Author：Wall Street CN
Larry McDonald, a market veteran who experienced the collapse of Lehman Brothers, is issuing a new round of warnings to investors.
In a recent interview, Larry McDonald, founder of the independent research firm "Bear Trap Report" and a former Lehman Brothers trader, systematically explained his judgment on the current market: a private credit crisis has arrived, the energy shock is creating real stagflation, the "crowded trade" in tech stocks is breaking down, and funds are accelerating their flow to hard assets.This round of "great migration" of hard assets has only just entered its second and third phase.
Private lending:"This is the subprime mortgage crisis."
McDonald stated bluntly: "This is the cycle's subprime. There's no doubt it's already a crisis."
He said that he had met a large number of top credit investors during the series of "creative dinners," and since last year he had heard more and more pessimistic voices—"It's a mess, people will go to jail because of it."
His logic closely mirrors that of 2008. Before the subprime mortgage crisis, sell-side research reports repeatedly used the term "idiosyncratic" to downplay the risks. McDonald said,In the third and fourth quarters of last year, he saw the word "idiosyncratic" used "hundreds of times" in sell-side reports to explain one bad debt after another in private lending—"either it's a lie, or it's completely detached from reality."
The structural root of the problem lies in:
Rating agency chaosMcDonald described how someone in a Westchester County home led an eight-person team to rate thousands of privately placed credit securities purchased by insurance companies. He directly drew a parallel to a scene from "The Big Short"—"History repeats itself."
The incentive mechanism is seriously distorted.To attract retail funds, private lending products promised financial advisors "quarterly liquidity," even though this asset class is inherently extremely illiquid. "They needed to bring this money in—I don't want to call it 'dumb money,' but it was the latest money to come in," McDonald said. With hefty commissions, everyone was incentivized to keep the game going.
A liquidity crisis has emerged.Currently, private lending typically has a 5% redemption gate, but 10%-15% of investors want to get their funds back. McDonald points out that insurance companies are the biggest "bagholders"—they buy large amounts of private lending in pursuit of higher yields, and now some investors are starting to short insurance companies like MetLife that hold significant exposure to private lending.
McDonald believes that once the securitization machine begins to slow down, risks will flow back onto bank balance sheets, at which point a full-blown credit crisis will erupt. He noted that an analyst from UBS had already "left the sell-side camp" and begun warning of the large-scale default risks in private lending—"When the first analyst starts to switch sides, you know that Wall Street's credibility is in question."
The difference from 2008 lies in scale: McDonald believes the private credit crisis "will not be as severe as the subprime crisis," but the direction is the same.
Tech stocks are experiencing a "monkey squeeze" phenomenon: a 34 trillion yuan loss has shrunk by 4 trillion yuan.
McDonald used the analogy of "monkeys crowding a tree" to describe the overcrowding of tech stocks—there are so many monkeys in the tree that at the slightest sign of trouble, the weak hands will all jump down.
The data speaks for itself: the Nasdaq 100's market capitalization has shrunk from $34 trillion to approximately $30 trillion, with $4 trillion flowing out. Microsoft and Nvidia, the two largest weighted stocks in the S&P 500, together account for 14%-15% of the index, but Microsoft has fallen about 28% from its peak, and Nvidia has fallen about 19%, while the S&P 500 as a whole has only fallen 6%.
McDonald said, "I was shocked that the S&P 500 only fell 6%." The reason behind this was the massive rotation of funds—flowing from crowded tech stocks to hard asset sectors such as industrials, materials, and energy.
Another reason for the pressure on tech stocks is the sharp rise in data center construction costs: diesel prices have increased by about 100%, DRAM memory costs have soared, Caterpillar construction equipment supply is tight, and about 20% of data center sites have problems (overheating, insufficient water resources, community resistance) and need to be relocated. McDonald believes that these factors are squeezing Mag 7's profit margin expectations, and the market is already pricing in this reality.
The Great Migration of Hard Assets: Still in the Second and Third Rounds
McDonald refers to the current asset rotation as "The Great Migration" and provides historical coordinates.
