Is Private Credit a Systemic Risk? (A Regulator’s View) | Fabio Natalucci
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The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough. Thank you. Let's close this f***ing door.

Today, I'm speaking to Fabio Natalucci, Managing Director and CEO of the Anderson Institute for Finance and Economics. Fabio brings over two decades in public and international finance with senior roles at the Federal Reserve Board, the U.S. Treasury, and most recently, the IMF. Fabio, welcome to Monetary Matters. Thank you so much for having me. It's a pleasure to be here.

The pleasure is all mine. Fabio, it's my understanding that you've spent a while doing a deep dive into the world of leveraged finance, the world of funding high finance deals on Wall Street. This is the junk bond market in the 1980s. Right now, it looks something very different. It goes by a

The IMF put out a phenomenal report a year ago, April 2024, just about this asset class, which is really transforming Wall Street and our economy, frankly. Tell us your intro into the world of private credit through your eyes. First of all, again, thank you for having me. It's a real pleasure.

We started looking into private credit. It was a natural evolution from the work I had done when I was still at the Fed on leverage finance during the GFC back in 2007, 2008. I think one striking feature is the growth of the asset class. It's reached, including ViPath, about $1.7 trillion back when we did the report in 2024. Most of it is in DOS, and it's part of this

I would say market structure change that we have seen in a way this intermediation essentially with banking sector to what we call non-bank financial intermediaries.

The idea was, the simple question was, is the sheer size of the sector enough to make it an issue for financial stability? So there are not many data to use to do this work. We used the commercial data that were available, but I think it was also a journey to try to understand the asset class, just spending a lot of time in New York City meeting with people, both on the banking side, as well as the asset manager, just the manager side. We came out with some sort of like a framing to think about private credit.

where could vulnerabilities could be, whether it would be the asset class as a percent of say, its quality, what kind of liquidity risk there could be, leverage, interconnectedness. I think in terms of liquidity, I think for the most part, we came away relatively pre-lead in the sense that

liquidity's risk seems to be with one exception and discussed later limited because most of the investors into this private credit funds have a long investment maturity you can run essentially the run risk that you would see the bank it's very limited

with the exception of the deep the expansion into retail leverage we spend a lot of time talking some of this on the borrower side as well as the lender side the banks in the end um sort of there are no numbers obviously you can look at bdc's to get a number that's a very specific subset

My takeaway was that everyone uses some leverage, but it's not a significant amount per CID. The concern, if anything, was the layering of leverage. How much the actual firm borrowing the market employ leverage. Those, again, those are either unrated or high-yield software firms, so sub-investment grade. Then there is the leverage potentially employed by the credit funds and then potentially the investors. So it's the layering that was the more complicated part. It takes me to the interconnect response.

If you do, I put together a panel in early January in New York, trying to replicate the ecosystem. And once you start inviting and looking at who has a role in this ecosystem, you have the private credit funds, you have insurance companies, investors, pension funds, banks. So very quickly start bringing in all the major players in the financial system. So do we have a good sense of where the risks are?

There are not many data. That's the downside is that you can't really monitor, particularly the cross-border integration. Some of the large US private credit funds play also in Europe, for example. So that was the assessment. I think since then, I will note a couple of things. One is the big question is if the US economy slows, if we go into either a significant slowdown or a recession,

how will the asset class perform? I don't think we have any... You can't really look back. If you go through our business cycle, the sector was very small. So it was never to a potential slowdown in the current size. So we don't really know how the sector per se will perform.

There's a lot of focus on markets on, for example, the PIX usage rates or numbers like 25, 30% of PIX being used. I'll be careful in how to interpret those. In some cases, I think they are okay. They're a natural tool to where you manage. It depends in which sector, whether they were part of the original contract, whether they were added later. But that's one metric some people are looking at. The other one is the share of firms that, for example, have negative earnings.

So, that's a starting point. If the economy slows, how would the asset quality of the asset class perform? I think that's one. The second concern that I mentioned perhaps before is this evolution of the asset class. In some sense, at some point, you cannot continue to grow at this growth rate and stay within corporate loans. You run out of, essentially, corporate loans.

So the sector seems to be evolving around two dimensions. One is expanding to other asset class, for example, real estate, for example, infrastructure or consumer credit, where anything that is asset-based finance that you can securitize. Plus, how to asset like infrastructure, lots of demands for data center, renewables. The other, and those I see them as positive revolution of the after class, obviously,

need to be careful if you start putting together funds that invest in a bunch of things that have very different liquidity, time horizon type of investors. The other dimension of the evolution is toward different types of investors, beyond these more sophisticated investors. Try to bring in retail investors, lots of discussion and go straight on bringing in retirement money, for example.

I think on the retail, I'm much more concerned because in the end, if you think about a different phone and there's a number of deals or possible lines that's been announced, whether this is KKR and the Cavito Group, they just announced they're offering two funds. The threshold to get in is very low. It's $1,000. So you really just reach out to the retail companies

other agreements between Blackstone, Vanguard and Wellington, for example, or Apollo and State Street offering ETFs. There are different forms. You go from ETF to mixing debt, public and private debt with specific share to perhaps the broader portfolio blended approach where you access different funds that invest in different asset classes. Perhaps that's the future we're headed. To me, at some point,

this starts smelling like banking business. You take on money that, yes, maybe you can only withdraw once a quarter, maybe there are gains. They start more and more looking like deposit, especially if the expectation of a retail investor going in is that you have some degree of liquidity.

Liquidity that you may have in normal times, but as the asset class grows, managing that liquidity becomes more challenging and at times of stress. So if you start raising gains in times of stress, I don't know how much retail investors are going into the asset class with that expectation. Then you have more illiquid loans on the asset side. So it does smell a little bit like banking at some point.

With two issues. One is there is no deposit insurance on the liability side, if you will. And there is no lender of loss resort. No access to the discount window, effectively. So that's the part that I think is worth keeping an eye on. The PIX is payment in kind. So lenders, private credit lenders being paid in more debt instead of being paid in an actual...

And these companies, these loans have generally been to corporate loans, but specifically buyouts. So a private equity company that buys a firm is going to borrow money. It used to borrow money in the high yield bond market. Now it's borrowing money in the private credit market. Fabio, one chart I loved from the report last year was just the share of companies who do private credit who also do private equity. And

It really is quite connected. They're kind of lending to each other, aren't they? I have an alternative asset management firm and you have an alternative asset management firm and my private credit arm lends to your private equity businesses and your private credit firm lends to my private equity business. Are you worried about that interconnectedness? Yeah, so I didn't mention that. I was going to mention the interconnectedness and I can add a piece to that, which is also if you own an insurance company, like some of these companies

groups do, some 100%, some majority or minority stakes. They also seem to run in a very different way. Some firms would not, if you want, commingle, if you want to use that word, would not use some of the money coming from the insurance business and go straight into some other business. They will outsource some way. Some other firms, they manage more as one group. I think it's important to

to think about in some sense how much of like how this is that this risk of interconnections are being one molecule from the public sector. And again, it's very difficult to do a risk mapping primarily because of lack of data. Another issue with

difficulty in assessing risk is that a lot of this asset, a big chunk of the asset class doesn't reprice effectively. Right. Or gets repriced, say, I don't know, once a quarter, they may use third party to reprice. The lack of pricing, which is a feature of the early days of the asset class, as you get much larger, as you start bringing in more liquidity savvy or liquidity dependent, like retail investors, that lack of pricing increases.

can be okay, I think, in normal times if it allows you a bridge to restructure some of the debt. So that's always been sold as a positive.

