Trump & Powell Fiddle as Private Credit Burns

September 5, 2025 | Last week we took profits from a number of high-beta stocks in our portfolio. Why did we take some double digit gains in Nvidia (NVDA) and other high flyers off the table? Suffice to say that the outlook for the balance of the year is darkening with each passing day, mostly due to the behavior of members of the Trump Administration. We’ll be updating subscribers to our Premium Service on changes in our portfolio next week. 

Cracks in the world of private credit are getting so wide that some of the inferior players in the game are starting to fail. Remember when American International Group (AIG) pre-2008 thought they were a price maker, but they were actually the chump to a lot of Wall Street banks? Readers of The IRA recall that Goldman Sachs (GS) played a significant, and some say predatory, role in AIG's failure by selling the insurer toxic mortgage-backed securities and then using credit default swaps to bet on their failure.

Now we see the cracks in the wall as Wall Street has stuffed trillions in market risk into the book value world of insurance. Connecticut's Insurance Commissioner is preparing PHL Variable Insurance Co. and its affiliated businesses for potential sale. But there may not be any bidders, meaning that other CT domiciled insurers may have to pass the hat to clean up the mess. 

PHL was placed into rehabilitation as of May 20, by order of the Superior Court of the State of Connecticut, Judicial District of Hartford. PHL Variable Insurance Company is severely insolvent. In May 2024, the Connecticut Insurance Department and Superior Court found that the company was in a "hazardous financial condition" with a negative capitalization over $2 billion.

Based on affidavits of actuaries submitted to the Superior Court by the rehabilitator, the ArentFox law firm reports, the request for rehabilitation of PHL is the result of (1) high face value universal life insurance policies issued by PHL Variable Insurance to insureds over 70 years old between 2004 and 2007 maturing, and (2) a substantial portion of the companies’ investment assets consisting of bonds and structured securities that are “below investment grade or are at the very lowest rung of investment grade.”  That is, junk bonds. 

PHL Variable Insurance Company is reportedly owned by the Nassau Financial Group, which is backed by private asset manager Golden Gate Capital.  At the start of 2025, Nassau Financial Group reportedly raised $200 million in nonvoting equity from Golub Capital, which now holds the largest minority equity stake in Nassau. Private credit powerhouse Golub Capital joins previous investors Fortress Investment Group, Wilton Reassurance Company, and Stone Point Credit as investors in Nassau. 

But is private credit really an attractive area for new investment? Why do major firms focused on retail investors push private credit strategies? Fees. Most mutual fund firms cannot survive in their present form. Pushing risky credit strategies onto retail investors is a way for investment firms to immediately and dramatically boost returns. This includes management fees equal to 1-2% on committed assets vs a few basis points for operating a mutual fund.  The asset-weighted average fee for all mutual funds dropped from 0.44% in 2023 to 0.42% in 2024.

Apollo Global (APO) CEO Marc Rowan spoke to CNBC earlier this week “about the foundations of our financial system, the shift we’re seeing towards integrating both public and private assets in investment portfolios, and the evolving role of private credit as a fixed income replacement.”  To listen to Rowan, investors should sell all of their public equity and debt securities and put their assets into private credit. Right? There’s no concentration risk in private credit, right Marc? 

Even as private credit players like PHL Variable Insurance head for the rendering hut, the wheels are starting to come off of the cart more generally in private credit and the related disaster known as private equity. The number of PE portfolio companies that are using “payment in kind” or PIK to avoid default on private debt is growing, but US regulators at the SEC and the Fed are strangely silent. And even a Fed rate cut may not save many private equity issuers from collapse. 

The usage of payment-in-kind (PIK) debt in private credit, which is a component of many PE portfolios, has reached a new high, with one report indicating 11.4% of all private debt investments had some form of PIK in Q2 2025. PIK is when an insolvent borrower pays investors by giving them more debt or equity instead of cash.

As we described in The IRA Bank Book for Q3 2025, loan forbearance and negotiation with creditors have replaced foreclosure and bankruptcy, but this behavior has a finite endpoint. How much of total bank exposure to private credit is receiving some form of forbearance? We'd guess at least one quarter of all deals. We commented on the change in bank rules regarding forbearance and loan modification in a report by Joshua Franklin the Financial Times.  

Meanwhile in Washington, members of the Federal Reserve Board are worried about the upcoming meeting of the FOMC and the continuing attacks by the Trump Administration, which wants to put Steve Miran on the Fed before the September vote to ensure a reduction in interest rates. 