From 1968 to 1981, the industrial, materials, and energy sectors together accounted for approximately 50% of the S&P 500. In recent years, this proportion once fell as low as 9%, but has now rebounded to approximately 13%.McDonald believes it won't return to 50%, but "it will return to 20%-25%," and this great migration is only in its second or third phase.
He specifically named companies that control physical assets, including Glencore, BHP, and Freeport-McMoRan.International resource stocks and natural gas stocks(Especially the "trapped natural gas" concept in Canada and Texas)Coal stocks(Core Natural Resources, a major holding of David Einhorn's Greenlight Capital).
In terms of precious metalsMcDonald stated that his team sold gold and silver ETFs such as GDX, SLV, and SIL in January of this year and has now begun to buy back during the pullback. His judgment is based on the fact that gold miners have pulled back to near the 100-day moving average, while household holdings of gold and silver still account for only about 1.25%, far lower than the about 3% in the 1980s, "still in a seriously underweight state."
Energy Shock: Stagflation Has Arrived, and the Federal Reserve Is in a Dilemma
McDonald characterized the current macroeconomic environment as "real stagflation".
Iran's attacks on energy infrastructure in Bahrain, Dubai, the UAE, and other Middle Eastern countries have impacted the entire energy supply chain—from fertilizers and distillates to aviation fuel. McDonald predicts that even if the situation in the Middle East eventually calms down, energy prices will remain sticky for "at least 5-6 months." This is because rising insurance costs will take time to absorb, companies withdrawing assets and then returning will also take time, and the entire region's logistics system has been disrupted.
Rising energy prices are dragging down GDP by about 1 percentage point. Meanwhile, the wave of layoffs in the AI industry is accelerating—McDonald cited the example of Square, Jack Dorsey's company, which laid off 45% of its workforce before its stock price rebounded by 30%, and many other companies are following suit. Consumers are bearing the brunt of a "hidden tax" on energy, economic activity is slowing, and the risk of recession is rising.
This puts the Federal Reserve in a dilemma: sticky inflation hinders rate cuts, but a slowing economy requires easing. McDonald's assessment is that in the short term, front-end interest rates are "pegged," and the yield curve tends to flatten or even invert, rather than the "steepening" previously bet by the market.
Last week, this prediction came true—several funds that had bet on a steepening yield curve were wiped out on Wednesday and Thursday. McDonald said, "That was real casualties; several funds went bankrupt last week."
His advice is to buy 2-year or 3-year US Treasury bonds near the 4% mark. The logic is that a 3%-4% risk-free return can be obtained during the holding period, and if the recession deepens and the Federal Reserve is forced to cut interest rates significantly, bond prices will rise sharply, with a total return potentially reaching 8%.
Tail Risk: Britain May Become a "Canary in the Coal Mine"
McDonald named the UK as having the biggest tail risk.
He described a scenario of weak government, high fiscal deficits, slowing economy, and energy cost increases far exceeding those in the United States. If Britain were to experience debt financing difficulties, the bond vigilantes' offensive could serve as a precursor to other high-deficit countries (such as France and Italy).
Regarding the US dollar, McDonald believes it will not lose its reserve currency status within the next 10-15 years, but will remain in a long-term "secular downward" trend. During geopolitical crises, the dollar may experience temporary safe-haven rebounds, but this does not change the overall trend. He quotes a statement from his book: "Democracy can only last until voters discover they can plunder public finances." The US debt-to-GDP ratio has risen from 70%-80% in 2008 to 120%-125%, and the 6% fiscal deficit rate is twice the average of 2%-3% over the past 50-60 years.
The following is the full text of the interview:
Opening introduction
Host (Julia LaRoche): Welcome to another special live recording of "Julia LaRoche's Show." Today we have a familiar face on the show, former Lehman Brothers trader Larry McDonald, founder of the independent research firm "The Bear Traps Report," and author of several best-selling books. His latest book, "How to Listen to the Markets,"...How to Listen When Markets SpeakCongratulations on the second anniversary of your publication! It's a pleasure to see you again.
