The Financial Sector Prepares for Recession | Marc Rubinstein
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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 door. I am joined by Mark Rubenstein, former hedge fund manager and author of the Net Interest newsletter. Mark, welcome to Monetary Matters. Good to be here, Jack.

Mark, you're an expert in all things financial sector, banks, non-banks. We're going to get into it. We're right in the thick of a bank earning season. And I've got a question. Number one, what have you made of the bank earnings? But are banks prepared for a recession? And are the credit losses that they've taken, are they reflective of the concerns you've seen in the broader market about tariffs and a potential recession?

Yeah, it's a good question because as you say, we are right in the middle of banks' earnings season and they closed their books on the 31st of March. The world changed subsequent to the 31st of March. They've spoken. So I've listened to a ton of calls, at least 10 of them last week. There was a fundamental change in the accounting, the way banks account for their allowances and reserves for loan loss provisions that was introduced last

actually in anticipation of COVID, but after the great financial crisis of 2008-2009. And what this accounting change requires them to do is to load up provisions in advance of any deterioration in the broader economic backdrop.

And so they were all asked on their calls over the course of the past week, what unemployment rate as a metric for measuring what kind of stress they might be seeing. They have baked in to their reserves. Right now, as you know, unemployment is just over 4%. And there was a range of estimates that the banks disclosed

from 5% in the case of PNC, for example, right up to 6% in the case of Bank of America. And what they've done is, because there hadn't been enough time to thoroughly re-underwrite their models, what they've done is typically every bank will have three or four economic scenarios and they weight them

And what they'd all done between the 31st of March and the date they reported, kind of 14th of April, is they skewed the waiting in favour of the downside scenario, which is a deep recession, which City, for example, suggested...

discounted 6.7% unemployment rate. So they've kind of skewed towards that downside scenario, but the uncertainty is clearly rampant. And that was the big theme of these earnings crawls.

And when they skew those earn the unemployment rate to the to the upside, because we had Liberation Day on tariffs announced on April 2nd. Does that actually impact only the guidance and kind of their tone on the call? Or does it actually influence the numbers? Like, are the numbers settled as of March 31st? Or do they have wiggle room to actually adjust their provisions for credit losses, which subtract from their net income and their profits going into the quarter when they actually report?

So again, it is a good question because in theory, they are meant to close their books on the 31st of March. And as you say, on the 31st of March, we didn't know what we knew two days later. Having said that, they do have a bit of wiggle room. JP Morgan bolstered its reserves by close to a billion dollars. They...

And they gave some sensitivity. They said that going into COVID, they increased reserves by $15 billion as unemployment went from 4% to 15% in a very short amount of time. It's actually interesting. I'm sure you've got some views on this. What the appropriate historic analogy is for what we're seeing right now.

Some people say it's like the global financial crisis. Some say it's like COVID. Some say it's like Brexit or what we saw in the UK. I'm based in the UK. We saw a bond market backlash to government policy in September of 2022. Maybe that's a good proxy. And various banks laid out what their proxies are. JP Morgan went with COVID.

Bank of America put some data out there which compared how they stand today with how they stood going into the financial crisis in 2008 and COVID. But taking COVID, Jamie Dimon at JP Morgan said back then they had to add $15 billion to reserves. Currently, as I just said, they've added just less than a billion dollars. If things get bad,

That kind of gives a sense of what they have to increase their provisions by. But he wasn't going to be drawn on how bad things are going to get because the uncertainty right now is just too significant. So in 2020, banks massively over-reserved with the benefit of hindsight. They took too many losses and then they actually were able to

do the opposite and take those losses out and they book those as profits for the rest of 2020 and 2021. What do you think the risk is right now that banks also are over-reserving or are they adequately reserving or are they maybe under-reserving? And why do you think that banks now are not willing to prepare for Armageddon or prepare for severely negative outcomes when they were so willing to do so in 2020?

We've all got various views on what we think the probability of recession is. Again, actually, the banks laid out their base case views. JP Morgan deferred to the JP Morgan economist who puts the probability of recession at 60%.

No color on how deep that recession might be, but 60%. Wells Fargo, similarly deferred to their economist, 55%. Bank of America's economist doesn't, from where we're standing today, or at least where we were standing a week ago when the bank reported, doesn't think we're going to tip into a recession. If we do tip into a recession, and it kind of feels certainly that short-term data around

around company investment suggests that it kind of feels plausible, right? Then they're under-reserved. But the reason why they can't take more is because it goes back to a case that SunTrust, now known as Truist, suffered back in the 1990s, I think it was, where there was a conflict between their two regulators, the SEC and

And the banking regulators, banking regulators wanted them to take more provisions because of prudence. The SEC thought that was earnings manipulation, sandbagging, and didn't want them to do that. And actually, SunTrust, as it was known then, was sued by the SEC. They had to release reserves that they'd taken prudently. And since then, banks have been very cautious only to reserve for what they can see in front of them.

with a high degree of confidence. That changed somewhat with the introduction of CECL, which is the accounting standard I mentioned a short while ago. But they still can't take an overriding negative view. It has to be backed up by some concrete expectations. And so that prevents them from taking provision. So yes, if things deteriorate, and from where we're sitting today, it looks like they might deteriorate.

then provisions will be going up in future quarters. Now, can they accommodate that? Yes, they probably can. One thing's for sure is that this sector broadly, the banking sector broadly, is in a much stronger position than it was not necessarily in 2019 going into COVID, but in 2008.

And actually, the American consumer is a lot more secure than they were going into 2008. There's kind of 100 trillion more financial assets, less financial liabilities in the household sector now than there was then. The banks individually, Bank of America, for example, the average loan to value on their home assets

Loan portfolio is 50%. So there's huge amounts of cushion. In other words, the consumer has a lot of the average consumer

not talking about the bottom 20%, but the average consumer has a lot of equity on their domestic balance sheets. And that puts the banks in better stead compared to 2008. Maybe that's not an appropriate benchmark given how bad 2008 was for both the consumer and the banking system.

