Why America’s Credit Rating Dropped — ft. Scott Goodwin
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Today's number, 37.5. That's how many megabytes of data there are in each human sperm cell. Ed, what do I say when I climax? What? Surrender, Dorothy! A little Wizard of Oz humor there. Or, or, you're not laughing, you're laughing at this one. I'm melting. 977, no me diga no, lo lo que siente.

True story, Ed. Let's move on. Did you know how I paid for my junior year in college? This isn't a joke. This is true. How's that? Well, guess. We're talking about sperm. How did I pay for my junior year in college? Use your critical thinking, fucking Princeton. I got to start hiring someone from a better school like Fordham. Anyways, what do you think I did my junior year? I think you sold your sperm.

That's exactly right. So I know you want to hear a story about this. Yeah, that's right. I went in with two water polo players who were literally blonde gods, much better looking, much smarter than me. And they give you this full test. And they give you an IQ test. They take pictures of you with nothing but your underwear on. They create a portfolio for you, a little dossier. So wanting parents, parents come in and they pick who they want their biological father to be.

And I went in, first thing, and also what they do is they do a VD test, which I've never had before, which is not very pleasant. And no one gave me a heads up and I fainted. But despite that, I got called in, true story. I got called in three or four times a week for a year. And I made about 200 bucks a week, which was enough to pay for UCLA in 1987. And my mom made me stop. She scared the shit out of me. She's like, you realize your son is going to start dating your daughter and you're not going to know. And there's all sorts of ethical implications. So I stopped it.

We have gone so far afield here, Ed. We? I think you dragged us here. I haven't really said a word yet. Well, okay. You want to know more about this? Fine. So there's a site you can go to. No joke. There's a site you can go to. And if you fill it out, they send you a certified letter. And if you sign it, an email goes out with your contact information to all of your biological children.

And they can contact you if you want. The problem is, is you can't pace it. An email has to go out to all of them. And I don't know if I have two kids or 2,000. And so I think I'm going to do it like the week before I die, just so I have a bunch of people to come visit me and hang out with me. I think the funniest is just imagining, I mean, I would bet this is the case, that there are people listening to this podcast right now who unknowingly are your sons, your sons and daughters. Dad? Dad?

I mean, that's genuinely possible. You've gotten pretty big. You donated a lot of sperm. It is genuinely possible a fan of Scott Galloway could actually be the child of Scott Galloway. That's very possible. Do you have a ridiculously big nose, prone to anger, very cynical, trouble staying focused for a long time?

Decent wit. Anyways. What else are you good at? That's about it. I think I've run out of things. I used to be really good at foosball. Did you pick up foosball like no tomorrow? Dad? Dad? All right, get to the headlines. Let's do it. Now is the time to buy...

I hope you have plenty of the wherewithal. Moody's downgraded the US's credit rating from AAA, citing concerns over the growing deficit and rising interest costs. In response, 30-year treasury yields briefly hit their highest level since 2023. Before falling slightly, stocks initially dropped but closed higher as traders bought the dip. Harvard, Yale, and at least two other universities have sold or are considering selling discounted private equity stakes from their endowments on the secondary market.

The sales are intended to help them meet capital calls and cover their federal funding gaps. And finally, after Walmart's CFO warned that tariffs could soon lead to higher consumer prices, President Trump urged the retailer to absorb the costs instead. He wrote on Truth Social that they should, quote, eat the tariffs and not charge valued customers anything. Walmart stock fell slightly following his comments. So let's just start with the Moody's downgrade.

The U.S.'s credit rating has been downgraded from AAA to AA by Moody's. Scott, any initial reactions to this news? So I thought this was a bigger deal than I guess the rest of the market thinks. And maybe that's some of my bias towards bigger deficits and looking to complain about the negative externalities of bigger deficits. And I'm not a fan of the Trump administration, so maybe I'm more prone to catastrophizing. But the way I see it is everything just got a little bit more expensive.

that the majority of debt instruments do price off of the 10-year and treasuries, I think, although our guests will point out, Scott Goodwin, that the delta is compressed between those two things because people don't have the same insecurities about corporate as they do about sovereigns. But I don't want to spill too much of the thunder. But I think that we are behaving irresponsibly. This was the third and last agency to do it.

And keep in mind, these are the agencies that rated a lot of the subprime debt or subprime mortgage debt in 2007 as AAA. So they get it wrong. But I don't, you know, our U.S. interest expense is now over a trillion dollars annually. So we're spending more on the debt to service the debt than military spending. And it's our fastest growing budget item. That's just not a good idea. The fastest growing budget item is an investment investment.

in universities or even the military or education, but it's interest rate on the debt.

I was looking for more evidence that this is just unsustainable and a bad idea. The markets so far seem to have kind of yawned. What are your thoughts? I'm with you that this is a big deal, not in terms of actual market dynamics, because as we saw, we saw like only a sort of a slight reaction from the markets. But to me, it's more of a it's more symbolic than anything. I think the reason you're not seeing a big

swing in the markets is this isn't news to people. Like, Moody's comes out and says the U.S.'s fiscal situation is not good. That's not a surprise to anyone. And anyone who just starts selling just because a ratings agency

decided that they didn't like the credit situation anymore. Like, that's not a good investor. You don't want your investment team basically just following whatever Moody's does. These ratings agencies are supposed to move pretty slowly and pretty carefully. So, you know, in terms of what it actually does at a technical and mechanical level in the markets, yeah, it's not going to have that much of an impact. But I do think it is important at a symbolic level

I think what makes it especially important is sort of the context around the headline here. I mean, this is coming in the same week that we saw one of the most fiscally irresponsible tax plans in history both proposed and then approved.

by the Congressional Budget Committee, which is going to reduce revenue, government revenue, by $5 trillion, increase our debt burden, increase our interest payments. And it's all coming at a time where I feel like we all thought that we had agreed we need to get deficits under control. Like, it seemed that everyone had decided, yeah, like, we should balance the budget. Our president said that himself. And then the GOP comes out and says, never mind all that. We're going to keep spending. We're going to increase our military budget.