Larry McDonald: Julia, thank you. Every month at Sunday brunch I tell my wife Annabella: As a former Lehman Brothers trader, it would probably take us a million books to recoup the losses from holding Lehman stock.
Host: So how many copies of your books have you sold in total?
Larry: The two books have sold nearly a million copies in total.
Host: Then let's keep working hard.
Private lending crisis: This round of subprime mortgages?
Larry: Sales of Lehman's book have recently rebounded because people are comparing subprime mortgages and private lending, wondering if history is repeating itself.
Host: Yes, we talked about this last time: private lending could be a breeding ground for the next crisis, or perhaps a crisis is already brewing. It's been about four months since our last interview. Could you give us a rundown of the current market and economic situation?
Larry: In my books, in the Bloomberg discussion group, and at our "Thought Dinner," I've always been striving to do the same thing—to gather wisdom from all sides and build an information network. Last night, we hosted a dinner at the Harvard Club, inviting a group of outstanding individuals, including chief investment officers from hedge funds and pension funds. My goal is to accumulate a sufficient number of excellent mentors and, through years of accumulation, gain truly valuable insights from them.
When observing the market, I synthesize the voices from all sides of the buying side and try to outline a clear narrative. I've noticed that if you have a high-quality information network, you can identify which stage of a market theme is in its life cycle and the extent to which the market recognizes this story.
Regarding private lending, I first heard about these ideas from some very talented lending professionals, such as Boaz Weinstein and Karen Goodwin, whose views were very straightforward.There are also some people I know from other credit cycles who have recently become very pessimistic about private lending and business development companies (BDCs).
Therefore, in our Bear Traps Report, we recommended shorting the financial sector for two reasons: first, the risk exposure to private credit, and second, the disruption brought by software companies and artificial intelligence. The financial sector is currently facing both of these pressures simultaneously.
Host: A double whammy.
Larry: Yes, they happened simultaneously. So we've been going through a period where the financial sector has lagged behind the S&P 500 by almost as much as since the financial crisis. Of course, it's currently somewhat oversold. Looking at the proportion of stocks in the XLF index that are trading below their 50-day moving average, the number of oversold stocks in the financial sector is quite substantial.
Host: Getting back to private lending, you mentioned Lehman Brothers,Many people are asking: Do you think private lending is the subprime mortgage of this cycle?
Larry: Yes, this is the subprime mortgage cycle. One of the best credit investors I know was at the dinner last night, and I heard the same assessment from several people: it's a mess, and eventually someone will go to jail for it.
When I sat down to talk with Charlie Munger years ago, he mentioned the "three Ms": Mark to Market, Mark to Model, and Mark to Myth. This is precisely the problem with private equity lending.
But will this spread to the public markets, including high-yield and investment-grade bonds? What I've actually heard is that it will actually benefit public market bonds. Private lending deals with private companies, which often involve significant overvaluation and misconduct; while the public market generally has higher credit quality. Therefore, we may actually see a large amount of capital flowing out of private lending and into the public credit market.
Host: For safety reasons?
Larry: For security, and for transparency.
Munger's "Three Ls" and Leverage Risk
Host: Munger's "mythical pricing" is indeed very insightful.He also disliked leverage, which he said was another thing that could get him into trouble.
Larry: He was referring to the "three Ls": Liquidity, Ladies, and Leverage.
Host: May Charlie Munger rest in peace. He left behind so many wonderful words.
Larry: He appears in the book. I know you sat and talked with him in Omaha.
Liquidity difficulties and redemption issues in private lending
Host: At these dinners, did anyone mention redemption issues or liquidity problems? Who can get their money back? How can one exit?
Larry: Before discussing that issue, let's talk about a more optimistic topic—natural gas. Looking at the performance of the FCG ETF, natural gas stocks have significantly outperformed the S&P 500, and their valuations are very attractive.