How are you, Mark, thinking about how tariffs are going to be impacting the financial sector? In your newsletter, you have a piece starting out with how, I think it was a CFO from Standard Chartered, a UK bank, had a very, very negative outlook on how tariffs would impact the financial sector. And also, there's an ancestry there because you write about how the antecedents to Standard Chartered were

drastically hit during the 1930 and 1931 Smooth-Holley tariffs? Yeah. So there's, like in all sectors, there are first order consequences, second order consequences, third order consequences. For the banking system broadly, first order consequences are muted. They are not, as a sector, subject. They will not be subject to tariffs. But

Jamie Dimon used this analogy on his call that the sector is like a cork on the ocean, and the ocean being the economy. And so if the economy deteriorates clearly for reasons we've discussed around credit exposure, banks will suffer, maybe call that the second order consequence. There is

To come back to Standard Chartered, another set of second order consequences related to those banks that intermediate global trade. And there are a group of banks whose whole business model stemmed from that. Standard Chartered is one, HSBC is one, Citigroup is another.

If you go back and read the history of Citigroup, its global network was set up to facilitate trade from initially US companies that wanted to go abroad. Often these banks can be the growth of these banks.

So the UK ones, HSBC and Standard Chartered, and then the US ones can track the global influence of the countries in which they're headquartered and the currencies in which they operate, be it the pound sterling through to the 1920s, 30s, 40s, and then subsequently the US dollar. I often think banks like Citigroup historically are kind of the arms of US foreign policy.

And that was the case also for Standard Chartered historically in the UK. And they still facilitate a lot of trade, trade finance. So they will suffer as trade flows decline. And it is those European British banks, maybe HSBC, Standard Chartered, and then Citigroup obviously is American, but that facilitate global trade because, Mark, there's the world of global macrobe and balance of payments. And that's...

Then there's the world of reading JP Morgan's earnings reports and reading Wells Fargo's earnings reports. And I'm kind of having somewhat unable to connect those things. And if someone only were to read JP Morgan and Wells Fargo and some other regional banks, I think they could be forgiven for almost basically not really realizing that

the rest of other countries other than the United States exist. So tell us what are the exposures to cross-border trade maybe for the more vanilla U.S. banks other than Citigroup? And then also, is it the global banks or the non-U.S. banks that have more of that exposure to global trade and why?

Well, it's not necessarily... So JP Morgan, I would put in that list actually, JP Morgan historically. JP Morgan strategically identified several years ago that it was lagging Citi and HSBC and some others in global payments, global treasury, global cash management solutions, and made a concerted effort to close that gap. So I'd throw JP Morgan in there as well. You wouldn't have seen it in the numbers,

Partly because it's so diversified and so big, and partly because the numbers we've just, again, we've just talked about this, the numbers we've just seen related. You know, you can, provisions can be forward-looking, but revenues are not forward-looking and they close their books on the 31st.

of March. But Standard Chartered has been pushing in there. They hosted an investor day last year. They've been pushing in all of their investor materials, this idea of corridors and that they sit in between a lot of flows that occur within Asia.

a lot of trade flows that occur within Asia and a significant proportion of their overall revenues are sourced from these corridors. Now, one of the things about bank presentations is there'll always be a slide that reflects the last wall. And in this case, it was specifically

the trade war between China and the US. Now, that is still highly relevant, but we've kind of gone beyond that now. And so what the Standard Chartered slide tried to demonstrate is we're not that exposed to those trade flows. It's less than 2% of their network income, their global network income. And look, we've got all of these intra-Asia corridors

But unfortunately, those could be under pressure as well. As protectionism takes hold, as the world, as protectionism takes hold, we don't know yet whether the US will impose a requirement that other countries take.

in order to get a trade deal with the US, cease trade, reduce trade with China. We don't know that yet. But these are all risks that put all of these corridors under pressure and not just that China-US trade corridor.

Has facilitating global trade historically, I mean, over the past, let's say, 20 years, been a profitable and growing business? One of the few things I know about Standard Charter is that the stock has, like many European banks, performed not very well, let's say, over the past 15 years. But you think of a payments business generally as a high-quality business, such as Visa. You did a piece recently about WorldPay and global payments. Well, yeah.

Tell us about just that business of Standard Charter and why it hasn't been super successful, at least superficially. Yeah. So I suppose there's two observations here. One is that the balance sheet required in order to facilitate those trade flows and to sustain a network globally is large. It's a capital intensive business. These banks will argue that it's

irreplaceable it's difficult to replicate that kind of network but it's very capital intensive and that's and investors have shied away from capital intensity one of the reasons why why why payments businesses retail payments businesses have been so attractive in investors mindsets is because they are not as capital intensive even stripe and adyen which have built up

networks globally. They've done it very efficiently. And the amount of capital expenditure compared with what a bank has to support is much lower. So that's one point. And the second point, it's just a general observation, is that anything past 15 years, anything non-US has trailed anything US-oriented. Exceptionalism. I wrote a piece back in January, which

entitled Catch Me If You Can, which looked at the question about whether Europe in particular can, and its banks, can catch up with the U.S., whose outperformance, as you know, has been just remarkable, exceptional, literally U.S. exceptionalism exceptional over the past 15 years. And so without direct access to the U.S. market,

every bank has been competing with two arms tied behind its back. On the topic of US exceptionalism, I'd like to divide it into two areas. One is the US on a fundamental basis really is exceptional. JP Morgan has grown its revenues and profits a lot more than the average European bank. And

And then the second one is basically style drift, that money has been flowing into the United States, and so asset prices have been going up, and therefore it's a self-reinforcing cycle. So basically, the former I'm talking about is a weighing machine, and the second is a fashion contest. How much of the outperformance of U.S. financial stocks over the rest of the world's financial sector would you say is because

you know, deservedly US financial stocks have outperformed and their return on equity and their growth rate is higher versus it's just kind of a fashion show and actually, you know, basically US financial stocks are somewhat overvalued relative to their peers.