Oh, and by the way, we're going to cut taxes on the rich and the ultra-rich. So I think that's one piece of context here where you combine it with Moody's downgrading our credit rating that makes it a big deal. The second piece of context is the one that you referenced, which is that with this downgrade, the U.S. no longer has a single AAA rating among any of the ratings agencies. This is the third of the big three to do a downgrade. The S&P downgraded in 2011.

Fitch downgraded in 2023, and now you've got Moody's downgrading in 2025. So to me, it's sort of a symbolic nail in the coffin where it tells us that this is now consensus. It's no longer a matter of opinion that our fiscal situation in America is unstable. It's now a matter of fact.

Yeah, and I'm not sure it's fair to say it's unstable. We're just no longer bulletproof, right? There's now nations that appear to, at least from the market standpoint, be lower risk in terms of their ability to pay off their debts. And you would have thought the most prosperous country in the world with the biggest economy would be the most bulletproof in terms of its debt.

Maybe there's some – I'm just trying to think what the steel man argument is, that we need to be more aggressive and that we're investing in growth and rich people are our most productive citizens and that additional capital in the hands of our most productive citizens will trickle down. Basically, Reaganomics that has been proven over and over to be total bullshit. And I go to where – I forget which study it was, but it was a nonpartisan study that said that this tax bill goes through.

This is going to be the largest single transfer of wealth in history from the poor to the rich, or as I call it, that's Latin for from young to old. Let's move on to these Ivy League schools, which are now selling all of their stakes in these private equity funds. They're trying to sell it on the secondary market.

To me, this is just kind of an interesting example of second-order effects, where I don't think many of us really put it together that if you target the Ivy League schools, if you cut their funding, and if you increase their taxes, which, by the way, I'm not saying any of that is a bad thing, but it's just interesting that if you do that, you also end up affecting the private equity industry and the venture capital industry, because the dirty secret of VC and PE is that the system is...

heavily subsidized by these multi-billion dollar college endowments, Harvard and Princeton, Yale. They're all big, big investors in VC and private equity. And in fact, more than a third of their allocation as of 2024 is invested in PE and VC funds. So this is a significant position in

in alternative investments. And so now that they're less liquid, or at least there is this threat of less liquidity in the future because the government is targeting them, now they need cash. So they're dumping these private equity stakes at these supposedly very large discounts in the market. Scott, your reactions.

We talked about this, and when it was on the editorial call, you said, if I were Scott, I would be looking at this because it feels like it has a smell of forced selling, right? They get cut, or they're funding cut from, or potentially government investments in the National Institutes of Health or government funding of research, which, by the way, has been shown to have incredible ROI, but that's a risk. And so a lot of these universities are thinking maybe we need to create some liquidity. So I actually looked into it.

Yeah.

And that is the reason why hedge funds and alternative investment managers go out of business is not because of performance, although that is a key indicator that they're going to go out of business. But when they actually go out of business, it's because of mismatched durations where they raise money short and they invest long. And that is they have investors where they don't have lockups and those investors can redeem, but some of their investments, they go long and are illiquid.

And this is kind of a case of mismatched durations in the sense that there haven't been a lot of distributions. They haven't gotten a lot of money back from these investments. And some of these investments are probably still doing pretty well in terms of their mark. They just haven't had much liquidity because the M&A market has been fairly dormant and the IPO market has been in a kind of a deep freeze for a couple of years. So I know this firsthand. The limited private equity exposure I have, I haven't gotten any checks, but I continue to get capital calls now.

And so that basically creates a liquidity squeeze. Now, what they also said, though, was that, keep in mind, Scott, I thought, oh, this is great. We're going to make a lot of money buying from a for-seller. He said, well, you'll probably make, you know, and the reason why we're raising money, said, you know, big fun, because we do think there's opportunity here. But be clear, this isn't a distressed sale. This is universities and endowments recognizing they need liquidity, but also deciding it's not a terrible time to sell.

that the markets are still pretty strong and they have good positions. And there's so much capital out there looking for return that one of the reasons they're selling is, one, they need liquidity, but also they believe they're going to get good prices for these stakes. The thing that strikes me about it or where you typically would find opportunity like this is that the universe of buyers is

I like environments where there's a limited universe of buyers because it's hard, right? You have special access, you have to do a level of diligence that other people aren't capable of doing.

And I would think to value or mark a private equity stake or Harvard's $100 million tranche in this private equity fund or whatever, investment in a KKR, that that's pretty sophisticated analysis that would intimidate most people, right? It's not like, well, I like Apple and I'm going to look at it and I understand the PE and I like the products. This is trying to

put a number in fine price discovery on a bunch of private companies that may not even have publicly available documents. I mean, I would imagine Harvard gets, you know, decent reporting, but

But that's not an easy task. I would think there's a limited universe of people who have the confidence to go in and buy these tranches in bulk and can do the work and make sure that they're getting what they believe is a decent deal. So the bottom line is I'm not as smart as I think, and they're not as dumb as we're hoping. Well, I think they're skating ahead of the puck here, which is they recognize that there is a risk

of a liquidity crisis in the future. But that's why they're selling now and they're trying to sell early because these are very sophisticated investors and they recognize, I mean, I'm sure they're not in a liquidity crisis right now. These are multi, multi-billion dollar endowments. They're just trying to be very, very safe and recognize, okay, if we're going to have to start paying all of these taxes...

We might be in a precarious situation. So let's start to sell now, which I think sort of reflects what those private equity guys told you when you asked them about it. I do wonder, just in terms of other implications, I do wonder what this means long-term for venture capital and private equity. Because, you know, as I mentioned...

34% of their portfolios, these Ivy League portfolios, are allocated to VC and PE. And if liquidity is going to be more of a concern going forward, I would bet that these endowments are going to start trying to make their portfolios more liquid long-term, which would mean trimming their allocation into PE and VC. So, you know, 34%.