Wall Street folks may believe that President Donald Trump is calling for Fed rate cuts because he’s concerned about the growing pile of defaulted assets accumulating in the world of private equity and credit, but that would be a lie. In fact, Team Trump is merely trying to cement a win for Republican Party in next year’s mid-term elections. They are largely indifferent to the growing signs of distress in private equity and credit.

But the big threat to the markets may be a repeat of the Fed’s mismanagement of the short-term funds market a la December 2018, when the very new Chairman Jerome Powell almost crashed a couple of money market funds and mortgage REITs. He quickly executed a perfect pirouette, dropped the target for fed funds three times and began to buy securities and sell TBAs – this a year before COVID began. Now banking market insiders are saying that the Fed’s model for the minimum level of bank reserves may be wrong. 

“We could see some temporary pressure around the tax date and quarter-end in September,” Dallas Fed President Lori Logan said last week in remarks prepared for a panel at a conference hosted by Mexico’s central bank. She expressed confidence that the standing repo facility (SRF) and discount window would suffice to deal with any funds shortage in the money markets.

Meanwhile, Bill Nelson, Chief Economist at Bank Policy Institute, penned an alarming comment about the Fed’s management of bank reserves.  Nelson is a very careful and knowledgeable economist who understands the cash reality of the Fed’s relationship with the US Treasury. Given the size of the Treasury’s General Account (TGA) at the Fed, and the significant fact that this $800 billion cash pile is half funded with debt, Nelson’s warning is notable.  Nelson:

“The minutes to the July FOMC meeting indicate that the Committee may be intending to take an odd and unnecessarily reckless approach to balance sheet management in the coming months.  The minutes note that because the ON RRP facility will soon decline to zero, further reductions in Federal Reserve assets will result in sustained declines in reserve balances for the first time since QT began in June 2022.  The minutes also note that there will be days – “quarter-ends, tax dates, and days associated with large settlements of Treasury securities” – when reserve balance will temporarily drop sharply.  The desk manager indicated that on such days, “utilization of the SRF [standing repo facility] would likely support the smooth functioning of money markets…”  Similarly, a couple of FOMC participants “…highlighted the role of the SRF in monetary policy implementation…”

We see two basic problems with the Fed’s management of bank reserves, deposits with banks that it creates via open market operations. When the bond purchased by the Fed is redeemed, the deposit created disappears because the Treasury is in deficit.  But the Fed really has no visibility into the disposition of reserves and thus the availability of liquidity to the broad market. Both Nelson and George Selgin of CATO Institute have made this point about the uneven (and unknowable) distribution and availability of market liquidity.  

The second and more significant problem is that many banks and dealers are still not prepared to actually use the SRF or discount window. We agree with Nelson that placing emphasis on the SRF or the discount window as solutions to a sudden scarcity of reserves is reckless and quite strange. It's almost as though Fed officials want to see the money markets to seize up a la December 2018.  Again, Nelson comments on the odd choice made by the Fed staff:

“The Fed’s official plan is to continue QT until reserve balances decline to what staff judge is the minimum amount needed to implement monetary policy using the Committee’s current approach – a “floor system.” This is an odd plan because the Fed has two options that are superior to relying on the SRF that are not mentioned.  Most obviously, the Fed could use temporary operations to offset the sharp declines in reserve balances.  The days when the declines occur are known in advance.  The Fed could either conduct a large repo operation on those days, or layer in term repos in advance of those days, or both.  As the TGA returns to its normal level, the temporary operations could be wound down. By doing so, reserve balances can continue to decline gradually rather than abruptly.”

To us, the Fed’s management of market liquidity is the single most glaring operational deficiency at the central bank. Instead of following the lead of other central banks that rely upon market indicators to judge liquidity, the New Dealers at the Fed are still trying to play god with private markets, trying to manage the ebb and flow of the money markets and the crucial relationship with the Treasury’s cash raising and remittance operations. This effort is bound to fail, perhaps with disastrous results.

If the Powell FOMC crashes the short-term markets, again, because the Board staff mismanages the required level of liquidity, Powell will need to resign same day but the real loser will be the Trump Administration.  Neither the public nor members of Congress will understand who caused the latest market upset, but they will be happy to blame Donald Trump and members of his team.

Further Reading:

How Fannie Mae, Freddie Mac release could change mortgage costs

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