In Canada, for example, there is a large amount of "struggling natural gas"—gas that cannot be transported out due to insufficient pipeline infrastructure and remote locations, resulting in extremely low gas prices in certain regions. Meanwhile, approximately 820 data centers will need to be built over the next five years. Many of these locations are not ideal.Overheating, water scarcity, the NIMBY effect, and environmental resistance are among the reasons why tech giant "Mag 7" is currently under pressure.
Meta's stock price fell more than 20%, and Nvidia's decline was close to its 2019 low. The market has already invested heavily in data center construction, with expectations of completion within five years.However, it faces challenges such as rising energy costs and soaring memory costs (from which Micron Technology has profited significantly), putting pressure on Mag 7's profit prospects.
Regarding natural gas, some poorly located data centers will relocate to places with lower gas prices, such as Canada and Texas, which will support a bull market for natural gas over the next five years.
"Trump's Exit Slope" and the Risk of Stagflation
Host: This is an optimistic trading strategy. So, how many people in the market have incorrect position sizing today?
Larry: You could interpret it this way: compare the "Trump exit ramp" in 2025 and 2026.
In 2025, the Trump team underestimated the "beast" of the bond market, leading to pressure on the bond market and tightening financial conditions. They then locked Howard Lutnik in the White House storeroom for a full month and gave Scott Vincent frequent appearances on Sunday talk shows, ultimately quelling the crisis with a precisely executed exit strategy. The S&P 500 subsequently rose steadily from April 8th, presenting one of the most important trading opportunities of our careers—we bought heavily in hard-asset companies between April and May.
By 2026, the Trump team had underestimated one more thing: Iran's ability to strike the entire energy ecosystem and surrounding countries. From fertilizers and distillates to jet fuel, the entire energy supply chain was disrupted. The Trump team was eager to declare victory and end the war because they needed to achieve this goal before the midterm elections.
Host: Do you really think so?
Larry: Yes, the midterm elections. They're so eager to extricate themselves from this war, which is one of the reasons we're going long on volatility. I've said before that all controversial moves should be made as far away from the midterm elections as possible. But once April and May arrive, voters will start holding them accountable, especially as Election Day approaches.
Therefore, in the next three to four weeks, the Trump team will push the situation very aggressively in an effort to achieve a so-called victory.The market might rebound due to the so-called "TACO deal" (Tariffs Always Chicken Out). But this time, there's a larger private credit crisis behind it, coupled with rising energy prices that will have a substantial impact on GDP.Oil prices will remain stubbornly high even after the war ends, because the damage Iran has inflicted on the entire energy ecosystem and supply chain is too profound. In other words, inflation will remain high this year, and the economy will slow down in tandem—this is true stagflation. Stagflation is beneficial to hard assets.
Host: Stagflation isn't very friendly to other assets. Could you elaborate? Do you think energy prices will remain high even after the war ends? How sticky are they?
Larry: Energy logistics are incredibly complex. Iran has struck numerous assets in Bahrain, Dubai, the UAE, and other locations. Once key energy regions descend into chaos, companies withdraw assets, driving up insurance costs. It's not just the Strait of Hormuz that's disrupted; the entire region is thrown into disarray. Insurance companies need time to lower premiums, and companies need time to reinvest in assets. This will keep energy prices high for at least the next five or six months, dragging down GDP and limiting the Federal Reserve's room to cut interest rates.
The market had previously expected three interest rate cuts this year, but that now seems likely to be a false alarm.
Host: Wait, did you say "boosted GDP" or "draged down GDP"?
Larry:Rising prices for energy, natural gas, and jet fuel will likely reduce GDP by about one percentage point, thus slowing the economy.
Looking at the yield curve—the spread between the two-year and ten-year yields has recently experienced dramatic fluctuations, which was one of the topics discussed at the clients' dinner last night. Many people were trading on a "curve steepening," betting that the two-year yield would remain low while the ten-year yield would rise. However, this crowded trade was completely wiped out last week, with several funds going bankrupt on Wednesday and Thursday.
Host: I remember seeing related news.
Larry: The reason is that once stagflation begins, energy costs remain high, and short-term yields will be pegged, causing the yield curve to flatten or even invert.