I could see that number coming down over the next five or 10 years, maybe to the teens, maybe even to single digits. And I just wonder what that would do to the venture capital and the private equity industries, which, as I've said, have been sort of very quietly quite reliant on these Ivy League schools and these gigantic endowments investing into these funds.

So I could see that happening. And then the other question would be, okay, well, where will they go to instead? If they can't go to Harvard and Princeton to fund these private equity funds, then where are they going to go? My prediction would be they're going to go to the same place they've been going over the past few years, which is billionaires.

and ultra high net worth individuals. Because I think this is what we're learning is that's where the money is now. It's increasingly not going to be the institutions and it's not going to be the colleges. It's going to be the individual people who have absurd amounts of money and who, unlike the Ivy League schools, are set to receive even more tax breaks than they've gotten in the past. So if I had to make a long-term prediction,

Very, very second order. Increasingly, we're going to see less Harvard and Princeton on those LP lists, and we're going to see more individual billionaires. Let's wrap up these headlines here. Walmart and this skirmish with Trump. Walmart said that

They're going to increase prices because of the tariffs. Trump then complained about it. Initial reaction, Scott? Well, Donald Trump has declared bankruptcy over and over again and is a shitty business person and has left just a trail of unpaid subcontractors. And Doug McMillan is arguably one of the better CEOs in corporate America. And he's supposed to take business advice from Donald Trump. Walmart operates at some of the lowest margins of any company in history.

And so one of my kind of role models economically is a guy named Bruce Buchanan, who's this amazing economist on the faculty at NYU Stern. And he taught marketing. And he has one of the constructs that changed my life as a pillar of how I think about things. And that is all shareholder value is a function of the ratio between three lines. The top line is the perceived value of a product. The middle line is the price you're charging. And the bottom line is the cost. Right?

right? The cost of the supplier, the retailer, the business. And essentially what happens is, is if the perceived value of a product goes up because of technological innovation, branding, or that market is hot, that line goes up, you can do one of two things. You can raise the prices you're charging and thereby the margins go up, right? Between your costs and the prices, meaning more shareholder value, or you can leave prices where they are,

And the increase in the delta between the price you're charging and the perceived value creates more market share and you have bigger volume. The other way to add value, so you're in the business of pushing the top line up, perceived value. The majority of companies are in the business of trying to push up that perceived value line. There are a small number of companies that are total focus is on pushing the bottom line, the cost line down every day. That's their total focus. They're all about business to scale, right? A Home Depot, a Walmart, a Dell computer.

And if you can keep pushing that line down by putting pressure on your vendors, better supply chain, some wonderful things happen. The delta between your costs and the prices you charge go up, meaning more earnings, or you can lower, along with your lowering your cost bar, you can lower the price bar and the delta between price and perceived value goes up and you get more share. Walmart is in the business of constantly pushing down their cost bar, and then immediately they pass on those savings to

to their consumer. They pull down the price bar. They don't get greedy and say, we want to expand our margins. The moment they can source cases of ginger ale for less money, they lower the price bar and increase the delta between the price charge to consumers and the perceived value, thereby expanding share. That has been their entire strategy. They have done that better than almost any company in the world. And as a result, they have some of the largest top line revenue of any company in the world, and they operate on exceptionally thin margins.

So the idea that this company, which is so optimized for price and has become the company and the brand known for the following, when you start shopping at Walmart, I love this value proposition. If you switch from another retailer to Walmart, it's like getting a promotion.

It's like you get promoted from manager to vice president in terms of the quality of your life because you can upgrade from Budweiser to Heineken. You can buy better quality diapers. You can buy a nicer stroller because they are so incredible at scale and pushing down

that cost line, and then pulling down the price line. This is an incredibly, arguably one of the best managed companies in the world. And him telling them to absorb the tariffs, I mean, it's so stupid. It's so ridiculous that he's picked out these companies. And two, all they're going to do, this is exactly what they're going to do. They're going to say, okay, just placate them. Yes, we need to be thoughtful. They've already come out and said, we're probably going to try and hold the line on groceries. They're the largest grocer in the world.

That's probably because I would think the majority of that is not imported. So the tariffs don't impact that the most. And they could put out a press release and signal that, OK, we're taking the president seriously. And they'll just placate the idiot, the bad business person, and he'll move on to someone else or something else. And they'll go about operating their business, which will be the following. Their margins will stay approximately the same. They'll probably take a tiny bit of a short-term hit.

because they know how to price their product better than anyone to create the biggest retailer in history. And he'll move on to something else. Do you think there's like a marketing opportunity here? I mean, one thing I've been seeing on TV, a lot of companies are saying,

boasting about how they build in the US and they're sort of putting out this very sort of MAGA type rhetoric. And I just wonder if there is sort of like a market share opportunity here where

Maybe Home Depot looks at what happened with Walmart. And yes, I agree. Trump's comments were ridiculous. I mean, the idea that he puts a policy out there and then a company reacts to the policy and then he complains about how they reacted. It's like five-year-old meets socialism or communism. It's ridiculous.

But it's still highly possible that there are people out there who agree with him and who go, yeah, Walmart's the enemy. Walmart should have ate the tariffs. Donald Trump's right. And maybe we would start seeing a new pitch from companies saying, well,

look, we're pro-America, we're going to eat the tariffs and we're not going to raise prices. And I wonder if that is sort of an opportunity for a Home Depot to go in there and steal some market share from Walmart. There's a lot of studies, a lot of research and data around this, and the results are really clear on this. And that is,

Consumers talk a really big game about caring about sustainability, made in America, supporting union labor, not having child labor, and then they will buy the absolute cheapest thing they can buy regardless if it was built with the organs of orphans from third world countries.

