(Bloomberg) - Federal Reserve Governor Michael Barr said stress in private credit could spark “psychological contagion” leading to a broader credit crunch, once again warning against loosening the reins on Wall Street at a time of rising risks.
In an interview with Bloomberg News, Barr said that while direct links between banks and private credit do not yet appear “super worrisome,” there were other areas of concern such as the insurance sector’s overlaps with private lenders.
“Then you also have the problem of kind of psychological contagion,” he said. “People might look at private credit, and instead of saying ‘this is an idiosyncratic problem, these were high risk loans, the rest of the corporate sector is different’, they might say, ‘Wow, there seem to be cracks in our corporate sector. Maybe over here in the corporate bond market, there are also cracks.’”
“Then you could have a credit pullback, and that could lead to more financial strain,” he added.
Previously the Fed’s top bank cop, Barr has been an outspoken critic of the Trump administration’s push to deregulate. He was the sole Fed dissenter on a diluted bank capital proposal tied to Basel III after pushing for a significant hike in 2023.
He has repeatedly warned of risks building in the financial system, including the $1.8 trillion private credit market, where investors were left in a queue to withdraw about $5 billion earlier this year as redemption demands soared for funds with only limited liquidity.
Wall Street banks, which have piled into private lending, have also cautioned that there will be more blowups, though they remain sanguine about the overall health of the asset class.
PIK Risks
Barr is also concerned about payment in kind structures, where interest is paid by creating new loans.
“Basically that just means you default on your loan, and it’s not counted as a default. So that’s worrisome. You can’t look at the book and know which loans are really actually under stress,” he said.
More broadly, Barr is highly-critical of growing calls to ease liquidity requirements for US banks, which he sees as “super-short sighted.” He also said that the Basel proposals announced earlier this year triggered a rush of buybacks before the ink was even dry, while bank pay is now “extraordinarily high.”
“So that’s who’s benefiting from this deregulation, not farmers and ranchers, not small business owners, not the US Treasury market,” he said.
After years of wrangling over regulations designed to avoid another financial crisis, bankers are now lobbying for the rules to be eased further.
“I’m worried that we’re heading down a path that we’ll regret in several years, not today, not next year,” he added. “The banking system is very strong, but over time, we’re weakening the things that have made our country so strong."
Still, he sees reasons for optimism, against a backdrop where the US has ditched swathes of multilateral agencies.
“I did not take for granted that the new administration would stay in the Basel process, and stay in the Financial Stability process, which they’ve done,” Barr said. “And I didn’t take for granted that they would put forward any Basel III proposal, but they have, and the bulk of the proposal I agree with.”
By Laura Noonan