Host: So what do you think the Federal Reserve will do? Cut interest rates or raise them?
Larry: Let me offer a prediction. The current consensus is that due to inflation stickiness, the two-year yield will be pegged. But if you lived through the 1970s and 80s, you'll know the pattern of energy shocks—in the short term, the Fed may be forced to raise interest rates to combat inflation, causing front-end yields to rise; but subsequently, the impact of energy shocks on GDP and economic activity begins to show.
At the same time, artificial intelligence is leading to massive layoffs. For example, Jack Dorsey laid off 45% of Square's employees, yet the stock price rose by 30%, prompting many to follow suit. Add to this the fact that rising energy prices are essentially adding a heavy tax on consumers. These combined factors will dramatically increase the risk of a recession this year, forcing the Federal Reserve to cut interest rates.
Therefore, my conclusion is: if you're watching this show right now, consider buying when the two- or three-year Treasury yield is close to 4%. You can lock in a 3% to 4% risk-free return, and once a real credit crisis or recession hits, the Fed's rate cuts will drive these Treasury prices up significantly, potentially resulting in a total return of 8%.
"The Great Migration": From Financial Assets to Hard Assets
Host: This logic regarding bonds is very interesting. We also discussed last time that 2026 will be a crucial turning point for the transformation of investment mechanisms. Do you think this transformation is already underway?
Larry:The Nasdaq 100 once had a size of $34 trillion, and now it is about $30 trillion, with about $4 trillion flowing out to oil and gas companies such as Chevron and ExxonMobil, as well as hard asset companies such as various copper mines.
We call it the "Great Migration" in the book.Between 1968 and 1981, the industrial, materials, and energy sectors together accounted for approximately 50% of the S&P 500; in recent years, this proportion fell to a low of about 9%; it has now rebounded to about 13%. We won't see it return to 50%, but 25% is possible. Currently, institutional funds are shifting their allocations towards international equities and hard-asset companies, such as Glencore, BHP Billiton, and Freeport-McMoRan. These types of assets tend to outperform in stagflationary environments.
Host: So Mag7 funds are flowing out. You mentioned double-digit drawdowns earlier, and we've also discussed the large influx of passive investments into these names. Is this bubble starting to burst, or is it just a healthy correction?
Larry:The S&P 500's two largest holdings—Microsoft and Nvidia—once accounted for 14% to 15% of the index. Since our last conversation, Microsoft has fallen by about 28%, Nvidia by about 19%, while the S&P 500 as a whole has only fallen by about 6%.This indicates that the market is undergoing a large-scale rotation and structural expansion. This is exactly what we've been talking about: a rotation from overcrowded "monkey in the tree" trading to companies with a large number of hard assets.
Host: Do you expect the S&P 500 to fall further?
Larry: The Trump team will try to push the exit ramp again. On the surface, inflation stickiness will continue to push funds from Mag7 to other sectors, but behind this lies the looming economic slowdown and the quiet approach of private credit risks. Therefore, every rebound in the S&P 500 is met with selling, and market confidence is weakening.
The S&P 500 and Nasdaq have been trading almost sideways since August or September of last year, leaving many investors with no returns and accumulating significant emotional pressure, leading to selling on any rebound. Therefore, overall, I believe the market will continue to decline, but there are indeed structural opportunities within the market that could significantly outperform.
The link between energy prices and private lending
Host: Is there a link between energy price fluctuations and the private credit crisis?
Larry: Yes, they are related. The sharp rise in energy costs has directly driven up the construction and operating costs of data centers—diesel prices have increased by about 100%; heavy construction industries such as gold mining have also been affected; memory costs (DRAM) are also soaring, with Micron Technology taking a big hit on Mag 7.
These factors combined will significantly increase the construction costs of data centers, directly squeezing Mag7's profit margins. Adding to this the previously mentioned issue of poor site selection—many data centers are built in areas with excessively hot climates, water scarcity, or NIMBY (Not In My Backyard) issues—approximately 20% of data centers will have to be relocated. This, in turn, provides demand support for the cheap, struggling natural gas and coal industries in regions like Canada.