And that is sustainability and fair trade and onshoring or sourcing from domestic American manufacturers. It does count, but it doesn't count a lot. It's a tiebreaker. So if someone says this company, this retailer is really good and sources as many products locally as they can, yeah, that means something. You know, local kind of local farm, that kind of stuff, that's for a high-end consumer. But the majority of consumers just don't have the luxury of

of doing not only the diligence, but there's a lot of consumer dissonance here. But I'm sorry, I'm saying the marketing, in addition to that, I'm saying the marketing opportunity is you come out and say, we'll eat the tariffs. I know it doesn't work long-term, but it's something that could get people excited. What's the first question on your earnings call? You committed to eating the tariffs.

How has that impacted margins? And while you're out there virtue signaling, the people who decided to invest their 401ks and all these teachers through hedge funds who are investing in you now, you're out there posturing or wrap yourself in the flag. And what has that done to earnings? So I don't think that's a good idea. I think the marketing opportunity is basically to, in as elegant a way as possible,

And without even mentioning his name, to say that we're an American company and we believe in American values, we think trade wars are bad. The people who have the most disposable income are probably in the middle or center left or left. And that is the people who would really get angry at an ad like that are driving RAV4s, have trucker hats and not a lot of disposable income.

And so that sounds very elitist and it is, but marketing can be elitist. It does. Yeah. But it's true. Yeah. So I think the biggest opportunity of marketing in a long time right now is to elegantly but forcefully say we are an American company.

And we believe in upholding of American values. And what is going on right now is disturbing to us. And that company would see so much hate, so much graffiti, and a massive uptick in high margin sales from the 10% of America that now controls 50% of the economy. And that is the wealthiest 10% who skew way left now and look at what's going on in America and quite frankly are really disturbed by it.

We'll be right back after the break for our conversation with Scott Goodwin. If you're enjoying the show so far and you haven't subscribed, be sure to give ProfitMarket a follow wherever you get your podcasts.

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Welcome back. Here's our conversation with Scott Goodwin, co-founder and managing partner of Diameter Capital Partners. Scott, thank you very much for joining us today. Thanks very much for having me. It's been a long-time listener, first-time podcaster with Scott Galloway. So, excited to be here. Hell yeah. We're excited to get into it. So, Scott...

I'd love to start off with your thoughts on this credit rating downgrade from Moody's. Moody's has downgraded the US's credit rating from AAA to AA. Your thoughts on whether this is important and what this means for the markets. I think that the story of kind of now is that the

the credit risk is on the sovereign balance sheets, not on the corporate balance sheets. So globally, the volatility in the long end of the yield curve has been much higher than the credit spread volatility in, say, high yield or bank loans or even investment grade. So the

the idea that G7 or sovereign balance sheets are behaving like emerging markets is a lot more of what the story is. This downgrade, I think Scott Besson said it well. It's yesterday's news. You know, it was downgraded

by S&P and Fitch a long time ago, doesn't really create much for selling. It was an excuse for people if you wanted to sell it's an excuse to sell. But I do think what you're seeing now globally is the long end of the yield curve with the fiscal excess of the past 25 years is being challenged whether it was Liz Trost a couple of years ago in the UK, the long end move in the German yield curve when they said they were gonna have their fiscal expansion

I think Japanese yields yesterday in the long end moved, or this month have moved something like 40 basis points. And obviously you've had a couple moves in the U.S. in the long end over the past few months as the new administration's kind of rolled out their policy platform. So the

fiscal sustainability in the long end, not just U.S., but I think globally is something that's being tested. So what does this say about our economy and our fiscal situation right now? You say it's old news because we obviously had these downgrades from Fitch and from S&P, but does this signify anything larger? Is this important from a fiscal perspective? You know, Trump came out this morning and said he's a fiscal hawk. I think he

In principle, he's at least trying. Both parties have had excess spending the past 20, 30 years. He's at least trying at a headline basis, whether it's Doge or some of the other things to reduce spending. Although I think government spending is up year on year. Last time I checked, um,

So the issue now is the level of rates combined with the level of deficit is a pretty dangerous policy cocktail. When we should have been issuing a lot of long duration paper four or five years ago when rates were very low, we were instead issuing a lot of short duration paper. So the problem of the treasury management and the excess deficits then is coming back to haunt us now. So the long end of the curve, it sounds like, Scott, you don't think that this is sort of trickled down or trickled down?

sideways or leaked into the corporate bond market that the volatility among sovereign debt has not yet been reflected in the borrowing costs of corporates. Is that correct? Well, it has because this corporate's traded a spread off of the sovereign. But if you think about, think about like investment grade credit, the percentage of the yield on an IG long bond, let's say Apple or Amazon long bonds, the percentage of that yield that is

U.S. government yield versus corporate spread is near historical lows. Same for high yield, frankly. So the treasury, the fiscal is crowding out a lot of the credit spread. So it is causing corporate borrowing costs to be higher, but that's the base yield, the nominal yield, not the spread. If you have a situation where the fiscal excess leads to less government spending, then

leads to them causing things that cause job losses, then it will flow into credit spreads and defaults. But so far, the economy is doing okay. You had tech stocks have been booming the past few years. Housing is doing terribly, but everyone refinanced their mortgage in 2020 and 2021. So there's people who own a home are sitting here and are kind of are fine. And it's the lower quartile or third of the economy that aren't homeowners, that are renters that are getting screwed by higher rates.

So just a thesis, because it sounds like you have what I'd call a more middle-of-the-road view of this, and that is that we have been fiscally irresponsible for the last 20, 30 years, both administrations or both sides of the aisle. And this latest quote-unquote tax cut, big tax bill, whatever you want to call it, looks like it's going to add somewhere between $4.5 trillion at the low end and there's other estimates that go much higher.

And that we appear to be at least – I don't know. People would argue we're moving towards a breaking point or at some point you just run out of room here and your cost to borrow go up, which impacts the cost of everything. And that this kind of lack of fiscal responsibility – again, and I'll assign blame to both sides –

But this at some point starts to create a downward spiral. That doesn't worry you about the state of the credit markets moving forward? I think it worries me. But you could have said the same thing at any point in the past five or 10 years. It's just been getting marginally worse. If you look at the situation Japan's been in for a long time, although they're more self-funded, their numbers are much worse than ours. So it's a question of when does the market care?