Yeah, it's an interesting distinction. With financials, I would say there is an overlap between them because financial markets themselves are a driver to fundamental underlying performance. So we see that, for example, in capital markets, trading and investment banking related revenues, where US banks going back to 2008,

controlled maybe 50% of the global revenue pool, but now they control 70% of the global revenue pool. It's always been the case since Goldman Sachs opened its office in London, that it's been a formidable presence in global markets. And it's been the case that European corporates have hired Goldman Sachs for all the same reasons that US corporates have. But

At least in the early days, there was often also a local regional European bank on the ticket. And that ceased to be the case in the past 10 years, let's say. We could see a swing back. Again, this could be as a response. One of the interesting things about Europe, kind of going off on a tangent a little bit, but one of the interesting things about Europe is that it was seen as an underperformer under the US.

It was a kind of fragmented quilt of different economies. There was no capital markets union. There was no banking union. And the currency, clearly not as attractive as the US dollar. In response to what's been happening very, very quickly, just in the case of the past few months, very, very quickly, Germany has overturned some of the kind of fiscal constraints that it labored under for many, many years.

There is potentially scope for a capital markets union. And there's a kind of an unprecedented cohesion and cooperation in Europe in response to the US. Obviously, Ukraine is a factor as well that we just haven't seen before. So all the reasons why Europe lagged as a response to what's happening in the US right now, they are potentially becoming strengths.

And as part of that, it could be that European corporates say, well, we need... There was a case in Switzerland not that long ago where a public pension fund whose charter is controlled by the government in Switzerland had hired... They fired UBS and they'd hired State Street as their custodian. And when...

up to the parliament in February, March, I went up to the parliament in March to question about whether the custody of Swiss pension assets should be handled by a US domicile firm that could be ultimately influenced by Washington.

Now, they went to a vote. They voted not to abandon that contract, not to terminate that contract early because it was seen as dangerous to Swiss citizens.

reputation as a financial center. They decided not to do that. But the fact that this question came up, increasingly in Europe, the question will come up is, do we need a European investment bank alongside potentially the US investment bank on the ticket, the M&A ticket, the capital markets ticket that we used to have, for example, in the 1980s and 1990s? So we may see a swing and a

kind of maximization of the share of the revenue pool that's being absorbed by US banks right now. Or we may see a swing back to the Europeans. But to come back to your question, it's difficult to disentangle those two things in financials because financial markets are a big part of underlying operating performance for banks. And not just in investment banking and capital markets. Clearly,

Clearly the dollar is also an important factor. And one advantage of those US banks is they have access to dollar deposits, which European banks do not.

And so the fact that Europe does not have a capital markets union, I'm guessing that means that if a Spanish firm were to issue a Spanish bond and French investors were to buy it, the laws are slightly different, the contracts would be slightly different, and the capital markets union would join all those forces? Yeah, exactly. Precisely. There's no banking. Another feature has been there hasn't been that much cross-border

consolidation in the banking system in Europe. The Unicredit of Italy took a stake in Commerzbank some months ago, which kind of fired up expectations that we might see more. But each country still retains its own deposit insurance scheme that hasn't been unified.

Each country, I mean, Switzerland's not technically in the EU, but something that UBS is facing right now is this idea that the Swiss government will force UBS to put aside capital in Switzerland sufficient to fund all of its international operations. And they think about it not in a regional sense, but in a very fragmented sense.

So we just don't have the union in Europe. I would say we, I'm based in the UK. They don't have the union in Europe. That clearly has been a big feature of the US that has created a homogenous, unified market.

So no unified banking insurance scheme would be the U.S. equivalent would be if a bank in Florida went under instead of the FDIC bailing it out. There'd have to be the Florida version of the FDIC and New York depositors would be dependent on Florida. So you can see why that would cause consternation. Mark, talk about why how the U.S. dollar helps U.S.

Two things I would say. One is...

Well, technically it doesn't because of swap lines. So the Fed appreciating its role as the gatekeeper to the US dollar has set up, and this was the case since the financial crisis and it was utilized again during COVID and other occasions.

had to swap lines with all the various central banks such that they, and in turn their banks, have access to US dollars if they need dollar liquidity, which as you point out is kind of what the whole global financial system runs on. The flip side is it gives US policymakers control over banks globally. So many non-US banks suffer the costs

but don't necessarily get the same benefits of access to the US dollar because if they... And we saw this with HSBC, which was heavily fined. We saw it with Standard Chartered, which was heavily fined, some of the French banks, which were heavily fined for either anti-money laundering violations or

violations of sanctions, often, or in the case of Swiss banks through tax violations, then US government can impose US law on these banks. And they've been pretty explicit about this, actually, when UBS was penalized for a number of those things in the past, the US regulator said that these banks need to be

in line with US law. And so they're kind of quasi, so they are subject to the laws of the US across all of those dimensions without necessarily getting the same benefits. But to all intents and purposes, kind of in the belly of the curve, it shouldn't matter because they have access to dollar liquidity when they need it, but it's still a risk factor nonetheless.

And it doesn't improve their competitiveness, just the fact that they're based in the country that has the dollar reserve currency because of swap lines? Well, no, kind of short. So clearly in the case of JP Morgan, they have access to US acquired deposits, local deposits, and the stability that they bring. And that's of huge benefit to them in their international operations as well.

Mark, are tariffs on goods, you know, semiconductors, shoes, oil, things that you can exist in the real world, not services. So current account deficits rather than trade deficits are goods as well as services. The U.S. has a has a service surplus with many countries and the entire world.

And a big part of that is in the financial services. Pretty much everything in the financial sector is not something you can touch with your hand. It's insurance, asset management, banking, cross-border payments, everything. So I imagine it's accurate to say, correct me if I'm wrong, that the U.S. financial sector has a huge surplus with the rest of the world, that the U.S. does the financial work basically of managing assets of the rest of the world. And from Europe, from Asia,

from Brazil, from all these countries, money is just flowing into the United States for investment services and the US is benefiting from that. And it's not even high finance on Wall Street, it's payments like we talked about. Okay, so has there been any rumors of

retaliation from the rest of the world on the US impacting that services and financial services? It's my understanding China has imposed tariffs on the United States, but on goods, not on services. Is there any risk that this goes from the level of tariffs on goods to the tariffs on services? And the US version of that maybe would be the US delisting Chinese shares that are listed on the NASDAQ and the New York Stock Exchange. David Gardner