Gold, Silver and Bitcoin
Host: Speaking of precious metals and industrial metals, could you share your current views on gold and silver? Gold saw an astonishing surge last year, reaching around $5,500 at one point. Where is it now?
Larry: Hard assets did indeed surge last year. In January of this year, when the call/put ratio (i.e., the skewness indicator) for silver options reached 8:1, we sold a significant proportion of our gold and silver positions in a trading alert.
The recent correction in silver and gold mining stocks, partly due to rising diesel costs squeezing profit margins, has not diminished the overall profitability of gold, which remains high. Overall, prices have pulled back to near the 100-day moving average, presenting a good buying opportunity in a new bull market.
Moreover, historically, households currently hold approximately 1.25% of their assets in gold, silver, and hard assets, compared to as high as 3% in the 1980s, indicating that overall holdings remain relatively low.
You can think of it as a bull market where a large number of "casual buyers" (analogous to tourists in Hawaiian shirts) have just flooded in, only to be shaken out by short-term fluctuations, leaving behind genuine investors who continue to buy at lower prices. We experienced the same scenario with uranium mining—buying near the 100-day moving average, especially in a historically severely undervalued asset class, was likely a great opportunity.
Host: Did you add to your gold holdings after this correction?
Larry: We sold all of our GDX, SLV, and SIL in January and are now gradually buying them back during this pullback. In addition, we did something unprecedented – we bought Bitcoin for the first time.
Host: Wait, is this the first time in history that Bitcoin has been bought?
Larry: Yes, for the first time ever.
Host: Tell us, what were you thinking?
Larry: There are two points to consider.
First, the ratio of Bitcoin to gold (in Bitcoin to gold terms) once reached as high as 38 times, but has recently fallen back to 13 times. Although there is only five years of data, historically, when this ratio enters a low range of the teens, it is advisable to moderately reduce gold holdings and increase Bitcoin holdings.
Second, ETFs launched by institutions such as BlackRock have, to some extent, diversified the investor base for Bitcoin. Five to ten years ago, about 18 families controlled about 60% of the circulating supply of Bitcoin—if one of these major players needed liquidity due to a credit event, the market would crash, and retail investors would suffer a 70% drop.
Currently, Bitcoin still possesses the attributes of a hard asset—scarcity and hedging value against global currency devaluation. The fiscal actions of the United States (regardless of whether it's the Trump or Biden team) and the United Kingdom are absurd, refusing to raise taxes while drastically expanding defense spending, merely diluting their currencies.
Therefore, when the Bitcoin-to-gold ratio falls from a high of over 30 times to around ten times, seizing this Bitcoin pullback opportunity is a reasonable allocation strategy.
Host: Do you trade through ETFs?
Larry: Yes, we use the iBit ETF. It's the most convenient option for a wider range of investors. It's important to note that for commodity ETFs like UNG or USO, the rolling over of futures contracts generates ongoing natural attrition. This has little impact on short-term trading, but for long-term holding, the returns may not be as good as holding the commodity itself.
The UK Crisis and Warnings for Global Bond Markets
Host: Bear Traps Report is known for identifying risks. What do you think is the most underestimated potential risk right now?
Larry: The biggest risk is in Britain. A real crisis is brewing there: a severely weak government, a huge fiscal deficit, a continued economic slowdown, and energy costs in Europe are rising far more than in the US. The events in the Middle East have had a severe financial shock to the European economy. I think Nigel Farage is very likely to become the next British Prime Minister.
If the UK faces sovereign debt financing difficulties and a bond vigilante movement erupts, it would be the biggest black swan event of the year. The situations in France and Italy are also worrying; their long-term bond yields have already begun to break through resistance levels, and a 20% to 40% increase in energy costs would hurt consumers, slow the economy, and reduce tax revenue, yet the governments would still need to continue issuing large amounts of bonds to stay afloat.
Host: Could Britain be the "canary in the coal mine," the first to warn other countries of similar risks?