It's always been that question. We're single name credit investors, sector credit investors. We're thinking about telecom or software, healthcare, much less than we're thinking about where 30-year rates should be, frankly. But we are macro aware. And I think when we're thinking about credit markets and opportunities, where's the forseller?

And in around the tariffs and the long bond sell-off that you saw at the beginning of April post-liberation day, a lot of the forced selling was in rates. It wasn't in corporate credit at all. In fact, you had more buyers of higher quality corporate credit as yields went higher due to the rates moving higher because that spread was creating more and more opportunity. And what was interesting is we looked at it and we said, wow,

I can buy Amazon, Apple long bonds. Bonds that were issued in 2020 and 2021, so 2020, 2050 and 2051 maturities, that because they were issued rates were low, have three, three and a half percent coupons. And because of the duration and the higher rates now, they're trading at 55 cents on the dollar. So the forced selling of treasuries by levered entities, and I don't think it was that much foreign entities so much as levered domestic entities, is

led to the opportunity to buy really interesting credits where their spreads had gone from 80 spread to 120 spread. So your spread is 50% wider on

Apple or Amazon that has a better balance sheet than the US government, that was where we saw the dislocation. So we bought that paper, which had 5%, 6%, 7% current yield in the mid-50s, credit convexity and spread convexity. And that was a nice trade. It wasn't an investment. It was a short-term dislocation. I think the bigger question long-term is when do higher base rates flow into a negative impact on the economy? For baby boomers, they own their home. They were earning zero on their savings. Now they're earning five. That's been great for them.

It's been negative for people in the velocity of housing market and negative for people at the low end that aren't savers. But in terms of when does it matter, I'm not the right person to ask. We'll hopefully be prepared and can react, but we're not macro predictors on the interest rate side of it. At a very basic level, isn't it? I would think, and I'm talking your book a little bit now, but

I've always been all equities my entire life, which isn't a good idea, but I've never owned a bond until just a few years ago. That was a really good decision from 2010 to 2020, though. It was all intentional, right? Yeah, it's better to be lucky than good. I just don't understand credit markets. I understand stocks, or think I understand stocks. But it feels like for the first time in a while, you're getting paid for the risk to be in credit.

I'll just put that forward. Does that change? Have you seen way more inflows and interest in credit funds? You run a large credit fund. Have you seen a lot more interest as people are thinking, wow, I mean, for the first time, I'm happy to leave money in cash. I never thought I would say that. I leave a decent amount of money in cash now because I'm getting paid for it. Has there been...

a meaningful change in asset allocation across institutions and individuals? Sure. So the rate hiking cycle of 2022 was really the change of the Rubicon or the changing of the guard, where you went from wanting to be long tech stocks, private equity, things that had money multiple and really benefited with through multiple expansion from lower rates to being a yield

a yield receiver, a saver, a creditor, because you're getting paid a lot more for that. We've seen over the past three and a half years really increasing interest from all different types of investors and partners, be it a family office, a bank, a sovereign wealth fund, a pension, an endowment. Everyone's sitting there saying, "Wow, my pension was 20% underfunded, S&Ps at the highest, now it's funded."

So that's one type of person that says, okay, I can take that, put it into Apple long bonds at 6.5% or at 6%, and now I'm fine. I don't have to worry about the equity market. That's one constituency. And there's another constituency of people who have made a lot of money in equities, a little more worried about valuation, and are saying, where can I go for a little bit more of a safe yield opportunity? And obviously, private credit and the returns there, combined with the lack of volatility of that asset class, have drawn

drawn a lot of capital as well. So it's not just the base yield. It's been different types of yield products have really proliferated. And you've had smart players in the public alts world, be it an Apollo, a Blackstone or others, pushing a lot of that product out, not just to the institutional channel, but to the retail channel as well. Now that this credit downgrade has happened, I think everyone probably agrees that this is going to be, or at least directionally speaking, a good thing for high-grade corporate debt.

And, you know, I think investors are probably getting, you know, more and more wary of treasuries. And you talked there about how being invested in high-grade corporate bonds has paid. And there's one line that you said there where you said, you know, we're invested in Apple debt, for example.

and we feel better about the balance sheet of Apple than we do about the balance sheet of the United States of America. And we're getting paid more. To be clear, I feel pretty good about the U.S. balance sheet too, but in the Apple situation, there's no more asset-rich country in the world than the United States. But in the Apple situation, you've got a net cash position. So that's pretty incredible. And I think you're seeing over time the spread premium demanded to hold corporate risk versus treasuries.

Yes. Because there are investors who are looking at that and seeing a ratings compression between the corporates and the treasuries and also seeing a balance sheet situation where there's a lot of supply of long-dated treasuries and less supply of corporates. That's also leading to that spread compression. And I guess the question I would ask is how new is that? And I think for a lot of people listening to that,

at least for me, and I'm not an expert in the credit markets, but the sound of that, it sounds not good. I mean, it's an investment opportunity and that's something to note, but it sounds like not a great thing, this idea that actually the debt on these companies is actually more safe from a balance sheet perspective than the treasury market. And I guess I'm just wondering how new is that phenomenon now?

I think it's been a creeping thing as you've had the fiscal crowding out

private for the last 20 or 30 years. It's been creeping over time. Maybe it's becoming a little more acute now. And part of what I mentioned was the dollar price on those long duration bonds we were looking at is 55 cents on the dollar. So your claim is 100 and you're buying them at 55. So that's part of why it's such an interesting and compelling investment because you have a current yield and you have convexity. I think you've been in an environment for the

which is just how much carry can I make because volatility was low. Now you're in an environment where there's more realized volatility, whether it's through the tariff headlines, what's going on in the economy globally, some of the changes with the German fiscal, what's happening in Japan. So you want to have more convexity in your portfolio and maybe a little bit less carry. So that's why that investment was a focus for us. It was less about a view on the U.S. government versus any of those. Scott, can you define convexity?