Yeah, that's, I mean, that's a critical example. I haven't seen, look, I mean, you know, I think it's a starting point, even on goods, the kind of 10% blanket, which covered countries, which in some cases did not have a deficit with the US in any event, still to suffer a 10% would be a starting point. Look, I, you know, no one anticipated what would be on that piece of cardboard in the Rose Garden. So, look, who knows? But you're right, the US, the US,

the UK too, and Switzerland export financial services. Although my thesis is right that increasingly in response, some European corporates may now seek an investment partner, investment banking partner amongst European firms in addition to what they're currently getting out of the US.

and wallet share shifts, then maybe that will change. And putting your macro hat on, your former hedge fund manager hat on, are you seeing just the flow of dollars into the United States slow down with the US stock market going down, the US bond market going down, i.e. yields up, and the dollar weakening at the same time, gold going up? Does that suggest to you that the foreign...

the foreign money that is the capital surplus of the US could be drying up. And also, a lot of the Wall Street firms we haven't actually talked about, but like the alternative asset managers like Aries and Apollo that raise large amounts of money from the rest of the world. How is that going to be affected? So on the first question, it kind of feels like, I mean, I know you've done some work on Japan, haven't you, Jack? And it kind of feels there was a number of theories around

why yields were rising post tariff day. Some of them were technical kind of market structure related theories and others are more fundamental around flows and we have had some early data

you've written about it, which suggests that maybe there is some selling pressure and it kind of feels credible. But it might've happened anyway, given how extreme positioning have got in the run up to April of 2025. You look at the size of a stack, could have mentioned it earlier, but I'll throw it out now. You look at the size of European stock market to the US stock market,

2008, they were similarly sized. And now just the US market dwarfs the European market. It's partly not just a function of what's going on inside the US, being flows and listings as well. But if that reverses, you kind of mentioned China being delisted, maybe London Stock Exchange now

has seen kind of the trough in terms of its share loss versus New York, maybe that will begin to change. As I say, we were in an extreme anyway. The alternative managers, that's interesting. I don't think that's necessarily a US story. I think that's a story also about extreme positioning around alternatives and the flows that they've enjoyed over the past few years. They

There was an interesting story recently about Yale Endowment, which is...

A really interesting case study, because this was one of the first institutional investors to embrace alternatives back in 1985, when David Swenson took over as the CIO of the endowment there, potentially selling $6 billion worth, up to $6 billion worth of private equity on the secondary market. And that's 15% of the overall value of the endowment. That's big.

So if first in is first out, and they've been quick to disclaim that it's a secondary market sale, they're still committed to private equity, blah, blah, blah. But if it is first in and first out, and at the same time as retail is now a completely new channel,

It used to be going back to the early days of alternatives and private equity. It was high net worth. It was endowments. And then it was pension funds. I read a piece about KKR a few weeks ago looking at Washington state pension scheme, Washington and Oregon were the two first movers from the pension industry into private equity. We've gone through that. We then went through sovereign wealth.

kind of 15 years ago when Blackstone and the like were IPOing, they often got sovereign wealth funds to anchor invest in the equity of the GP. And that was part of them winning mandates from sovereign wealth. We've been through that. And now we've come to retail. I don't know who said, if it's first in, are the endowments a first out?

And retailer kind of picking up the slack. That's not great. But then retail is a big market. And one thing we, interesting observation, is I thought we'd see it in 2022 when we saw the market correction. And we're seeing it again now. One thing that intrigues me is how resilient retail actually is in this market. You know, it's 2000 when the TMT bubble imploded. Retail were out.

for a long time subsequent to that. 2022, they came back in. Charles Schwab reported last week. It's all record trading activity. You're always going to see that on a down day, but it's all record trading activity. And everything we're hearing from, clearly Robinhood stock is down, but everything we're hearing from retail brokers and from alternative asset managers, Blackstone reported last week,

Is that retailer resilient? They're still there. And the question is what it will take for them to retreat.

So, Yale is selling. A lot of institutional investors are kind of saying, "No mas, no more on private equity." And private equity and private credit is saying, "We are now raising money from retail investors. Let's get your 401k money. Let's get some stuff in ETFs." Just how far along is that process? I know of two private credit ETFs where you can invest in private credits.

I'm not aware of any ETFs that invest in private equity deals. The general partner stock is a different story, of course. But can people allocate either 401k money to private equity deals in $1,000, $10,000 lots? What is the status of that? And is it still kind of an aspiration for private equity, the industry, or is it already a reality? Will Barron: Right now, it's not a reality.

The industry was lobbying the new administration prior to the events of April to allow, and it's more technicality, there's a kind of a safe harbor they were trying to lobby for, which would allow very risk-averse 401k managers to allocate to private companies.

So it wasn't so much it would require a change in the law, but it would require a change of positioning that the industry was very hopeful would emanate from Washington. And certainly I was in New York kind of in December, just post the election, and the animal spirits were high. I met with a number of the management teams of the alternatives, and they were all talking about it, that change.

401k, private allocation, restrictions will be relaxed. So where that stands now, I don't know. It hasn't happened yet. What they have all launched over the past several years is a variety of not ETF funds. They don't offer daily liquidity, but they offer monthly liquidity, kind of evergreen funds that offer monthly liquidity. And in many cases, they've grown. So Blackstone now runs trillion dollars of assets.

I think I'm correct in saying that a quarter is, they call it the wealth channel. A quarter is high net worth slash retail in various guises. And these are new product structures. They're not your typical fund, which launches draw, they're not your typical draw down fund structure. But they're not quite ETFs. Although they're coming as well. Apollo has launched a private credit ETF. Yeah.

But the flows in those monthly liquidity funds have been high enough.

And those have been for private equity as well as private credit. I remember reading in the Financial Times a few months ago that on a year-over-year basis, or maybe quarter-over-quarter basis, private equity AUM actually shrunk for the first time, which didn't even happen in 2008. But I think the huge area of growth has been credit. So talk about that and how for these alternative asset managers, they're not just private equity shops anymore. They also do real estate and credit and how in particular, credit has been the real growth engine. Yeah.

