Weakness in US private credit market could be a 'canary in the coalmine', says official, flagging risk of another financial meltdown
Bank of England governor Andrew Bailey has said the collapse of two private credit lenders in the US bears similarities to the events preceding the global financial crash in 2007-08, describing those failures as a potential “canary in the coalmine.”
Bailey told a House of Lords committee on Tuesday that it was an “open question in the US” as to whether the blow-ups of auto parts manufacturer First Brands and subprime auto lender Tricolor exposed trends limited to the private finance sector or reflected a deeper, wider problem.
Those collapses sparked fears that more could be ahead, with JPMorgan chief executive officer Jamie Dimon describing potential “cockroaches” in the financial system.
And Bailey suggested regulators and policymakers should be on the lookout for early similarities to the strain that triggered the 2008 meltdown.
“I don’t want to sound too foreboding,” he said, “but the added reason this question is important is if you go back to before the financial crisis when we were having this debate about subprime mortgages in the US, people were telling us: ‘No, it’s too small to be systemic. It’s idiosyncratic.’ That was the wrong call.”
He drew parallels between the complexity that’s crept back into private credit markets and some of the methods used to package debt before the subprime mortgage crisis, which were seen as a key reason for the crash.
“We certainly are beginning to see… what used to be called slicing and dicing and tranching of loan structures going on, and if you were involved before the financial crisis and during it, alarm bells start going off at that point,” he said.
“That stuff was a feature of the financial crisis so that’s another reason why we’ve got to use these cases as another reason to have more drains up.”
The central bank is mulling the introduction of a stress test for the private credit market, Bailey and deputy governor Sarah Breeden said, in an effort to better understand how debt is structured.
“I would hope that we’d be able to come up with an answer to the question, ‘Is a shock here likely to be contained, or likely to subprime-like spiral in an amplifying way?” Breeden said during an appearance at the House of Lords Financial Services Regulation Committee.
“We’ve been talking to the firms involved, asking them if they would find it valuable to participate and they’ve been willing to do so.”
Stock futures wobbled on Tuesday morning as investors took a wait-and-see approach on the economic outlook amid a slew of scheduled earnings releases.