What is the skew or payoff profile of the investment you own? So if you own a bond at par, let's just say, and it's callable at par, and callable means the company can call it away from you at par, the best you can do is get your coupon. So if it's a 5% coupon, the best you can do is 5%. It can only go down. Let's just say the interest rates, base rates right now are 4 and mid-4s. Let's say they go to 10%.

you're going to get that bond. You have no upside. It's going to go down. It's going to change. It's going to re-rate based on those base rates. On the opposite side of it, the Apple bond I was talking about or Amazon,

If that bond was issued in 2021 or 2020 when rates were very low and it's got a 3%, 3.5% coupon, but because rates have moved up, it's traded down on a dollar price basis. I'm buying at 55 cents on the dollar. So my current yield, just my cash on cash yield is 5%, 6%, 7%. I'm earning that. If base rates go up a lot,

That doesn't matter to me as much because my current yield is nice and I'm buying it at a low dollar price from a claim perspective. But if credit spreads tighten and if base rates go down, everyone's all, all we're talking about now is higher rates, but what if they go down?

I have a huge amount of convexity in that I have a positive credit spread yield, and I have spread convexity, I have spread tightening convexity, and I have interest rate convexity. All those things are in the right direction for me because I'm at a much lower price. I'm at essentially a bond floor or a recovery floor. Something we've been tracking is what appears to be sort of a reversal or a slowing of the flows of capital into the U.S. equity markets, and a lot of institutional investors have expressed that

Less interest in investing in U.S. equities and more interest in looking abroad, whether it's China or the EU or Latin America. What are the trends in terms of capital flows in and out of the U.S. credit markets? The historical valuation difference that exists between maybe U.S. equities and European equities or other parts of the world isn't the same in credit. First, the U.S. has the most developed credit market by far.

Let's say if Europe is second, it's still a bank-driven market. So you have a deeper, more developed capital market, better rule of law from a bankruptcy and creditor rights process. So if anything, the higher yields are bringing more capital in, not less. The situation where you can have a potential problem, and I think what you saw at the beginning of April was you had both the dollar selling off and rates moving up at the same time.

Some of the foreign investors own the US credit unhedged. So if you have rates moving up, that means their bond prices are going down and you have the dollar selling off, they're losing on both sides.

That can lead to a nasty spiral. And that's part of why I think you saw a change in behavior by the U.S. government in terms of reacting to that spiral that was happening where you had weaker dollar and higher rates. What they really, I think, want is weaker dollar and lower rates. And which sectors do you find convexity or dislocation? Is it based on the sector, the individual performance of the name, or do you see certain trends? Right.

Right now, it's pretty rich with forward opportunity, if you think about it. When I started, telecom was going through a big bust. You had all the commercial fiber had been built out, and the first things we were trading in 2002 were Global Crossing, Level 3, WorldCom, and some of the same investments now. We're still trading Level 3, and there's still too much commercial fiber, but guess what? Now you have AI.

And that all these data centers are getting built. And when the information needs to leave the data center, when you move from training, where the chips are all talking to each other in the data center and learning from each other, to inference, where we're using our phone or our computer to use the model, it's got to go on the commercial fiber or over the airwaves. So the demand for commercial fiber is going to go up a lot. That's been a huge opportunity in...

the distressed or formerly distressed debt of level three, which is now performing debt. I think it will lead to a big opportunity too in the spectrum space where you're going to see a huge ramp in demand for spectrum. Some of the owners, you think about 10 years ago, Sprint was distressed. And then Sprint was spectrum rich, turned out as we went from 1G to 2G to 3G to 4G to 5G,

There was more spectrum needed. You're going to be in the same situation. You're going to have probably a 4 to 10x increase in demand for mobile data over the next five years, let's call it, as you go from AI training to inference, whether it's us using it on our phones or robots, cars, other sort of edge AI needs, that

that mobile data increase is going to leave people short spectrum. So the companies that own spectrum, some of which are in the public credit market, could be big beneficiaries of that. So that's one theme. I think the biggest theme we like to think about is who's a for-seller, who needs capital. Part of that has been banks at times have been for-sellers. Post

Post-GFC, they've put themselves much less in that position. That's been the growth of private credit. So right now, some of the forced

sellers or the people that need capital from a company perspective, our company is impacted by tariffs. So we did a first lien deal that we worked with Morgan Stanley on a couple of weeks ago for Kohl's, which is a retailer that sources a lot of their goods in China, but they have a lot of really good distribution center networks. So we did a financing that we leaned up the distribution centers

and got a really nice piece of paper. So those opportunities I think are coming. We're getting calls every day from companies that need capital. I would say they're less acute now than maybe they were 10,

10 days ago, pre the change in the China policy. But I think that need of capital, as there's A, uncertainty, and B, changes in the way companies are earning money, changes in their supply chains, is only going to increase. So that's an exciting opportunity for all of our products, whether it's the hedge fund, the drawdown fund, or some of the private credit businesses. Stay with us.

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Scott, I learned that Diameter was one of the first buyers, or I think the first buyer of the Twitter debt when Elon took over Twitter and renamed it X. Could you take us through what happened there? What was the investment thesis? How did you wind up buying that debt and how has it all played out?

So I think Elon bought Twitter, I want to say mid-2022. So he's owned it now for about three years. And Morgan Stanley was the lead bank to finance it, but there were other banks involved as well. The $12 billion financing package. Usually banks would syndicate that package.

But because of what happened in the credit markets in 2022, higher rates, credit markets selling off at the time they announced the deal, and then an advertiser reaction to Elon owning it that was negative, including, I think I looked today, Scott's last tweet was at some point in 2023. The revenue went down and the banks said, we're going to hold the paper. We're confident it's covered, but we don't want to sell it at a discount to PARP.

Fast forward two and a half years, we're tracking the data just like an equity fund would track how many subscribers Meta has or Instagram had. You can track that data for X. And we're seeing that in the back half of 2024, especially in the last quarter, those subscribers are starting to return.