So on that first point, yes, on that first point, that is right. And the reason is because with the drawdown funds, and this is an issue for Yale, with the drawdown funds, the institutional investors typically require distributions in order to reinvest back into the asset class. So they're maxed out in terms of allocation. They need the distributions to reinvest. And there haven't been any distributions. They're at a

material low because IPO markets have been closed. M&A, certainly under the last administration, actually we've just seen in my sector, the Discover Capital One deal allowed to go through, part of which is predicated on the new administration being more favorable. But certainly in the last administration, M&A was muted. IPO market was closed.

and so they haven't been distributions. And as a result, the institutional investors weren't getting their distributions to reinvest back in new commitments. Retail don't have those constraints. Retail are looking... They're starting with a zero allocation to alternatives, so they don't have those constraints. So private equity overall

This was in the Bain report, actually, which is a great report on private equity that the FT reported on, showed that AUM in private equity for the first time because of that feature was flat. Private credit, you're right, has been huge. It's been a huge market. That Apollo in particular and Ares, which they've got a shared history, ex-Drexel, have promoted and they've been at the forefront of. And that

The dynamics changed probably with high yields. But again, coming back to kind of my curiosity about why things didn't break in 2022 in terms of retail engagement with the market, nor did they break for private credit when the thesis prior to that had been, look at these low rates, see what private credit can offer. And yet even when rates went up, private credit continued to grow.

What do you think happens with private credit from here, if there's a recession and if there's not a recession? If there's a recession, it's negative, but it's more negative than private equity, which takes the first loss. So depending on how these things are structured, private credit, a lot of which is investment grade, should be fine. If there's not a recession, the fear is it's just growth. One of my rules of thumb looking at banking and financial services is

is to avoid growth. You can kind of trade it like you would trade a bubble, but ultimately there's going to come a point where the biggest risk factor is growth. And we've seen that in every crisis, even the one that led to the collapse of Silicon Valley about a couple of weeks ago, where the growth was in deposits, which is the raw material for other securities. But it was the early warning sign, if you like, was growth.

unprecedented levels of growth. And he's seen that in private credit. So I kind of worry about... I don't necessarily worry about it, but regulators have worried about it and they've looked at it very, very closely. There have been a number of features, though, that private equity has flaunted to suggest that they are less risky. One, as they said, historically, we're not retail.

Two, as they've said, we don't offer daily liquidity. Both of these things can generate risk. Three, as they've said, there's no leverage here. You know what's great about private credit? Because what they're really competing with is the banking system. And they've literally explicitly said that the size of the market is as big as the assets that sit on a bank's balance sheet. And they are the better banks.

holder of those assets because they don't offer daily liquidity on their funding. They don't put leverage up against those assets. They're kind of fully funded. And the funders are grownups, they're institutions, they're not retail, who kind of know what they're in for. Now, over the past couple of months, six months, year, couple of years, each of those things has been compromised.

And so we've talked about retail, there's creeping amounts of leverage coming into some of these structures and liquidity kind of linked to the retail piece is being offered on a shorter term perspective than the kind of draw down fund or the longer term funds that typically house this stuff. So at the margin, some risks creeping in.

Marc, you said that a lot of the private credit was investment grade. That's something I've heard from the private credit CEOs and spokespeople. But what does that really mean? Like, is it, you know, Moody's? Do they have they started giving stamping these with investment grade, you know, a few years ago? Like it's are they are they triple B? It's you. Is it is not is it is it the same thing as a publicly traded bond being investment grade? They are they are different things, right?

Well, yes, but kind of who cares what Moody's says? This is, you know, who cares? I mean, Moody's, try a record. Moody's is a phenomenal business. I look at it as well as a financials analyst. Their imprimatur is, you know, that stamp is worth, is hugely valuable, but it's a function of a kind of social structure we've created where we need a third party stamp.

Right. What do you say is investment grade? Or when the CEO of Apollo says it's investment grade, the backing of that is Moody's or S&P, right? Exactly. So to get to the point, so no, it's neither. And one of the arbitrages they see, if you like, is that Moody's and S&P who get paid by the issuer.

don't go out and stamp all the credit that is available in the market, that the universe of available credit is a lot larger than what Moody stamps. And so, but they're looking at performance and the equivalent track record of credit performance is such that it

is investment grade. It tracks investment grade. And so that's kind of what they're talking about. Now, having said that, what they've also started to do, Apollo now has, they say the constraint isn't so much on the investor side, whether it's retail emerging, whether it's pension funds who are looking, they call it fixed income replacement, where pension funds are looking for more kind of esoteric

investment grade assets that don't necessarily have the Moody's stamp. They say there's enough kind of investor demand to meet the supply. The constraint, they say, is the supply, is the supply, is the origination of new credit. And so what they've done is they've gone out and acquired a whole bunch of origination platforms.

that are doing all kinds of loans, asset bank loans. They're doing home mortgages. They're doing airline leasing. They're doing rail leasing. They're doing receivables financing, all kinds of stuff to create product, which they're then able to sell into this pool of demand. And that looks a bit like GE Capital back in the day. That imploded. Typically,

Again, my track record as a financial analyst is these standalone, they're not necessarily consumer finance, but because they also finance airline leases and so on. But the track record of these monoline financing businesses that fund via capital markets is that they're highly cyclical. A lot of them collapsed in 2001. A lot of them collapsed in 2008. We saw a cycle in India.

localized to India more recently than that in the 2010s. Apollo argues that we're putting them all together in great diversification. But if there's a risk, maybe that's the risk. That the track record of those companies, those monoline origination companies, is not great.

And Mark, if there's a recession, if there's a credit cycle, you, other analysts, have a pretty good idea of what that would look like for the publicly traded high yield market and investment grade market. Banks pre-2008, they own too many of these things. It could cause some trouble. Now they don't because of regulation. A lot of them are owned by pretty unlevered players like insurance companies or people who don't have mark to market risk.

or run risk, I should say. And spreads widen 300 basis points in a mild recession. In a severe recession, they go 900, even more. Who knows? But you have analogs. But when it comes to private credit in a recession, I'm going to ask you, what do you think that looks like? What happens to private credit in a recession? You're going to give the intellectually honest answer of, I don't know, because no one knows. But just how are you thinking about that? And what

How are you eyeing the possible scenarios? I think it's difficult to look at the average. I think there'll be a dispersion, there'll be a distribution of outcomes. You know, again, what happens when we see, you know, it's the tide going out, who's swimming naked at that old line, which was actually made, interestingly, everyone knows the line, but it was made about insurance, it was made specifically about the insurance industry. So it's not a dissimilar industry, the one we're talking about now.

