, for example, job losses are there, and they've been there for months, but they aren't huge numbers right now. What happens to all this credit if they do start to get big? That's really the smoke. Employment problems don't just mean higher potential losses in consumer credit. As ADP also said in its negative November numbers, those job cuts were coming from small employers. In other words, in a truly flat beverage economy, both workers and employers struggle badly to stay afloat. And if private credit providers don't want to provide information that the market really badly needs under these circumstances, the public, the investment public, the markets will make up their own minds. One key out-of-the-way signal to that end from the consumer side of things, Americans can't afford car insurance. They've gone without and they've traded down and went over the details in the video link below. As always, thank you very much for joining me. Join me for URIDAL University Live. There's a link in the description if you want to book your call about that. Huge thanks to URIDAL University members and subscribers, and until next time, take care.