It looks like the ad dollars are starting to return. So we dug into the business a bit more. The premium users, which were basically nothing when Elon bought it, are now close to 3 million. He had cut, I think, 75% of the employees, taking CapEx from a billion to 70 million a year. And EBITDA, which was around a billion five when he bought it,

is right about that, if not a little higher right now. So he's turned the business around by cutting costs, changing the earnings, the revenue model. And if you think about what the debt might be worth, we were looking at the debt, the first lien debt at the time when we were looking at buy earlier in the year was about a $10 billion tranche with a coupon around 11%. And the bank's

We're looking for a couple people for a proof of concept to buy 500 million each. It was, I think, us and one other fund that publicly bought it. And we said, okay, what's the right price for this debt? If it's 10 billion and you've got that billion five of EBITDA, let's call it. So let quote unquote leverage would be around six times. They also own a stake in XAI, we learned. Because X chips were used to incubate XAI.

And XAI at that time was raising capital at $50 billion, so they owned a 12% stake in XAI. So we've got the $1.5 billion of EBITDA on X, which we think is worth a lot more than the six times terms of leverage. Snap trades at 20 times. So if you put a 20 times multiple on X, that's high 20s, $30 billion, plus their 12% stake in XAI, which at the time was worth another $6 billion. You've got $10 billion of debt.

then your loan to value or your debt versus the total value of the enterprise look like something like 25%, 20% to 30%. And in the market, 20% to 30% loan to value debt at that time, a few months ago, was trading at call it 7% to 8%. Because of the uncertainty, the amount the banks own, we were able to buy it around a 13.5%, 14% yield. We thought we were getting really

a lot of compensation for the excess spread there. Now that debt trades at par, they since merged with XAI and the numbers have continued to improve. Other people have bought the debt from the bank since trading more liquidly. But we think as a creditor,

It's a really good business and Elon's done a nice job with it. And the public comps obviously trade at high multiples, which would make us feel really good about that valuation that we bought it at. And that's been a great trade for you now. So far, yeah. But still in it. Excited about the future. We talk a lot about how to be a great stock investor on this show.

And you've been very successful as a credit investor. I'm just wondering, what do you think are the characteristics of a great credit investor? And does it differ from being a great stock investor? Are there differences there?

between those two games and what do they look like? Great question. The great stock investors over the past 15 years have done much better than we have in credit. We've been earning our coupon. Now maybe it's our time to shine. But equity investors are thinking about what is this business? How can I create a multiple on this business? There was a really interesting podcast that Patrick O'Shaughnessy did with my friend Neil Mehta a couple of weeks ago where Neil talked about trying to find the next

S&P 500 company. He's really thinking about which companies can he invest in at the venture or growth stage that can be hundreds of billion, trillion dollar companies. We're just thinking about, is this company going to pay us back? So the credit investor is much more focused on downside protection, legal protections, where the business is going, yes, over the next 12, 18, 24 months, not necessarily trying to earn a money multiple of return on

on their performing credit. Now, there are opportunities, like I mentioned, level three, that was at 30 cents on the dollar. We figured out there was going to be a big AI winner. The debt's now near par. So you've had a two, three, four X money opportunity there. But that's not the everyday opportunity in credit. Credit is much more about avoiding mistakes and loss avoidance. You think about the people who've done really well in credit, it's those who have never

not made mistakes. And I actually think that that lends itself more to learning from macro people. The guys that are really well in equities are the ones that picked on mega trends, you know, mag seven, big tech software,

Internet, a lot of things Scott's been talking about for the past 15 years. In credit, one of the first jobs I had was working for Paul Jones and John McFarlane at Tudor one summer in college. And the shark I have behind me is kind of in honor of Paul because he had a big shark on the trading floor there. And my son's a big shark fan. But a lot of what I learned from him was if you think you're wrong or something's changing in your thesis, sell. And that has trained me to be a fast seller.

So if something changes in our view, something changes in the macro that changes the way a company earns or underlying earnings power that company, we get out, especially if it's par debt. We talked about convexity. A lot of the things you might own in a par debt fund, you're owing for your coupon, not because you think the price is going to appreciate. So if your base case is coupon and something's changing that could be negative for that business, you want to sell.

We tend to think much more from a total return perspective than a yield perspective. So we're always trying to think much, be much more forward looking, hopefully than the average person in credit markets who are more focused on that coupon. And that makes it a little more proactive seller when things are changing in the markets, either macro or micro. And I guess, so my question would be, what are the signs that

forced sales? How do you know that there are people who are, I guess, as Warren Buffett would say, who are getting fearful when you could be greedy? How do you recognize that? What's the liability structure of the asset owner? And I think this is something that has

has changed a lot in credit markets for the better over the past 15 years. And that if you look back 15 or 20 years ago, a lot of say the high yield market was owned by mutual funds that had daily liabilities. I could take my money out every day. So, but the underlying asset

They might own $100 million or $200 million of some bond that trades $5 million a day, and they're getting an outflow. And so they have to go and pay a lot of bid offer to exit that position. Now there's more longer-dated liability structures, locked-up money, a lot more drawdown capital that can take advantage of those opportunities. But the banks who are the intermediaries –

are taking less risk in that business. They're taking risk in the origination business, not the secondary trading business, which means that there is an opportunity when there are four sellers, whether it's an ETF that has to sell because there's just a natural arbitrage or somebody's withdrawing money for that ETF or a mutual fund that has to sell or has to buy.

You can have forced sellers or forced buyers. So that's every day in the credit markets. And because it's an OTC market versus the bonds trade by appointment versus trading every penny like Google stock or Amazon stock would, that creates an opportunity every day in small size. And then as you move towards the extremes when volatility is higher, there are structures, be it a CLO. What can cause a CLO to have to sell something? Ratings downgrade.