And what happens is when you see super high rates of growth, everybody goes in. And underwriting, no one's paid to do as good underwriting as they would in a more difficult situation.

environment. And so what you'll see is dispersion. So I said before, private equity takes the first loss, private credit sits behind it. So broadly, we'll start to see wobbles first in private equity, we should do before we say in private credit,

And then within private credit, we'll see just a dispersion of outcomes depending by companies, which companies were the last in, which companies were growing quickly, taking market share, which companies retained their... Again, it's the old kind of these cliche lines about dancing with the music, which was a Citigroup line from 2008.

Those will be the things to look for, I think, if we are to see a deep recession. Because you're right, a recession in the banking world has been stress tested. Actually, Aries would argue they were around in 2008.

And they've provided very good disclosures on how their funds performed in 2008. The scale is very different from now. And we've got a lot of companies, new companies in there that weren't around in 2008. But then the recession might not be as severe as it was in 2008. So...

Thank you. I've been impressed at the challenges with commercial real estate, particularly office that have been endlessly talked about since 2022. Many people were predicting a demise or severely negative outcomes for commercial real estate. I've been impressed at that industry's ability to kind of just sweep problems under the rug. And I think they've been able to kind of, you know,

emerged through this and they do it because it's a private market. So you're not having forced sales. It's a very slow moving market. Do you think that will also be an advantage for private credit? If in...

This year, let's say, there will be a date at the bottom that HYG will be trading at a very low price, high yield and spread, but it doesn't matter to the Aries and Apollo investors because they're never going to see that market price. So yes, firstly, though, that's a great example of dispersion. The financial services industry is so broad and competitive and in some pockets commoditized.

that you will always see some companies doing crazy stuff. And you write broadly about commercial real estate, but Japanese bank Azura took big losses on US office. There was a German bank, PBB, took big losses on US office. So there are examples.

You put out a tweet today, Jack, about where I'm based, a UK-based currency fund, which has taken losses and has suffered liquidity shock on what's been happening in currency markets right now. There are always examples of losers in the financial industry when a shock occurs.

Having said that, there is a playbook, which is, and we learned it in Europe in the Eurozone crisis, which is kick the can down the road. And this office kind of plays to that.

extremely well. When you're right, you walk down Broadway in Manhattan and you can see the losses and you go and open up a balance sheet and you can't see the mess. There's a disconnect there somehow and it's kicking the can down the road, which kind of works in a lower interest rate environment, doesn't work in a higher interest rate environment.

And these alternative asset platforms, they have so much less regulation than the banks. They would say for good reason. And they don't really take the risks on their balance sheet. Like Blackstone, as you said, manages over a trillion dollars. But their balance sheet, what they actually have as assets and liabilities is way, way smaller. They're just a manager. Tell us, though, the forays into alternative asset managers'

having a balance sheet and taking a little bit more risk. You look at Apollo, who has the homegrown insurance platform, Athene. And then you also have written about KKR, KKR's Berkshire Dreams. Talk about those forays into taking some balance sheet risk, how in the good times they can do tremendous things. But if there is a recession, is there some risk there?

So the analogy could be that with hedge funds, which typically they get to a certain size and they think about themselves, they kind of invert how they think about themselves. Rather than thinking, you know, we are capital light and we're taking 20% of the return through a performance fee or through a carry in the case of a drawdown fund.

They kind of invert that and think, well, hang on a sec. We're such great investors. Why are we giving away 80% of the upside to these guys? And in the hedge fund world, they turn themselves into a family office to capture 100% of the upside. In the private equity world, they say, well, and it happens also actually in venture where Sequoia has done a bit of this, they retain on their own balance sheet

some assets. And so KKR started to do this, looking to increase it. They've analogized themselves with Berkshire Hathaway, actually Apollo doesn't really do it now, but when it launched its insurance company, Athene, they also analogize themselves with Berkshire. I don't know if it's a kind of risk factor, but when anybody analogizes themselves with Berkshire, Bill Ackman did it recently as well with Pershing Square.

Or for different reasons, each have a different approach. But clearly, yeah, they're taking on risk, clearly. And they were never getting paid. The thing about these firms that have had now actually close to 20 years in public markets, Fortress was the first IPO in 2007 before it sold itself to SoftBank. But then Blackstone came in June 2007. So kind of 18 years in the public markets.

They were never really paid for performance fees. They were paid for management fees and they reoriented their income statement to reflect that. But they thought, well, we're such good investors, we'll keep some of it on our balance sheet and we'll grow net asset value.

In that way, we can get some benefit from that. And it clearly is a risk, but they are, you know, they are, don't be too cynical. They are fundamentally good investors. So you would think maybe there's conflicts there.

But you would think they would keep the good stuff on their own balance sheets. But there are conflicts there. You know, when you look at Apollo, which has done a phenomenal job, but when you look at them and you think about, okay, you're managing, you've got the private equity piece, you've got the private credit piece, and you're keeping some of it on your own balance sheet, you're keeping some of it on your assurer's balance sheet.

you're originating for other insurers as well. And then you've got different clients still, a lot of conflicts there. And there is a risk actually, irrespective of the economic risk that I think faces some of these companies. And this was faced by investment banks through the Spitzer investigation in 2000 around equity research. And then also in 2008 around kind of

you know, multiple cases around conflicts between their customers and their corporate clients and themselves. It could be that this is what the risk is. It could be that the risk is that these conflicts become unmanageable between the various stakeholders involved in the process.

Mark, what else in the financial sector is interesting to you? Are you finding any pockets, either that you're finding pockets that are companies that are undervalued and very compelling, pockets that you think are in somewhat of a bubble, or pockets that speak to the themes that are driving the headlines, tariff and international capital flows? So the great thing about financials is...