I think the issue arises if you have either a deep recession or you have a more system-wide need for liquidity. The lack of pricing, and you've seen at some point in real estate, in the rates, the publicly traded rates and non-publicly traded, you see an opening gap in terms of pricing. So if it's a short blip, essentially, I think the risks are limited. If it's just a prolonged slowdown, eventually that delay in pricing of risk will catch up with you.

When it does, it could become non-linear. Once you mark it, everyone else is going to start marking it, and it's going to start marking very quickly. As the asset class grows in size, I think some of this risk will become the interconnectedness and some of this vulnerability becomes much more difficult to assess and to manage.

And the growth has been enormous in 2008 when we had the last financial crisis. I think it was $100 billion or less in the industry. Now, as you said, $1.7 trillion. I think if you include leverage, it's more. And again, this is a year ago, so it is higher. And if you look through these companies, investor decks, Apollo, Aries, they say it's a $40 trillion investable, total addressable market. So they're not happy with $1 trillion or $2 trillion. They're

They're expanding to other asset classes, right? We can go into infrastructure, into real estate, into the asset-based finance. Again, I think there are positives. That's what we are trying to do in the report. Highlight there are benefits for the borrower, I think, because of kind of service you get, and there are benefits for the investor themselves. One trend to follow that would be interesting to see is how the competitiveness

flash partnership between banks and private credit funds is going to play out. There were assumptions that the Trump administration would accelerate on the regulatory drive. And if that happens, I think one question is whether banks are going to try, if the cost of capital for banks' balance sheet will decline because of less regulation, whether banks are going to try to take back some of their business or the partnership that they were investing on in the

capital up to, say, last year. Whether those will continue in the same form or shape or with the competitiveness, we come back a little bit. I think that's an interesting dynamics to follow that may also affect how quickly and where the sector may be headed. Right. So what private credit does used to be done by banks, but after the great financial crisis, there was a lot of regulation that made it very expensive from a capital point of view to do this activity. So that's been rocket fuel for the non-bank private

private credit, alternative asset management world. That's why it's grown so much. Fabio, are you a believer in the argument that fundamentally it is a good thing that these risks are not outside of the banking sector? We'll get to your point later on that the non-bank sector is increasingly starting to look like the bank sector. But fundamentally, before we even get there, do you think that it is a safer, more sound financial system that these risks are outside the banking system?

Okay, so I think there's two parts to the answer. I think one, in principle, yes, to the extent that you diverse and disperse risk in different parts of the financial system that have different risk appetite, different ability to deal with risk, different investment horizon, different liquidity stress, for example. I think that's a positive. So diversifying the funding source in general as a principle from a financial stability perspective, I think is a plus. The second part to the answer is yes.

To what extent this risk is really diversified away from the banks? So, for example, is that risk simply coming back from the back door to the banking sector? One example often people offer is, okay, take a hypothetical bank that will make 100 loans. That bank decides that instead it's going to be private credit doing these 100 loans, and then they take these 100 loans, they make a portfolio, they come back to the bank and they borrow against these loans.

From an economic standpoint, it's still the banks that are lending against those loans. The first case was directly, they would just sit on their balance sheet and hire capital charges. In the second case, the loans are made by the private credit funds and then the private credit funds borrow collateralized from the banks. And the banks get a better capital charge because it's a portfolio.

kind of lending. Economically, it's not that different. This is just an example. I think the point is to the extent that some of these risks, they appear to have been pushed to different corners of the system, but in the end, they come back to the banking system anyway. Leverage is an example. To the extent that banks provide services, they underwrite some of this activity.

there is an incentive for the bank themselves to keep the business going, right? Because the fees caps, essentially you go from a balance sheet business to a fee business, originated to be silly. It used to be in leverage finance, but it's a senior concept.

I think it's okay and it's a positive to have more diverse funding sources. You just want to be able that you actually, one, able to monitor where the risk goes, that you're able to actually price those risks, and that they don't come back from the back door of the banking system where the regulators and supervisors have less visibility. Then I think we are worth top at that point. And a world in which the only investors in private credit are

people who are supposed to be able to handle it, institutional investors, pension funds, insurance companies, endowments, high net worth individuals. That world is

what does a financial crisis to private credit look like? Do they begin pulling their money? And is that different from a world where we're moving to where now retail investors and through the wealth management channel are getting involved? And also, is there any evidence, Fabio, from March and April 2020, when in the public markets, the volatility and the market chaos was very evident, even in the safest market in the world, the US government bond market? Any anecdote, anything you saw from private credit? Or is that even...

Is that so opaque that even to you at the IMF, it was unable to be determined? All right. So let me answer maybe the second question first. I think back then there were evidence of positive but also risk.

The positive was, and I spent a lot of time trying to, there were no data, right? So the question that we had was like, okay, if banks stop lending, will someone else jump in and continue to provide credit or will the economy come to a complete halt? Like that was the March, April 2020 point.

My sense was that some of these players in private credit, they did in fact extend credit. They did provide a bridge. So I spoke to some of those, and I'm not going to go into the names, obviously, but the idea was that you could actually...

borrow from them. If you were like, I don't know, an SME, if you were the gym, you have to have some activity or even if you are a larger company, you'd be able to learn in different form. It could be senior debt, could be junior debt, could be preferred equity. It was expensive to borrow those rates. They were double digit rates, but it did work as a bridge.

toward the future. Now, of course, the bridge only takes as far as at some point somewhere where the bridge can land. So I think there

Worked because at some point then in April the Fed jumped in and not only did they get the traditional QE, but they effectively backstopped a number of markets. They went as far beyond investment grade corporate bonds to high yield and even high yield ETFs. Whether they actually purchased those or not, the announcement effect was huge and market turned around. So the bridge worked, but because then in second step, there was the Fed essentially backstopping the full financial system, broadly speaking.

So I'll be careful in not overplaying the role that they played in preventing a depression, of course, because everyone benefited from the entire market. On the first question, on the more institutional investor, I think they bring a different investment horizon. There is no run when you put money into the money. It's committed for a number of years, like five, 10 years. You have a different investment horizon, not just in terms of run risk, but also in terms of expected returns. You can be more patient.

That doesn't mean, obviously, that if there is a deep recession, that setup of the institution investor has no implication. So take an extreme where one of the institution investors' money invests in one of these private credit funds and they withdraw, whether because you are an insurance company, someone called the policy bank, or they withdraw from there as an institution investor. If you can't take the money out from private markets, you may be forced to sell whatever else you have that is liquid, whether this is

corporate bonds, for example, whether this is treasury. So you could see a situation where in a deep protracted economic downturn that you may be forced to sell something else because you cannot take the liquidity. So that may reinvents the

the sector itself, but that doesn't mean in principle that they couldn't be spillover to public markets or higher credit quality market simply because you can't take the money out, you're forced to sell something else. Now let's talk about the liquidity and the run risk. The argument is if the money is locked up for five years or seven years, you can't pull the money. There can't be a bank run like there was on Lehman Brothers, for example.

Tell us about this. Has there been an erosion in the illiquidity of the asset? And again, people listening, they think liquidity is a good thing. But from a financial regulator point of view, if people can pull their money, that actually makes the financial report less stable. So tell us, are things getting a little bit more liquid? Talk about the interval funds. Talk about the ETFs, the new things that are being launched, as well as the rise of secondary markets.

Okay, so let me start with the secondary market. I think the secondary market is a positive, right? Because it allows to generate market-driven liquidity that comes with the price. So, ability to exit some of this position. And I can think of secondary market going two different dimensions. One where a private credit fund may be able to sell some of the holdings and generate liquidity if needed.

or private credit, secondary market liquidity as an investor, an institutional investor being able essentially to transfer their position into private credit funds. I think liquidity for me and market pricing, it's always a plus. I know sometimes it's not a popular argument, but marking price where risk is, you take information, right? This is the information signaling of pricing.

