Federal Reserve Governor Michael Barr warned that stress within the private credit market could trigger a “psychological contagion” and a broader credit crunch across the United States financial system. As reported by Detik Finance, the warning comes amid rising concerns over liquidity and calls for deregulation on Wall Street.
The $1.8 trillion private credit market has shown signs of strain, with investors waiting to withdraw approximately $5 billion earlier this year due to soaring redemption demands. Barr highlighted that while direct links between banks and private lenders are not currently critical, other sectors remain vulnerable.
“Then you also have the problem of kind of psychological contagion,” said Michael Barr, Federal Reserve Governor.
“People might look at private credit, and instead of saying ‘this is an idiosyncratic problem, these were high risk loans, the rest of the corporate sector is different’, they might say, ‘Wow, there seem to be cracks in our corporate sector. Maybe over here in the corporate bond market, there are also cracks.’” he continued.
Barr noted that such perceptions could lead to a sudden withdrawal of credit, which would subsequently intensify financial strain across the corporate landscape. The Governor has previously dissented on proposals to dilute bank capital requirements, advocating instead for stronger safeguards.
“Then you could have a credit pullback, and that could lead to more financial strain,” added Michael Barr, Federal Reserve Governor.
Specific concern was raised regarding “payment in kind” structures. This mechanism allows borrowers to cover interest obligations by issuing more debt rather than paying in cash, potentially masking the true health of a loan portfolio.
“Basically that just means you default on your loan, and it’s not counted as a default. So that’s worrisome. You can’t look at the book and know which loans are really actually under stress,” said Michael Barr, Federal Reserve Governor.
Despite warnings from regulators, Wall Street banks that have expanded into private lending generally remain optimistic about the asset class. However, Barr characterized the growing pressure to ease liquidity requirements for US banks as “super-short sighted,” pointing to high bank executive pay and rapid share buybacks as signs of excess.