And I kind of alluded to this before in the sense that there will always be some companies that suffer in a bout of volatility. It's a great insight actually, from a bottom-up perspective into what is going on. Whatever the macro thesis you've got is, there'll be a financial company to play it. Although there'll be basis risk there. There's a company I've been looking at, a small company in India, which is a gold lending company.

I know what you're talking about. Yeah. Right. Interesting company. Actually, there were some regulatory issues that it faced recently. But I guess just the broader point is, whether it's emerging markets or whether it's developed markets, there will be a play on some kind of macro theme. And I think that's just fascinating. And that's really interesting. Specific pockets, I think payments. I think payments are changing.

I think we haven't talked about crypto at all so far, but it is fascinating what's happened there around stable coins in particular. And I think the whole payments landscape is changing is very interesting. The latest piece I wrote was about US payment companies, Global Payments and FIS, who both did deals

It's quite amusing, actually. Both did deals in 2019 and then realized they'd done the wrong deal as they swapped. They kind of swapped the companies they bought. They announced that just last week. That's interesting. It kind of reflects how difficult it is to navigate the payment industry and how quickly innovation is happening there by Stripe and Andean and companies and a lot of fintech companies that aren't public. That's interesting. Yeah.

I think Europe's interesting for reasons we've kind of talked about. What are some of your most interesting situations you're seeing in terms of specific companies? So I don't want to name specific companies necessarily, but we've talked a lot about them. We've talked about some of them on the call. So, you know, like Apollo and KKR on the alternatives, they're in the crosshairs. So there's going to be

an outcome there, which is potentially going to make people a lot of money one way or the other, depending on how it's played. I think European banks, given the extent to which they've underperformed US banks and the extent to which they could be a play on a reintegration of Europe in response to what's happening in the US. I haven't looked at, I need to look at Brazil again. I think actually a lot of the macroeconomists

macro strategists that I trust have almost without exception pointed out Latin America as perhaps a winner globally from the restructuring of the kind of global economy right now. So I probably need to go and look at Brazilian banks again.

So we talked about European banks, alternative asset managers. When it comes to the payment landscape, we'll share your article about that partner swap with global payments and world pay. But

How are you thinking about how the global payments landscape is going to change from here? Are there companies that have had a huge moat that you think will be disintermediated? Are there companies that have been left by the wayside that will emerge stronger? Tell us about this payments, which is one of the world's most important sectors. It is interesting because it's one industry where we've seen this before in other pockets of technology, where a perceived moat

turned out not to be as deep as the incumbent thought. And so distribution was seen as the moat in merchant acquiring that incumbent merchant acquirers, many of which were born as subsidiaries of banks had relationships with merchants either through the banking history or they were able to recruit Salesforce as

acceptance of credit cards grew and they were able to distribute their payments services to merchants broadly and distribution was seen as an unimpeachable note. And then Stripe came along and Adgin came along and they just turned that on its head. And there were actually a number of challenges, just kind of an interesting business case study because there were a number of other challenges which these incumbents faced at the same time.

And WorldPay, which I wrote about, is now on its... I didn't actually even count them up, but WorldPay is now being sold to Global Payments by FIS. FIS bought it in 2019. They spun off some of it in 2023 to a private equity firm, but prior to that had multiple, multiple owners. But it's not even that old, the company. It's less than 30 years old.

You wouldn't call it digitally native, but it's only 30 years old. And what it was highly successful at was selling to e-commerce providers. And so it had a leading market share in e-commerce. And yet, very quickly, it lost its incumbent competitive advantage to Stripe and Addyan.

So to answer your question, they're both worth looking at. I think it's not to say that they... Stablecoins could be the challenge now around payments, alternative payment mechanisms that arise that just kind of challenge the prevailing wisdom. So stablecoins is what I'm looking at. But for now, Stripe actually made an acquisition to mitigate against that risk.

That's an area worth looking at. And there's a lot of money in it. More in the US, and again, it's an interesting notion that in this super competitive market, which is the US, we actually have higher payments rates, higher take rates than we do in the rest of Europe, the rest of the world, where this is much more regulated. And

And part of the reason for that is because of kind of rewards, which is not a peculiarly US phenomenon. We all benefit from rewards, but it's almost religious in the US, the extent to which the consumer embraces rewards. And so you've got these very kind of complex ecosystems between the rewards provider, maybe it's the airline and the consumer,

and the credit card company and the merchant, which kind of create this structure, which is very difficult to unravel.

And so Adyen is publicly traded in Europe. Stripe is still private. Do you think stablecoins are going to disintermediate, for example, Visa and MasterCard? I think a lot of financial technologies, analysts and investors for a long time have said that they would disintermediate Visa and MasterCard, for example, PayPal. But actually, like most people who use PayPal, pay with their debit or credit card, which is Visa or MasterCard. Do you think stablecoins are finally the

the threat to that very strong moat that Visa and MasterCard have? Paul Leonard: Yeah, there's been a lot thrown at Visa and MasterCard and they survived it. Whether it's nationally sponsored competitors, like in Brazil and in India, and Europe tried but failed. Whether it's a response

We're seeing actually in Canada right now to the fact that they are US headquartered companies, US domiciled companies. And we saw a bit of that in Europe prior to the current administration where there was a move to set up a European based competitor to Visa and Mastercard for that reason, the homegrown competitor. So we've seen competition from there. We've seen competition from banks to bank to bank payments.

So there's a company Plaid, which Visa tried to buy, which kind of facilitates that. The DOJ didn't allow it and it was called off. Kind of echoes of Facebook, WhatsApp, Instagram, they kind of bought it to quash it. So they've had a lot thrown at them and they've succeeded. But nothing's forever, right? And we know that in financial services.

We know in technology, companies like PayPal, which was the future once at the advent of the internet in late 1990s. So this is the challenge that Visa and MasterCard will face. But in the meantime, I did a piece a couple of years ago on Western Union, which you thought would have been gone by now. It's one of the oldest financial companies, actually, I think,

It is one of the oldest listed financial companies in the US index. It's one of the longest index constituents in the US Western Union. It's still around. And one of the things that makes it difficult to short these things, particularly when they're not that capital intensive, is they just throw off a lot of free cash flow as divisa and mastercard.