Sometimes they overshoot, obviously, but it's important to have those. The idea that things don't move because there's no market to market, that's an illusory stability. Eventually, at some point, price will move. So having some benchmarking is important. I think the concern with these different forms of retail investor is that it's unclear to me whether the perception of retail investor putting money into his products

They perceive, and I'm going to simplify here, essentially this investment as an ATM with a much higher yield, where I can go in and out whenever I need to. They will tell you, maybe they'll tell you that you can only withdraw money quarterly, that 10% limits on how much money you can take. In normal times, that might not be binding. You might not want to get the money back. So 10% might be binding.

a manageable threshold where you manage your own liquidity. My concern is at times of stress, particularly if this becomes very large. When we did the report, the investment into these retail funds was about $100 billion of these products where retail have access to. What is going on most recently, those are different products. Whether we talk about a KKR and Capital Group, two funds, $1,000 to get in, where you bring in public and private,

asset to the most to the ETFs version we trades daily.

to the most complicated version of this portfolio blended approach where you can actually invest in different funds. They might actually have different underlying classes. So it's the combination of the moving away from corporate bonds, from corporate loans into more either illiquid long duration assets like infrastructure, as an example, or more esoteric structure, where there is asset-based finance that's like more securitization type

structure with different correlation embedded into it with the liquidity drain that if the retail sector grows could actually generate. So if you want, it's the combo of the move toward more potentially less liquid assets at the same time as which you are, I don't want to use the word promising, but you are selling products that at least may be perceived by the investor themselves as offering high frequency liquidity. It's the combo of the two.

which I think may potentially in a serious stress time, you start having this, it's very hard to assess at that point, liquidity risk, how much leverage is used, what are the interconnectedness, particularly because there's not many data. So this blurring line between public and private essentially, at some point, either it becomes closer to the publicly traded assets, which means it will require more transparency, more market pricing.

at a higher frequency, or it will try to stay more into the private. Not everyone agrees in the expansion to retail, for example. Some market participants view is if you go in that direction, then the line again between public and private, you're going to investor protection. There's a number of other concern that comes up and eventually we might actually lose what is where the important feature of private credit or private market. So there are a variety of views out there on how to manage this and what the risks are.

And talk to me about the leverage within the private markets, uh, um,

within private credit, you've got a table showing debt to equity ratios for closed ended funds, then BDCs, business development companies, which is a way of permanent capital companies issue basically a public company, and then CLOs, which have a much higher debt to equity ratio, but there's no rollover risk. So I think when I first heard about private credit, the way it was described was that it had almost no leverage

But that's changing, right? Now, most private credit funds have leverage now, right? And also, what is the term structure within there? What's the rollover risk there? Are they borrowing from JP Morgan overnight? Probably not. Are they borrowing for three months, one year? How much is the debt locked up? We talked about the equity. How much is the debt locked up for? Okay. So again, I think there's three types of leverage here. And again, it's the layering of these three different types of leverage that was our focus.

One is, and that maybe is the simplest one, is the actual firm that is borrowing private market. That firm tends to be sub-investment grade, more levered than other larger firms. So that's easy to do, though. That's a more simple way. It's easier to assess the leverage, right? The lender there, who are the private credit funds, has a sense, has numbers to see how much leverage the firm is using.

Then there is, let me go to the other extreme, the investor itself. That investor, whether this is an institution investor that, for example, use derivatives, or whether this is, once you move into the retail investor, you can imagine that there is margin debt. If I can get exposure to this through my brokerage account, eventually I would be also margin debt. So there might be some leverage there.

with the investor themselves, whether this is a sophisticated investor or retail investor. And then there is the leverage within this kind of fund and what type. My sense when we did the report was that the most typical one is borrowing as a private credit, you borrow from a bank. A bank where you borrow against a portfolio of loans is usually over collateralized, which means the value of the portfolio is larger than the loan. So the loan to value is less than one, say 50%.

So the argument from the bank side used to be there is a lot of collateral there. We do say price this portfolio quarterly and we use third party agent to do that. So there's a lot of buffer, essentially, if prices are moving quickly. Pricing quarterly versus higher frequency, it's a plus again in normal times. To me, it remains a little bit of concern. Prices are going down quickly.

That's one. The other form of leverage is often they have lines of credit, more plainly lines of credit.

And then there is, you can actually borrow against, for example, the committed lines, right? So if an institutional investor commits 100 and the call capital is, say, 50, you can actually put together these commitment calls and borrow against those from a bank. Those, my understanding, tend to be much more shorter term and it's more like sort of like, I don't want to use the word working capital, but a short-term kind of borrowing.

Those are the types of levels. Now, you mentioned something else. You mentioned CLOs. You start seeing stories where there are CLOs, they're all private assets on the asset side, if you want to balance it.

CLOs are much more highly leveraged structure, right? That's leverage embedded into a CLO itself. So you can see quickly how you go from the leverage of the firm, the leverage of the structure, then you have a prior credit fund. So all this layering individually, they might not be a major issue, but one, the lack of data.

very hard to have a risk mapping and aggregate assessment of this. Two, the delay in pricing. Even if it's collateralized, if you don't mark, if the collateral moves fast, you might get close to the point where it actually starts getting more dangerous. And then three, there's different types of leverage and you can't simply accumulate. So lack of visibility,

not frequent pricing, plus different types of leverage layering on top of each other. That was the concern that we were trying to highlight. And lastly, the cross-border piece. Some of the largest players in the US are actually large players also in Europe. So there is a cross-border aspect to that that it's often not really considered. It's mostly a US phenomenon. Mostly this is about Europe and the UK, the cross-border aspect.

But those are even less visible if you want than within the US one. Just how cross border is it? I know during the great financial crisis, and again, I'm not predicting anything. I'm just saying that, I'm just making an analogy that there were some definitely geopolitical issues because China and Asia and Europe owned so much of US subprime mortgages. How much of the European fixed income institutional investor world is invested in these types of products?

So I think so far, and we had a couple of charts back last year, US asset managers that are lenders in Europe. So this is not very complicated, right? This is one of the big names in the US that lends funds that actually lend to European firms. It can become a spillover effect. It says there is stress in the US and they decide to reduce lending to European firms, right? That's one way of...

spilling over like credit availability concerns from the US to Europe. I don't think it's as complicated. One is less broad. This is not the subprime that was scattered all over the world. This is mostly again, the US, Europe and UK.

There is something in Asia, but I think my sense is that what it prior created there primarily is essentially a structuring business, which is a very different kind of business than direct lending that we are discussing here. Fabio, several times throughout this conversation, you've used the term investment grade. And I think of Mark Rowan, the CEO of Apollo, who is a very intelligent person and a skilled entrepreneur. He's talked about how

a very large percentage, I think over 95% of the health insurance company that Apollo owns, Athene, has 95% of their assets are investment grade. Talk about this so-called investment grade. And OK, I understand if there's risky loans to risky companies, people understand that they're risky and that's fine. But what about these so-called investment

investment-grade private assets, what does that mean as well as people kind of pitching private credit as something that can be safe? And also, like, investment-grade says who? Moody's? Like, and based on what, you know? Yeah, so two things here. One is, so we did some work there separate from the global financial stability chapter. There was a previous December, a note that some other people working at the fund put out on what we call private equity linked insurance. We are looking at the insurance company that were linked to private equity.

And I believe we had a chart in the China Stability Report as well, comparing the share of assets held by private equity-linked insurance vis-a-vis non-private equity-linked insurance. The share of what we call level three assets or less liquid assets was much larger for the private equity-linked insurance. So those were data. They seem to invest more heavily than those insurance companies that are not linked to private equity.