Usually you can see those things coming. We talked about ratings agencies tend to be slow moving and late. So if you're proactive and forward looking, you can foresee those downgrades and be ready so that when there's a forced seller from a CLO, you can buy it from them at an attractive price, provide them that liquidity to buy an interesting asset. What else might make somebody sell? A downgrade for

for a pension or an insurance fund that owns only investment grade debt. If it gets downgraded to high yield, they might have to sell. So the credit markets are very rules-based.

liability structure, what's the duration, what's the sector, what's the rating. And every rating you have from triple C to triple A, every notch you go up, there's more buyers by rule. Every notch you go down, there's less buyers by rule in corporate credit. So understanding who the buyers are at each notch along the way and what yield or spread they'll demand can allow you to learn about those things. What else creates for sellers? Volatility.

So who are the levered players when there's high volatility? In early April, the most levered people were CTAs, trend followers, risk parity. They had to sell treasuries and stocks. You didn't have a situation yet where credit entities were necessarily for sellers in the same way because the economy is doing well. You haven't had a lot of defaults.

But we hunt around and we like to find those opportunities. And I think that the credit market now has, there's a lot of people investing in private credit, chasing private credit. You haven't seen any real force selling there. It's been a great asset class to be in. But there are bubbles within it building up a little bit. And that you have like almost a third of the private credit right now is software.

or tech-related loans. And typically when we've had a large percentage of the left-fin market become one sector, you think about energy in the mid-2010s, eventually there's a problem because people do unnatural things when they're exposing themselves that much to one sector. For a regular investor, for a retail investor listening to this podcast, mostly thinks about stocks, mostly thinks about equity, hears you, they'd like to diversify into credit, where would you recommend you start? Yeah.

There's plenty of ETFs. LQD is the investment grade ETF. HYG is the high yield ETF. And BKLN is the bank loan ETF. Those are simple products that you can trade every day with low fees. If you want to go into the alternative, there's us and then many others that have products across hedge funds, private credit, CLOs. There's active management and passive management. I do think that

partnering with active managers who could take advantage of some of the sectoral dislocations we're talking about, some of the volatility we're talking about on a go-forward basis is the right way to invest in credit because you do want people who can capture that convexity versus just sitting and waiting on carry. My final question, I learned that you are on the board of the U.S. national soccer team. I am a huge soccer fan, football fan. Scott is a budding soccer fan.

My question to you before we wrap here, when is the USA men's team going to get any good? Let's hope it's soon. One year, right? We've got the World Cup coming up next year. I've got dinner with the coach, with Mauricio next week in New York. What are the prospects looking like? Because I know the women's team has been incredible. Everyone keeps on saying the men's team is going to pop off.

and they keep on underperforming. What's happening? So U.S. Soccer had a really interesting person, JT Batson, who's a former software executive and soccer player, take over as CEO a few years ago. And his view was you had to reform not just the development process, which I've lived with my kids, Scott's lived with his kids in South Florida, which is not, you know, the youth structure in the U.S. needs work. Right.

To say the least. Just got now experienced it in the UK. It's much better in the UK. There's tons of free clubs. There's high-end coaching. You get bullied if you don't play. Yeah. Yes. And there's only one sport or one and a half sports. Here, there's a lot of sports. So JT hired for the women's program, Emma Hayes, probably the top women's coach in the world.

And the women's program has elite talent. Historically, they've had between five and 15 of the top 50 players in the world and maybe 20 of the top 100, although Spain and others are catching up. The men's team typically has maybe one of the top 100 players in the world, if that. So women's team has a bigger talent base. Title IX really put the U.S. ahead of everyone else when it came to women's sports. And now we have the top coach in the world. And it was a women's team that maybe needed a culture change. They go and win the Olympics.

So in trying to do the same thing on the men's side, where you had a need for a culture change, a need for a new voice, JT and his team brought in Mauricio Pocatino, who's a top 10 global coach. And now Mauricio has something called Grinta, which is an Argentine word for grit. And I think part of what the U.S. men's team has been lacking is that grit, that intensity. And one thing he said to me, it was an interesting conversation. He said, when I played for Argentina,

If I was playing in a friendly game, so let's say Argentina was playing, there was a national team camp, they were playing a friendly game against one of the club teams in Argentina. Or I was playing in the World Cup final, same attitude for Messi. We play the same, same intensity. And that's not necessarily been true, I don't think, about the American team on the men's side. So instilling that mentality of belief, grit,

hustle, heart is important. And hopefully that will lead to better results next summer. The gold cup's coming up in a month. So let's see. I wish you luck. Scott Goodwin is the co-founder and managing partner of Diameter Capital Partners, an alternative asset manager focused on the global credit markets. Prior to founding Diameter, Scott worked with Anchorage Capital Group as a portfolio manager and the global head of trading. He also spent eight years with Citigroup serving as head of high yield bond and credit default swap trading.

Scott currently also serves on the Leadership Advisory Board for U.S. Soccer. Scott, this was great, and it's good to hear that you're bullish on Team USA. Ed and Scott, thanks so much for having me. It's a real privilege. When I first got on Mike and the Mad Dog, after being a longtime listener as a kid, this is a similar moment for me. So it's really nice to be on with you guys. That's the first time anyone has ever used that analogy, but thank you.

This episode was produced by Claire Miller and engineered by Benjamin Spencer. Our associate producer is Alison Weiss. Mia Silverio is our research lead. Isabella Kinsel is our research associate. Dan Chalon is our intern. Drew Burrows is our technical director. And Catherine Dillon is our executive producer. Thank you for listening to Profity Markets from the Vox Media Podcast Network. If you liked what you heard, give us a follow and join us for a fresh take on markets on Monday.

So I went on ChatGPT while you were talking. Okay. And I typed in, if Scott Galloway was a sperm donor, what would the attributes of his children be? And it came out. This is what I got back. True story. Did this while you were talking. One, came out of the womb quoting EBITDA.

Six pack of abs by age six. We like that. Started a podcast from the womb. Emotionally unavailable, financially literate. There we go. Calls other toddlers unscalable. Already worried about loneliness at age three. Self cancels before kindergarten. Height 6'3", confidence 6'10", therapy bills $3,000 a month. That's amazing. AI, it's taken over. That was pretty good.