Yes. And, uh, Mark, I think, you know, I followed the crypto space. I think there's a lot of hype there and, uh, a lot of maybe over-promising and a lot of under-delivering and, you know, uh,

Are stablecoins finally going to pose a threat? Because with Bitcoin, it's existed since 2009. Is crypto going to actually do something? All the companies we talked about in the sectors, Aries, Apollo, they do stuff. Is crypto going to actually do stuff and stablecoins? Stablecoins might. So firstly, I would temper some of the enthusiasm I often see out of the US, which is stablecoins are a lower cost alternative. We've talked about why people

payments are more expensive in the US than they are in the rest of the world. And that's partly regulation, partly rewards. And partly that's on the card side, partly kind of the state by state, the history, the legacy structure of wire transfers in the US. Well, the Fed now changes that a little bit. In the UK, we have

Talked about Brazil and India. In the UK, we have faster payments. I can, 24 hours a day, seven days a week, I can make a bank-to-bank payment to anyone in the UK and it's instantaneous and it's free. Wow.

And is that because something the government made or that's... The government mandated it, but the banks support it. So yeah. No, it is. Sorry. No, it is. It is the government. The Bank of England that's just behind it. You know, I understand my car. I had a guy come around to buy my car. He comes, he looks at it. Yes, he wants to buy it. He makes the transfer immediately from his phone to mine. There's no credit risk. I can see it's popped up.

He takes the keys and he drives it off. So it makes commerce smoother and it's government supported. And we have that in other markets as well. So I would tend for some of the infusism I see out of the US for stablecoins globally, because I think it talks to a US phenomenon, which is perversely given how advanced the US is in most technologies.

not as advanced in payments as in other markets. Having said that, I think stablecoin is great. I was looking, Circle filed its S1 recently. Actually, I haven't checked. I don't know for a fact that it's been pulled, that IPO. I suspect it has given market conditions, but I can check later.

It's just really interesting. It's a very interesting intermediary between the banking system and BlackRock, which unlike other stablecoin providers, BlackRock manages its funds in return for a fee. So not dissimilar to kind of the sweep deposits that brokers will offer.

So that's very interesting. And I'll be watching the growth. Interestingly, the head of investor relations is ex-Pythagorean.

Goldman Sachs, XCity, Circle, so has a banking background. Very interesting to see how that develops. That's one company that from the bottom up, I look at to see the growth of stablecoins and what kind of penetration they're having globally. Will Barron: Mark, would you say it's fair to say that FinTech has kind of been in a bear market since 2021 and it went from being a very hot sector to a very underloved sector? Mark Solynd:

A little bit. So, I mean, Klarna is a great example. Klarna also filed an S1, Klarna buy now, pay later company based in Sweden, but filed list in New York just before tariff day. And then subsequently, the market conditions said that it was going to delay its IPO. I think at the peak, it was valued. The peak

was valued at $45 billion. This company, as you say, in 2021, was then valued down at $7 billion in 2023. I think that was in the secondary. And then was looking to IP at $15 billion. So we've seen a recovery from the lows, but you're right.

I think there was a confluence in 2020 and 2021 around low interest rates, as well as everything else that was happening in technology. And kind of the epicenter, if you like, of that was FinTech, where low interest rates, big boon for all technology, but particularly for FinTech.

Can you explain the buy now, pay later business model? How do they make money and what happens if people don't pay it back? I, to be honest, don't really understand it. Yeah. And so if they don't pay it back, they'll take a hit because these are unsecured. These are small ticket, unsecured credits. The argument is that they are small ticket and non-correlated. Yeah.

Clearly correlated in the event of a recession, but non-correlated because they now operate globally. Three big firms, one owned by Block, which was called Afterpay out of Australia, Klarna out of Sweden, and Affirm out of the US. All now global, all small ticket, all looking to diversify across different verticals, categories. So some of them have a background in

kind of cosmetics. Some of them have a background in apparel, but they're looking to diversify across that now. But really, you can think of them as marketing companies. They're kind of paid by the merchant to bring, either actively to bring customers to the checkout because they often now actually have consumer capture built into their apps as well. But even before that, to bring

improve conversion and they all talk about kind of 30% conversion improvement rates and the checkout. You know, if you can click buy now, pay later, you are materially more likely to go through the checkout process than not. And in some cases also it increases basket size. So as a result of those features, the discount fees increase.

that the merchants pay are higher than what they would pay a credit card company. And that's basically the majority share, at least for Klarna, less so for a firm, which does do more lending of their kind of revenue capture rate. So yes, they are exposed. But actually the other mitigating factor is the cycle of the loan is so short because it's buy now, pay later, later being maybe in 40 days time.

So within 40 days, these companies can change their underwriting models. They're getting continuous feedback from all the merchants, which help their algorithms. So they are exposed, but they can adjust very quickly. And most of their earnings, as I say, at least Klana, coming from merchants rather than from consumers.

That's interesting. Mark, I've wanted to interview you for a while, so I'm really glad I got the chance to do so. People can find you on Twitter at Mark Ruby. We'll share the articles on your Substack, your newsletter, Net Interest that we've discussed. Tell people before you go, what was the motivation to start writing? What was the gap you're trying to fill with Net Interest? Yeah, that's a really good question. So my background, I was a hedge fund manager for 10 years, sell side research analyst before that.

The fund I managed focused exclusively on financial stocks globally. We invested pre-financial crisis, during the financial crisis quite successfully, and then post-financial crisis less successfully for various reasons.

I started the newsletter because I was always fascinated by what goes on and what it informs us about the macro economy from within the financial services sector globally. And I felt there was a gap there, a lot of tech content and not that much content about what, when I launched in 2020, was an unloved sector, which is financials. Still, it's unloved relative to tech.

But, you know, there's nothing like a good crisis to change that. Definitely. Mark, thanks again. And thanks, everyone, for listening. A reminder to leave a rating and review on Apple Podcasts, Spotify or wherever else you get your podcast. And if you're listening to Monetary Matters on YouTube at the Monetary Matters Network channel, please like and more importantly, subscribe. It really helps the channel. Thanks again. Thanks, Jack. Appreciate that. Thank you. Just close the door.