Now there's nothing wrong per se investing in illiquid assets. Obviously the question is how much of that illiquidity premium is there, right? So it's okay to invest in illiquid sub-investment grade asset if you get remunerated for the illiquidity risk that you're taking. And as spreads and turn premium and risk premium continue to compress, one question that was coming up was, are investors being compensated enough for taking on more

I think the Apollo definition of investable asset, it's a broader definition, right? It goes beyond corporate. It includes, again, infrastructure, consumer loan, receivable firms, asset-based lending, essentially anything that could sit at some point on a bank balance sheet and then effectively can be considered investable.

That number is very large, but again, incorporate asset classes are very different from each other. Infrastructure assets are very, very different than, I don't know, inventory receivables or receivables or inventory financing or trade finance or lead. So you can take a broad view and say, okay, all this can be financed. All those are private markets. All of this can be funded by outside of the banking sector.

My concern, my comment before was that if you start offering funds that invest in a combination of those, it's going to be increasingly difficult to understand the liquidity leverage and interconnection and so forth, the correlation, if you want, among these asset classes. I would perform under stress. Again, the other issue I think that it's important is banking, this mediation of the banking industry started back decades before the century, right?

with interest rates, with money market mutual funds, with CPS, with investment grade bonds, high yield bonds, with mortgage backed securities, subprime, leveraged finance has continued from then CLOs to where we are today. What to me remains an unanswered question is to the extent that credit provision expands outside of the traditional banking sector and to the extent that the Fed

will do, or at least has done, what we have seen during COVID, which is essentially moving from backstop in either specifically financial institutions or the traditionally regulated banking sector. That is, deposit insurance, Fed is a supervisor and regulator. To the extent that essentially the Fed becomes a market maker of last resort, where essentially backstop credit market, everyone benefits when that tide comes up, right? As we have seen in April 2020.

If that's the case, I think we should spend some time thinking what is the appropriate regulatory framework or regulatory perimeter. So I don't think you want a system where some institutions are inside the perimeter or supervised regularly and have access to the Fed balance sheet directly, but then when there is a tail event,

whether you are inside or outside of the perimeter, the central bank steps in, provides support to the broader market, and that way it goes up, that time it goes up for everyone. I think where the regulatory supervisory period should be, to me, that's a fair question.

This doesn't mean that everyone should be regulated as a bank. That's not the case I'm making. I'm simply saying, as the market structure changes, as technology comes into this market as well, as the investor set broadens, and as the central bank take, as we have seen so far at least, an approach that is a broader approach to backstopping market in a tail risk event, I think we should ask the question, what is the appropriate supervisor of regulatory framework?

in terms of transparency, in terms of data collection, in terms of risk monitoring, investor protection. I think there's a need for a rethinking, bringing all these topics together instead of treating them one by one. The banking system is very regulated and has been since the great financial crisis, but the insurance system within the United States

is not regulated on a federal level. It's regulated on a state level. And that is a big success of Berkshire Hathaway of owning a car insurance company and other insurance products, and then using that money to buy riskier assets such as stocks. And Warren Buffett and Berkshire Hathaway have done a phenomenal, phenomenal job and generated enormous shareholder returns and compounding. And the folks in private equity have taken notice. And now they're doing that playbook to

Tell us about the risks that you perceive within a private credit firm or an alternative asset management company, buying an insurance company and putting it on their own balance sheets, and then using that to basically eat their own cooking and buy riskier assets. And I should say that Warren Buffett was, for most of Berkshire Hathaway's history, quite a conservative investor. And I think that these alternative asset management firms are

taking a little bit more risk. I don't think they're buying stocks, but they are buying private credit assets that yield more. So I think there's two pieces of it. I think one, it's how this more interconnectedness, if you want financial institution or broader conglomerates, whatever word you want to use, is being managed. And then what it means for supervision and regulation, where we have to go.

I would note that not everyone has the same approach. Again, there are firms where they manage in a very integrated way, insurance, private equity, private credit. It's one big entity. And so there is a stream of payment coming from the insurance business that fits into private equity, that fits into private credit. The argument is about synergies, it's about efficiencies, it's about pricing and bundling products.

But not everyone is taking that approach. There are other firms that don't own outright insurance companies that when they need to invest, for example, their money coming out of the insurance business, they tend to outsource, for example. That means, yes, they invest in private credit, but not the private credit or the group. They invest in funds, other funds. So there is no one way to manage this, neither in terms of scale,

How much do you fully own the insurance companies? So do you have a minority majority participation? And now do you manage the three business if you want the credit, private equity and insurance? Not everyone runs in a very integrated way. There are others that seems to have, again, a more outsourcing approach to this. And one of the risks is exactly this. Even if it's not an issue of risk percentage, they are very careful in terms of the perception.

That's one piece. The other piece is, yes, the insurance is not federally regulated, and there's always been a weakness. It was highlighted in the Dodd-Frank report post-GFC. There was an office at Treasury that was supposed to kind of like coordinate the approach to this. Then the step that Dodd-Frank was trying to

the steps forward that the top Frank was taking was to create essentially the ability from AppSoft to designate entities, right? And there were some steps in that direction and then we went backward a few words.

There is another aspect to this too, also, which is the reinsurance business as well. So you can add another chain there. And some of this reinsurance business is actually not in the U.S. jurisdiction, but in other jurisdictions. But U.S. policy makers, regulatory supervisors have no access to. That moves into other jurisdictions. And so that makes the supervision regulation even more complicated. My personal views is that there will be benefits from having a federal policymaker

approach to this in terms of the insurance business. The approach of the EXOC was supposed to, I think, replicate that kind of approach, but the lack of designation at this point kind of defied that purpose.

There is an issue of insurance. It's not just the US insurance. There are other large insurance complexes in the world. For example, they have large investors in the US with the income market. That creates another cross-border aspect that is important. There has been a lot of discussion about Taiwanese lifers, for example, in the past few days and the impact on

foreign exchange markets, foreign reserve, the share that they may own of US dollar fixed income assets. So those are all issues that create essentially spillover effects from one jurisdiction to another that in normal times could be an efficient allocation of risk and market pricing. At times of distress, this is where usually where the unknowns are known, so Camilla. And that's where we often end up being surprised, I suppose.

And run risk within insurance companies is very low, right? Because if you insure life insurance for people who are 50 years old and they're going to live to 80 on average or 85, you want a 30-year asset. You're not going to be pulling money in six months, right? The risk there was there was some work that was being done during COVID, but rates go from very low to very high, whether there is an incentive for policy order to essentially call the policy.

That depends how far you are from retirement first, obviously. It depends on what is the extra yield you get, how large you have the fees, if you had to pay fees, and whether this is feasible or not, what is the time delay and so on. And different jurisdictions have different

approaches to this. But that's the insurance equivalent of run risk was that the policy order was actually called their policies and trying to invest some words. I want to ask about more exotic structures within the private credit. First of all, earlier when you referenced leverage, you said that some firms could use derivatives, some institutional investors could use derivatives. What did you mean by that? And then let's also talk about

collateralized fund obligations, CFOs, what are those? How prevalent are those? And also net asset value financing. I think the idea was that the fund, even the latest global financial stability report, they have this chart where they show that some of these investment funds, they are starting to increase the use of leverage, how much leverage they can use to essentially enhance their return, whether this is to a few shorts or other more.

There's some data, usually, at least when I was at the fund, the work we were trying to do there was about, you have to go fund by fund and trying to look at this information. There's no aggregate way to access those data. So that's one example. Again, it could maybe, in aggregate, it's not a big deal. The numbers that they put out in the April report, there are some chance there. I think the numbers are something to keep an eye on.

