America’s private credit boom is turning into a game of musical chairs—and that’s a worry

Think of all the stories in 2006 and early 2007 about subprime mortgages, underwriting fraud and various other technical-sounding events that seemed far removed from the real US economy and retail investors—until they weren’t.

Starting late last year and accelerating in 2026, private credit has been the subject of lots of stories [in the US] about complicated problems facing a sector that’s gone in short order from being largely invisible to managing more than $3 trillion and becoming a crucial lender to riskier businesses.

We’re not seeing an abnormal number of defaults or missed payments, but this is due largely to the way these deals are structured. The ‘shadow default rate’ in US private credit increased 150% between the final quarter of 2021 and the fourth quarter of 2025. More broadly, the extra yield the market demands to lend to risky borrowers is near historic lows, so this is not (or not yet) a problem for public bonds or bank loans to companies.

The barrage of negative private-credit news may turn out to be a tempest in a teapot with temporary losses restricted to investors able to absorb them. Or it could be the opening salvo in a financial crisis.

It’s hard to tell now, when we’re at the beginning of a credit crunch which resembles a game of musical chairs.

Who will lose out when there are fewer seats at the cash flow table? And more importantly for the financial system, will there be an orderly assignment of losses into hands prepared to hold them? Or a messy scramble leaving all parties bloodied and chairs broken?

Private credit grew in the 2008 financial crisis’s aftermath, when regulators moved to get riskier lending off bank balance sheets and into the hands of long-term, real-money investors capable of absorbing losses during credit crunches. Until recently, only sophisticated institutions and ultra-wealthy investors could access private credit funds—a largely hidden corner of finance where non-bank lenders raised money to make loans to mid-size companies, away from the scrutiny of public markets.

The sector’s years in the shadows ended thanks to a regulatory change pushed through by an executive order last August, allowing private credit funds to sit inside 401(k)s [America’s employer-sponsored retirement savings plan].

For those who have one, some of their retirement savings may already be there. They may also own some public Business Development Companies or private credit ETFs. Their bank may have lent large amounts to the sector. Public pension funds, endowments and insurance companies have significant exposures to the market too.

During the ‘musical chairs’ phase, borrowers are not generating enough cash to make payments on loans or cannot access new funds to repay maturing debt. In simpler days, the bank lender absorbed the loss from its capital buffers and excess interest income on performing loans. It could afford to work for years through restructuring or bankruptcy to get partial recovery.

Private credit is more complicated. Some private credit funds retain as much as 30% of assets under management as cash to cover redemption demands and cash shortfalls. Most funds can limit redemptions and all funds can cut payments to investors. Some funds can try to raise additional capital or sell positions, but when private credit is troubled, these alternatives may be unattractive or impossible.

If a fund has borrowed money, its lenders can try to grab some cash by cutting the value of the loan on their books—although only lenders like JPMorgan have this power—and demanding additional margin cash. Many borrowers have the option to repay debt via additional debt rather than cash, further sapping the fund’s liquidity.

The original plan for private credit was when bad times hit, losses would be absorbed by long-term investors who would find themselves temporarily holding frozen investments with little or no cash return. With appropriate portfolio planning, this is a survivable event that should have limited impact on the real economy or broader financial system.

In the immortal words of Mike Tyson, “Everyone has a plan until they get punched in the mouth.” We are not seeing an orderly fire drill of people heading calmly for designated exits. Rather, there seems a tussle among banks, borrowers and investors to get the first crack at whatever cash is available. We are yet to see who gets punched in the face. ©Bloomberg

The author is a former head of financial market research at AQR Capital Management.