Larry: Absolutely. But one thing will save those guys in Washington—there are even more "dirty shirts" in other countries. Whenever tensions rise in the Middle East or a crisis occurs in a country, money flows to the dollar as a safe haven. This is a buffer for the dollar's reserve currency status, and it won't lose that status for the next ten to fifteen years, but the long-term fiscal path is worrying.
The Deep Logic of America's Fiscal Dilemma and the "Great Migration"
Host: Let's talk about the US fiscal situation. The national debt has exceeded $39 trillion. What are your thoughts on healthcare, defense, social security, etc.?
Larry: When discussing the dollar in the book, we quoted Tocqueville and Taylor: democracy can only last until voters realize they can plunder the public treasury. We now run a fiscal deficit of about 6% annually, whereas for the past fifty or sixty years, that figure has remained between 2% and 3%.
The Trump team plans to spend an additional $200 billion on this war, pushing defense spending from $1 trillion to $1.2 trillion, which means continuing to issue more national debt into the market. It's worth noting that when Lehman Brothers collapsed and the last financial crisis hit, the US debt-to-GDP ratio was around 70% to 80%; now that figure is 120% to 125%.
Once the economy enters any form of downturn, tax revenue begins to decrease while spending remains rigid. This is the fundamental driving force behind the massive migration of assets from financial assets (stocks and bonds, which are essentially just paper certificates) to hard assets.
Host: What stage of this migration are we in?
Larry: I think it's probably around the second or third game.
In-depth analysis of the private equity credit crisis
host: Is private lending already a crisis?
Larry: Without a doubt, it is. Some client feedback reminds me of 2008—when rating agencies gave a lot of junk ratings to subprime loans and securitized products; and in the last four or five years, all sorts of strange private credit rating agencies have sprung up like mushrooms after rain.
For months, we've seen clients shorting insurers like MetLife, which hold significant exposure to private credit. These insurers, initially seeking higher returns, have ultimately become the ones left holding the bag.
The way they were lured in is strikingly similar to the scenario depicted in "The Big Short"—sell-side research told them the product was extremely safe, while rating agencies used a small team to rate thousands of securities, mechanically applying models without any in-depth due diligence. History is repeating itself.
Host: So how can ordinary retail investors know if they have any risk exposure?
Larry: Karen Goodwin articulated this aptly—to bring retail channels in, private credit products promised quarterly liquidity to financial advisors and dealers. This is absurd for one of the most illiquid asset classes. Imagine simultaneously selling bonds from hundreds of private companies with opaque financials, where due diligence is extremely time-consuming and labor-intensive, while these products promised quarterly liquidity.
These products require retail funding to support them, so many holders are currently unable to redeem their shares smoothly. The 5% quarterly redemption cap is far from meeting the actual redemption demand of 10% to 15%.
The most alarming sign for me is that "the truth is slowly seeping out, drop by drop." When you see the narrative begin to shift within four or five months, for example, when UBS analysts have broken the sell-side "grouping" and started predicting that private lending will trigger larger-scale defaults, freeze the loan market, and spread to CLOs (mortgage-backed securities)—once this securitization machine starts to malfunction, the conveyor belt will stall, banks will have to bear more risk themselves, and the credit crisis will erupt.
The narrative shift from "it's just an isolated case" to "we have a big problem" is underway, revealing the credibility issues on Wall Street.
Conclusion and Contact InformationHost: Larry McDonald, it's always a pleasure to speak with you, especially face-to-face. I'm also looking forward to attending your book launch tonight. Before we wrap up, is there anything you'd like to say to our audience? How can we follow and support your work?
Larry: Thank you. Everyone can...
Contact us at info@thebeartrapssreport.com or via Twitter @convertbond. What I want to say is that this is not about me personally, but about how to build an excellent team of mentors who can extend enough "tentacles" in the financial community to observe the life cycle of market narratives and determine whether a trade has been priced in and whether it is in the early or late stages—that's what we've been doing.
Host: Larry McDonald, thank you very much for your time. Today's exchange has been very interesting.
Larry: Thank you, Julia.