The difficulties again is trying to come up with aggregate numbers that you need to build from individual entities. And then I would also carry on not to think too much comfort from people say the aggregate number not high because there could be concentration in some specific front, some tail of entities that use much more than others. And we have seen during SVB, our firm that would be not be systemic by itself.

If there's a tail bank that are perceived to be similar, that could be similar too, could create problems. The NAV loans essentially, it's effectively what I was trying to describe before. When you take a portfolio of loans and you get a loan against that portfolio of loans from a bank, and those are based on the net asset value, so if you own that portfolio.

That's attractive for the bank itself because it gets a better regulatory charge than if you do the individual loan per se. So would you say that risks in private credit are rising or have risen? I would say that when any sector or products rise in size very quickly,

it's always worth assessing those. And I think my approach to this has been going in with open eyes and look what the benefits from a financial stability perspective, as well as the risks. What makes me concerned is that there are different dimensions that they're moving at the same time. The move toward other asset classes, they have different features in terms of liquidity, in terms of long duration, long or short.

the willingness or the intent to open up to other investors, whether this is retirement money or whether this is retail investor. So it's the combination of expansion along different dimensions at the same time and growth that is fast.

at a time when the asset class has now gone through a recession, to a significant slowdown. So we don't know how it's going to perform. And we don't know how these vulnerabilities that are perceived could make you feel comfortable, how they could interplay. And then finally, a policy framework that is designed for a different market structure, if you want. And so even the policy frameworks have been adapting. The Fed has been very creative.

but it was originally designed for a more traditional banking sector. Whether you think of the scan window and some of the tools available. And so

That framework could be strained itself if we actually start seeing period of stress in the sector. Fabio, let's now turn to tariffs. We're recording in early May, and there's still a tremendous amount of tariffs on... There's a tremendous amount of uncertainty on what the U.S. tariff policy will be towards the rest of the world. I'm curious, Fabio, on your views of the economic consequences of tariffs, but also of the financial implications of tariffs

tariffs? And I'm not talking about, do you think the stock market is going to go up or down, but the connection of capital flows around the world from US to China, from China to the US, how will that be disrupted by the disruption in goods? We know the goods flow is going to be disrupted. How much is going to be the capital flow is going to be disrupted? Let me start maybe with the outlook first, and then we can look at the implication for monetary policy trade and then finance and then there.

I think in terms of the impact on the economy, I would start with the shock. This is a very different shock, right? This is not COVID, this is not the GFC, it's not the Russian invasion of Ukraine. Those were, you can consider those exogenous shock, if you want, most certainly the pandemic, or even the GFC, at least the perception was an exogenous shock. No one was expecting that. This is a policy-driven exit service, right? This is an intention to rewrite the global rules of trade and finance.

So, first of all, it could be stopped any kind. It could go to zero tariff or pre-april second tariff. Second of all, this is a different shock for the US versus the rest of the world. It's a stock inflation for the US, if you want. So higher inflation and lower growth. Negative growth, but could put upward pressure on price.

likely more negative demand shot for the rest of the world, slowing activity and putting downward pressure on inflation. So the policy response will be different in the US vis-a-vis the rest of the world. The other one is the size of the shot, right? If you take, I don't know, the Yale Budget Lab and you look what is the effective tariffs, where it could be, you've got to go back 100 years or more to actually see something similar in terms of the target. And so the question is like, what do we know? And this is the debate between hard data versus soft data.

We got a glimpse of the hard data with the Q1 GDP last week. We have seen US GDP contracting, but there were a lot of very extreme moves in different components, like a huge surge in imports, more than 40%.

significant increase in inventories. So I think the sense was that both particularly firms, but maybe also consumer were trying to front run the tariffs before the tariffs kicks in. You see more imports and you see building up inventories. So the question there is one,

how detrimental the impact of uncertainty will be on businesses and consumers, right? We have done work at the Fund before I left, when I was leaving, trying to look at how uncertainty, what is the impact of uncertainty on macroeconomic policy. What we show there is that one, even if you are in U.S. financial markets that are probably more sophisticated, the more deep markets,

You can actually add predictive power if you use measure of uncertainty by themselves, which is another way of saying the markets are not incorporating full information.

available from uncertainty. But the part that was most striking was that you actually, if you think about forecasting the full density of the distribution of GDP, uncertainty can actually have an impact on the tail, right? The tail risk or the probability of very severe outcomes. And that tail impact is larger the more you have vulnerabilities going to the shock and the more volatility will slow before the shock hit, which is where we were going into this exercise.

So, another data that came up was the note from Payo last Friday. I think that was a pretty sign pointing to a robust economy, if you want. So then how much weight do you put into the soft data, essentially the survey, right? Whether this is University of Michigan, conference board, it's Bank of America, global fund manager, fund. All of those are much more negative. Now there's a lot of caveats on how much they've been driven by political views, for example.

How much there's been a shift in people's perception of reality, this real reality with high inflation. So people seem to be more negative, right? Because the level of price has increased. But those are information points that you need to use. On the firm side, you've seen, I don't know, some firms scrapping their year ahead financial focus, right? Ford was the last one to do that. There are front-running tariffs.

I think the supply chain disruption, those are more concrete and you start seeing some evidence, whether you look at the decline, the big decline in shipping from China, whether you look at picture of shipping around China or getting to Los Angeles. I'll highlight here that this is a more concerning issue, particularly for SMEs, for small and medium enterprises, because those don't have working capital to pay

Very large tariffs. They don't have the same lead time that large businesses can do. Large businesses can say, okay, I'm going to build up inventories. I'm going to see how this plays out. I'm going to try to essentially wait out the uncertainty. Maybe I'm not going to hire. Maybe I'm not going to invest. I'm not going to fire you. I'm just going to sit and wait.

which is a little bit like the Fed approach to this. If you are an SME, I don't think you have the luxury to do that. And that particularly also because some of these SME relies on imports from China and other emerging markets for their inputs. And so on the inflation side, and the other piece of the puzzle here, it's inflation, right? What is the inflationary impact? So one tool of thought, you should just look through this. This is one level price impact. Price is going to go higher and eventually it's going to play out, going to go away. The Fed should look through this.

The challenge with this is that it's a function of the size of tariffs, like how high tariffs will be. This tariff seems to be moving more at a higher frequency than I think it would be ideal in terms of forecasting. And then also how long they're going to be out there. And so that makes the exercise much more difficult for inflation. And so the main question is like, who's going to absorb this tariff? Is it going to be the foreign exporter?

It's going to be the firms that import, and that is going to mean that it feeds through earnings. So it's going to end up with the investor or it's going to be domestic consumers. A few little evidence here. One is, for example, the Chinese e-commerce like Tiananmen, they have increased price quite a bit. The controversy around Amazon transparency in disclosing price of tariffs. There was an interesting Dallas Fed survey that was run at the end of April that shows that they asked,

essentially firms in the manufacturing. That's what I think is more interesting. How do you plan to respond to this? And 75% said that they said they plan to increase prices, for example. That's one data point again, but there are some evidence, I think, that you might start seeing some increase in prices. And then ultimately, I think from the Fed standpoint, what matters is what happens to equation expectations.

So different services give you very different responses. Whether you look at the Michigan Concrete Board. Also, there's a time dimension, whether you look at the one year ahead inflation expectation or the long term inflation expectation. The market seems to be pretty stable. If you take the 10 year tips, for example, it's about 270. So it's not too far from the Fed 2%. Other measure of five year, 10 year, the New York Fed and the long term of the New York Fed have not moved much. I think the five year

then there are other surveys where you have seen actually a significant pickup even in the long term. So that makes the Fed job much more... The challenge with the Fed is that they have, because it's likely to be a stock shock, they have two countries in two objective in conflict. So

Unemployment may go up, that will call for a cutting interest rate, but if inflation goes up, they will call for a hiking interest rate. And so Jay Powell in his April 16th speech made it very clear. They're pulling in different dimensions. They are happy to see they can afford to wait and see how this is going to play out. They have this balanced approach, which means based on how far we are from either objective, we will decide what lever to move with the

important point that price stability is a precondition for employment. You're not going to get full employment if you don't have price stability. So what the FOMC will face in terms of decision tomorrow

and the next few meetings coming, I think one is, are you going to be preemptive but gradual? Maybe what they did in September of last year in cuts, maybe more gradually and see how this play out. Because there is so much uncertainty, diverging objective, you're going to wait for longer, but then go fast. So when to go and how fast they go. That's one choice or two choices.

Another one is how much weight you're going to put on surveys. So the hard data that I'm giving you a message now, but you know they're more backward looking, how much weight you put on these more forward-looking surveys when you know that there are differences, there are some specific considerations. And how much weight, for example,

Suppose you had supply chain disruption, then it's cutting interest rate the right tool. If there is a disruption in supply chain, cutting interest rate probably is not going to necessarily solve that problem. So it's cutting rates the right medicine if you put a risk price stability. And then lastly, how do you communicate? You want to come out to be very hawkish. What message do you want to provide in terms of where to go?

wait and see works until you start seeing some evidence, but then at some point, the communication is to decide what kind of direction the Fed will go. I think that's on the outlook. On the trade, again, it depends on the size and duration of the tariffs.

I think one thing to highlight is this point has been made several times now, but the administration seems to have some conflicting objective with these tariffs in the sense that they seem to be used as a tool to reindustrialize the US and bring manufacturing back here. There seems to be a tool to have revenues. Those are meant to finance some of the tax cuts they have in mind, but also they tend to be a tool to renegotiate the global order in terms of trade and finance.

Different objective, a different answer as it relates to high or low tariffs, like revenues you own them high and permanent. If it's a tool for negotiation, maybe they can go up and then come down here. So there seems to be some conflicting objective there. And often they seem to pull in different directions. So that's, I think, one source of uncertainty there.

The other issue on the impact on trade I mentioned is supply chains. I think that's where it's worth putting attention now. There's a lot of discussion here that if you start seeing supply chain disruption, at that point, whatever the policy response is, you're going to have this cascading effect into the tracking industry, into the retail industry. And those are sectors that together, if I remember, they have something like 25 million employees. So it can very quickly get into...

There was an article a few days ago showing, I don't know, the 4th of July, like 95% of fireworks come from China. Presumably a lot of this had been front-run. And then this impact, I think, on the global finance. My view is that the US has benefited immensely from the World War II order in terms of designing the rule, in terms of how important global markets are for US multinationals. 40% of their profit comes from there.

There's a lot of focus on trade imbalances in the US, but first of all, the current account has a trade component and a service component. The US has very large services surpluses with other countries, like take Europe. And then the combo of the two, often the current account is not as large as you just look at trade. So that's one aspect. The other aspect to keep in mind is that the flip side of the current account is the financial account.

And so as the US buys goods from other countries, at the same time it's exporting services and also selling financial products. And so that's the current account versus financial account balance of the balance sheet. And just to give a sense of how exposed the US is to that piece of the financial account,

The net foreign asset, so that's the difference between financial assets owned by the US versus foreigners. It's a minus 85% of GDP in the US. So that's a very large number that has grown quite quickly. US equities account for about 70% of global equity in the US, despite the fact the US is only about 25% of global GDP. And then tech shares are 30% of US equities. So there is a very large exposure of global equity portfolios to the US.

And those portfolios have not readjusted. And you don't need, and that's just equities. So when you look at fixed income, maybe 30% is owned by foreigners, treasuries, another 30%. So you don't need a big delta or decline in the stock to have a price impact in U.S. financial assets. It's enough that at the margin, you don't reinvest or you sell at the margin. The stock is so large that you can actually have meaningful price.

price effect. That was all the discussion during the early day of April when you had that episode where you have risk off event, rates were going up, and despite that, the dollar was depreciating. There was all that discussion about coalition having broken, sell America trade, and so on. The risk to me, and then Mediasoft, is one of repricing of risk premium of the US dollar amount.

That's essentially rethinking the US existentialism story. There's been a number of trends that have been tailwind for the US over the last decades. Globalization that allows to lower the labor share, higher share of capital, rising margin for US firms. We have seen US particularly equity outperformance, capital flows into the US, very stable inflation backdrop.

and all of those reinforcing forces that made the US exception from a macro and a financial standpoint. To the extent that some of these changes, so mercantilistic policies, so tariffs, deriving the rules of global trade and global finance, the rupture of some of the alliances in terms of securities of US versus Europe or versus some countries in Asia,

The environment is very different than what we have seen after World War II, after the GFC. So the risk is that the risk premium that will be required by foreign investors to hold dollar assets could actually change, could actually go up.

And that's the issue of what will happen to the use of the dollar. Would the dollar, what we call here the exorbitant privilege, go away? And I think you want to look at a holistic way of this. It's not just the current account, but there is a twin deficit in the US. It's the current account plus fiscal account. The sum of the two now is north of 10%. When foreign app holds

about a third of Treasury securities. In some sense, you rely quite meaningfully from foreign holders. And if they reprice the risk of holding dollar assets, we have seen an increase in time premium in the US from September to today.

at the peak in April was 100 basis points. And this is a time when they are concerned about the fiscal outlook for the US. They were concerned about threats to Fed independence, the security umbrella changing. So there's a number of tectonic forces moving at the same time. I can add AI to that. Where the US has immensely benefited, in my view, over the last decades from the current world order,

And rethinking the framework and the basis for dollar and U.S. exceptionalism comes at a risk, particularly as the U.S. is so, in some sense, exposed to financial assets and financing of the fiscal account in the U.S.

So I think what you're referring to is other countries who've been massive investors in the United States in stocks and bonds, selling their positions, being net sellers. And I'd also say this is entirely in the financial world. This is not, you know, President Trump saying he secured multi-trillion dollar commitments of other companies to invest in the United States and build factories. That's foreign direct investment. We're talking about financial completely different or not completely different, but different. Yeah.

Portfolio flows. And so, for example, I've got some data from the Ministry of Japanese, from Japan's Ministry of Finance that for March 30th to April 5th, so that week of Liberation Day, the Japanese major investors were net sellers of foreign long-term debt securities of close to

$18 billion, which was the fourth biggest weekly decline in record, I think, going back to 2005. And so it was foreign, not just U.S., but I think a very large percentage of Japanese foreign holdings are U.S. foreign holdings, I guess, primarily corporate debt, but treasuries and agency securities. So-

How concerned are you about the rest of the world being net sellers of US assets? How concerned do you think the folks at the US Treasury and the US Federal Reserve are, which you have both worked at? Are they paying attention to these flows? And then also something from the Ministry of Finance report is they were net sellers of assets, but they also, in addition to reducing their dollar assets with their foreign assets, they also expanded their foreign liabilities, which I don't really understand what that

means in practice. And then also, sorry, I'm throwing so many questions at you, but when a foreign company or country sells dollar assets, what happens? Does the US interest rate go up? The bond yield go up? Does the dollar weaken or both? And then maybe walk us through a macro 101 argument as well as in real life and sprinkle some additional details on it. Okay. So Japan is the largest holders of our budgets, you said.

followed by China. It's not just Treasury, China, for example, MBS as well. So you can see if they sold off, there's an impact directly on mortgage markets in the US. The point I was trying to make, I think it's important. You don't need foreign investors to sell large scale. The stock is so high that it's enough you actually play at the margin. Either, for example, not reinvesting. When there's an auction, some securities mature, you just don't reinvest.

Even the non-reinvesting has an impact. And you can see in some of the weaker auctions, for example, that could be an example of how this could play out. And then, of course, if they actively sell, that would become even more relevant. I'm a little skeptical that any of this large, either at the government level or at the FX reserve manager or state-owned firms,

or even product tech, they would sell because if you sell massively, that has an impact obviously on your old, essentially crystallizing losses. So I'm reluctant to think that they will go out and sell a hundred billions of dollars. But you still add an effect, the margin by not reinvesting or moving more gradually. So I think you want to distinguish between the short term, how much pressure came action from this foreign investor have vis-a-vis what is a rethinking of the portfolio approach and design over the medium term. That's where I think some of the more

damage will be more relevant if there is a rethinking of what is the share of dollar asset you want to hold. Obviously, you'll need an alternative, right? So what is the alternative to dollar?

The euro seems to be the most obvious one, but you can think of a long list of things that need to be fixed before the euro can grow in size and become as liquid as did the safe US Treasury. The unfinished banking union, lack of capital markets, internal barriers, no central high fiscal policy.

Those are all challenges that Europeans have faced for a long time. So you can't solve that immediately. But I would distinguish between what the impact would be today in the short term vis-a-vis what are the implications for rethinking the overall global trade and global finance order. That's a much more

challenging situation, I think, for the US. What we don't see is that we haven't seen portfolio moving yet. At some point, global investors will start rethinking what share of equity you want in the US vis-a-vis the rest of the world. All things in common.

The impact on prices also is going to be a function of how much of this is edge versus not edge, right? So if some of this exposure are edge, then you get a very different impact. If you are completely on edge, what you do, you essentially sell, I don't know, fixed income asset that you have, you get dollar back, like actual dollars, and then you want to sell the dollar to buy another currency, right? So that will put downward pressure on the dollar value and upward pressure on the, whatever that currency was. Mm-hmm.

That could be an intended objective of the administration. There's always indication that there's a favor for a weaker dollar that would have manufacturing. My point is there is always a mirror image of that current account, which is the financial account. And so if there is a repricing overall of dollar assets, that could be quite meaningful in terms of how people perceive

the liquidity of US markets, but also the safety. I think discussion about monologue accord, importing fees on users of US treasuries, some of those discussions, if you have foreign investors that are having question about the safety of capital in the US, whether capital controls will be imposed or fees, whatever the form, that would imply, in my view, a repricing of dollar asset risk.

at a time when, again, the financial account, the exposure to foreign investors is very high. So I think those are issues that need to be covered very carefully. Some of this could be managed maybe in the short term, but that's a huge implication for the mid-term as well. So AI is another example. Your firm are leaders in the technology innovation AI sector, but you start seeing some more competition abroad as well. US firms are benefited immensely from their presence

40% of their profits come from abroad market. Not only that, but if the trade war turns into a cabial war, you could see foreign countries

looking at services as a way to retaliate, for example. The US, again, grants very low services and services usually include professional services, intellectual property services, financial services. So that's an easy target with whether this is a digital service tax or whether this is not allowing access into some countries, whether rethinking intellectual property.

It's an easy target at that point. And then there's the financial piece of it. Right. And the U.S. has a service surplus with the rest of the world, very large in financial services. I'm just connecting what we talked about. I think they manage the money that the rest of the world gives them. And then also, for example, President Trump announced that he's planning on looking into a 100% tariff on movies not made in the U.S. The U.S. also has in the movie industry, surprise, surprise, with Hollywood, a huge...

Surplus, it exports way more movies than it imports. And it's not on DVDs anymore. So that's a service. And then I think right now, the trade war, as intense as it is, it's, I think, so far only goods, things that you can touch with your hands and not services. But if it gets services, then it's literally entire economy, not just goods. It's not the trade war, right? Whether you expand to services. Now there is the caviar war, which goes into the financial account for the bonds of payment.

Right. And earlier you referenced Taiwanese life insurance. There's life insurance. What is going on with Taiwanese life insurance companies, as well as the tremendous weakening of the dollar against the Taiwanese dollar? And I should say, you know, we're recording this on May 6th. This won't air until the middle of May. But just as you understand it, what is going on here? And then going back to our earlier conversations, life insurance companies, they're not supposed to be sellers, right? They're supposed to be holders. Right.

I mean, the Taiwanese is very complicated. We look at some of it when I was at the fund. It's fascinating, but it's not something you can, I think, explain in three minutes. But the simple story is that these life insurance companies are very large in terms of share of GDP. So the dollar assets as a share of the Taiwanese GDP is very large. Part of it is FX reserve, right? Think of like TSMC, right? Those are produced chips to the rest of the world. So that is the current account piece of it.

And then there's a lot of reserve coming into a central bank. Some of these are being swapped with some of the insurance. And so the life insurance essentially invests heavily abroad in dollar assets. And they invest in sophisticated products

called callable bonds. I'm not going to go into that part, but the point is that there are very large players in US fixed income markets. A couple of years ago, I don't remember which report, but we looked specifically into some of this. And so simply some of this life insurance decided they're going to invest less in US dollar fixed income markets. They will have marginal, significant marginal pricing. And then there is this aspect of this

more sophisticated financial instrument that they use that is being in part helps reduce the amount of effects reserve that sits on the central bank partnership. But to the extent that, for example, the dollar weakens and the local currencies appreciate, you start having significant, you could potentially start having significant losses on your dollar investment, right? As a life insurance company.

And again, if you decide to then repatriate the money and sell some of those assets, they could have a significant meaningful price impact. So it's a very interesting word that those bonds are called Formosa Bonds.

But again, it's just an example of when you have a meaningful share of some asset held by a specific institution, a rethinking of their investment strategy is either because of this portfolio design or because of their maybe facing losses or because of a change in trade policy in the country of the central bank that they manage to reserve. That could have significant implications cross-border, but also in U.S. assets, depending on what they invest in the U.S.

Do you think that the Trump administration wants a stronger dollar? Both President Trump and Secretary Besant, Treasury Secretary Besant, have said that they don't like that other countries are, quote unquote, manipulating their currencies. I think if other countries stop, quote unquote, manipulating their currencies, what that means is stronger foreign currencies and a weaker dollar, right? It depends on the on the conjunctural aspect, right? So there's a

There's a more structural piece to this, which is related to a structural current account the US runs. And then there's a part which is more congenital, depending on where US growth is vis-a-vis growth of this account. I think the main issue here is an issue of imbalances. And this is the point that the FAMB has been making for many years. In some sense, if you step back and you look at the global,

savings pool and investment. The US is a country where there's a lot of domestic demand, a lot of demand for investment, consumption, and capital comes into the US to fund consumption, effectively an investment, particular investment. Then you have other countries which have an excess savings vis-a-vis investment. China is an example that is often made. Germany is another example. Japan is another example.

where increasing domestic demand, whether this is through fiscal policy, structural reform, plus if it's improvement in the fiscal output of the US, the combination of the two would probably help address some of these macroeconomic imbalances. Those are the main drivers of current account positions. Personally, I think it's going to be very hard to address this on a bilateral basis.

because the only thing you may end up getting is what we've seen in 2018 when some of the shipping ships from one country to another. What is drawing the structural force behind this large current account deficit and surpluses or financial account surpluses and deficit is the macro underlying. It's need for stronger demand in China, growth of domestic demand,

more expenditure of fiscal policy. For example, Germany is moving in that direction now. And you need to fiscalize one of the drivers of domestic demand in the US, which is the fiscal output. That would be, personally, I think, the structural way to address some of these issues. You need a combined coordinated effort, if you want, in the US to fix

the driver of Saudi's demand, partly with its fiscal policy, and you need more stronger structural domestic demand in some of the same countries like China, Germany, Japan.

Right. And you could argue that the origin of these imbalances are the lack of demand and consumption in Germany and China. China is talking a big game in terms of stimulating consumption. Do you think that China, number one, are they serious? Like, do they mean it or is it just public relations? And number two, if they mean it, do you think they will be successful or have they been kind of talking about boosting consumption for a long time, but it hasn't happened?

I think this was the policy recipe that the IMF has been proposing for a while. I think there are a number of challenges, right? So one is that until you resolve the underlying issues, challenges with the housing market, it's going to be very difficult to drive domestic consumption. In some sense, housing was one of the main pools of wealth.

for the Chinese household, and that wealth has been evaporated over the last few years. And so the immediate response, particularly at a time when the society is becoming older, demographic challenges, is to save more and not to spend. So that's a structural issue that requires not just

Fiscal instruments like swapping whole appliances for new appliances, those are much narrower. They require a much more macro-driven approach to this that involves, for example, taxation. So if you move away from an export-driven business model to more consumption, domestic demand-driven, you need a different taxation system that is less focused on the old business model. You need to resolve the issue of centralized fiscal policy versus

a lot of government fiscal policies. So, there requires the rethinking of the framework, the taxation system, the macroeconomic policies in place. Until you find the floor of the housing problem, I think it's going to be very difficult to push the map. That's one piece. The other piece is the direction that the leadership is trying to push going forward. There's a lot of industrial policies in place trying to make China the future market for renewables. They're already there. Solar, wind, rare earths,

but also AI, technology. A lot of these are industrial policy driven, which end up creating oversupply of some of these products. The renewables is a good example. Those two are two different philosophical approaches to growth. If you push an industrial policy export driven, it's going to be very hard to turn the economy into a domestic consumption driven economy. That's a high level policy choice on how to push for growth.

They require structural changes plus a choice how we want to take the country forward. Right. But maybe President Trump is trying to nudge China to a more consumption-driven model. I think what we're starting to see now in the precedence of the administration itself, I think they've at least hinted at, when you get a level of tariffs so high, you don't affect the stage prices anymore. You affect quantities, right? You just come to a complete halt in trade.

essentially. The trade structure between the two countries, that's an aspect that I think it's important to keep in mind. It's very different. The US exports more finished products in the products that are exported. China is a much larger component into intermediate inputs into production. So it's easier to

for China to buy some products from other countries, like soybean, like the agriculture, you can buy from Brazil or other emerging markets. It's much more difficult to swap away from China when you're buying intermediate goods because you can't produce domestically. So the China import component of some of the products is much higher. So maybe that's the objective policy. Maybe the case is about national security, it's about supply chain security, whatever the argument is. But it's a much more painful and longer argument

term driven exercise. I think finally there's another aspect which is, at least from an efficiency standpoint, there is no reason why certain products need to be produced. Every country needs to produce every product. There are efficiency gains, and this goes back centuries now, of some countries having advantage of producing. The U.S. has changed. The U.S.

the declining manufacturing employment in the US started in the 80s. It was not driven by globalization. It was driven by mechanization, automation. So I suspect that even if you impose tariffs, whatever policy, trade policy measure you take, some of the products, even if they get back manufacturing in the US, they would be automated. The same way we have seen in the auto industry. And then

In addition to that, the US has become a very service-oriented industry. And so that's a fact, that's a reality. And then you can see the fact that the US is the biggest broker of services. So there is an efficiency argument to be made. Now, of course, you want to be mindful of national security or avoiding supply chain disruption, managing some of these risks. And for some sector, I think it's a very...

It's a valuable argument. I don't think you can apply that argument to a bunch of other products, so I don't call them those categories. Thank you for taking us on a guided tour of private credit and trade and tariffs. Two very complex topics. Tell us about your day job at the Anderson Institute for Finance and Economics. What are you working on? What issues other than private credits and global trade is within your permit?

So I joined in September. The mandate was to set up a global think tank. Understand it's a global firm. We are in almost 180 countries, offer a range of products. The intent was to set up a think tank that was independent research of talk leadership. So I don't

I don't sell products. I don't generate revenues. We have a fantastic advisory board that is there to help us grow and set up this institute. In some sense, for me, this was like a startup. As I joined, the advisory board was there and I had to set it up. So the advisory board includes Larry Summers, Myron Scholes, Nobel Prize,

Raghu Rajan at the University of Chicago, he was formerly a economist at the Fund and the government of the Reserve Bank of India, Lubos Pastore at the University of Chicago, Rebecca Diamond at Stanford, Ken Rosen at Berkeley, and John Shaheen, which is the CEO of Anderson Consulting. So it's a very

strong advisory board that has been extremely helpful in El Paso growth and guiding in what direction to go. In terms of mandate of topics, the idea is to look at the big macro trends that are relevant now, macro financials, so geopolitics and financial fragmentation, look at innovation, AI, demographics, public debt,

or climate resilience and look at this both from a risk perspective and an opportunities perspective. My view is, and has always been that if you properly manage risk, there was always opportunities, but you need to understand price and manage risk. We're going to look at this in the angle that is going to

try to pursue, we're pursuing that it's going to make us different from other think tanks. We're going to look at this through the lenses of financial markets. How markets are pricing risk and opportunity. This is the beauty of prices. Prices send you a signal.

And we're going to look at this from a macro financial perspective and then obviously from a micro decision making, whether you are a policymaker, business owners, or how that impact your decision making. We have done some hiring. We now have a chief of staff who came from Bridgewater. We have a person who helped us set up the website. We actually ended up launching yesterday.

We have three visiting fellows that will join us in the next few months and we're starting to hire PhDs. I think from my perspective, it's a very good job market. That's a lot of- As a hirer, as someone who hires. As an employer. It's a good job market to look for experienced, good people. So I'm going to try to use this opportunity to bring on board really good people.

And then last step, we start in the US, but ultimately this is meant to be a global thinking. So the idea is to next year to go into Europe, then by the five year horizon to be present in the largest country. We want to be in Asia, we want to be in the Middle East, we want to be in Africa, Latin America.

So it's a very ambitious plan, but in some sense, it would have been much more difficult if we set this up in normal times when everything was calm and slow moving. Then you're competing with much bigger names in the think tank world. I think in a much more dynamic world where there's a lot of structural changes, rethinking of global trade and finance rule, being smaller and nimble and new allows you also to

to be more visible, but also to hire the right people that you want to have there now for the topics you have. And we also try to be visible by participating in the policy discourse. So

I sit on the NYU Stern, the Volatile and Risk Institute as an advisory board. We joined the Breckwood Committee as a think tank. We joined the Council for Relations and the Economic Studies at Brookings. This allows us to interact with others, but also be visible. So it's a very exciting time to do this. And hopefully we'll manage to play a role in the public discussion of some of these topics.

It really is a very exciting time. Lots going on. We'll link in the description to your LinkedIn, but what's the website for the Anderson Institute? The website is andersoninstitute.org. Fabio, thanks so much for coming on Monetary Matters. Thank you everyone for watching. Subscribe to our YouTube channel, the Monetary Matters Network, and leave a rating and review for Monetary Matters, the podcast on Spotify or the Apple Podcast app. It really helps the show. Until next time. Thank you so much.

Thank you. Just close this f***ing door.