What's Actually Happening in Private Credit | Sixth Street CEO Explains

This conversation with Alan Waxman, founder of Sixth Street, delves into the historical evolution of financial systems, highlighting how regulations and incentives have shaped market structures and investor behavior. Waxman outlines three distinct systems, tracing their origins and consequences. **System 1 (1933-1999): The Era of Stability and Separation** The narrative begins with the aftermath of the 1929 crash and the Great Depression. Prior to 1933, the financial system was largely unregulated, a "wild west" with commercial and investment banking intertwined, leading to significant conflicts of interest and contributing to the crash. The Glass-Steagall Act of 1933 and the establishment of the FDIC were pivotal. Glass-Steagall separated commercial banks (deposit-taking institutions) from investment banks (principal risk-taking activities). This separation, along with deposit insurance, created a more stable financial environment. System 1, spanning from 1933 to 1999, was characterized by conservative commercial banks with low-risk appetites. While it provided stability, it wasn't optimized for economic growth. The fixed-income market was less developed, and investment banks primarily focused on facilitating transactions rather than holding assets on their balance sheets. A criticism of this system was its lack of competitiveness in a globalizing world. This led to the repeal of Glass-Steagall in 1999, partly driven by the desire for American banks to compete with European counterparts that had already merged commercial and investment banking functions. **System 2 (2000-2008): Deregulation and the Global Financial Crisis** The repeal of Glass-Steagall in 1999 ushered in an era of deregulation, leading to a wave of mergers between commercial and investment banks. This consolidation created financial powerhouses but also necessitated investment banks to leverage up to compete, as they no longer had direct access to the cheap capital of commercial banks. Simultaneously, the fixed-income market experienced massive growth from the 1980s to the 1990s, providing financing mechanisms for increased leverage. This period saw significant increases in leverage for both commercial and investment banks, culminating in the Global Financial Crisis (GFC) of 2008. While the direct attribution of Glass-Steagall's repeal to the GFC is debated, Waxman suggests it was a contributing factor, alongside a broader lack of guardrails and misaligned incentives. The core lesson from this system is the inherent danger of liquidity and asset-liability mismatches combined with excessive leverage, a cocktail that has historically led to financial crises. **System 3 (Post-2008): Enhanced Regulation and the Rise of Private Capital** In response to the GFC, two key regulatory changes were implemented in 2010: Basel III and Dodd-Frank. Basel III imposed restrictions on capital (leverage) and liquidity for commercial banks, forcing some investment banks to become commercial banks. Dodd-Frank also aimed to regulate principal investing activities. These measures created a more robust system for traditional commercial banks, making them safer and more stable pillars of the financial system, backed by government insurance. However, these regulations created a gap in the market for principal risk-taking capital. This gap was filled by the burgeoning private capital industry, including private equity, private real estate, private infrastructure, and private credit. Unlike commercial banks, these private capital vehicles typically have matched assets and liabilities, meaning investors cannot demand their money back on short notice due to the illiquid nature of their investments. This system, characterized by safer commercial banks and private capital providing risk capital, worked well until around 2018. **The "Factory Model" and the Shift in Incentives (Post-2018)** The year 2018 marked a significant behavioral shift, ushering in what Waxman calls the "factory model" of investing. This model is defined by the industrialization of both fundraising (liability gathering) and asset deployment. The primary driver for this shift was the increasing multiples (Fee Related Earnings - FRE) that asset management companies commanded in public markets. Higher FRE multiples incentivized firms to raise capital as quickly and as much as possible, often leading to a concession on the terms of capital raised, potentially creating asset-liability mismatches. This factory model begins on the liability side: firms focus on raising vast amounts of capital rapidly. This abundance of capital then dictates behavior on the asset side. To deploy this capital quickly, firms may lower underwriting standards, increase origination volume, and accept less favorable terms. This contrasts sharply with the traditional "artisanal" model focused on outstanding investment returns. The industrialization of fundraising led to the industrialization of asset deployment, prioritizing speed and scale over the quality of investments. Initially, this trend manifested in Separately Managed Accounts (SMAs) within the institutional channel, where investors sought dedicated funds for specific strategies. However, as growth in SMAs tapered, the industry increasingly turned to the wealth channel (retail and mass affluent investors). This channel is historically easier and cheaper to raise capital from, but also more prone to rapid redemptions during times of market stress. The factory model, driven by the incentive to maximize FRE multiples, led to the raising of capital from the wealth channel in ways Waxman considers irresponsible, such as offering semi-liquid vehicles for illiquid assets. **Current Challenges and the Path Forward** The current situation, characterized by asset-liability mismatches in the wealth channel and the rapid deployment of capital under the factory model, is seen as a symptom of a deeper behavioral shift. While not currently systemic due to a relatively healthy economic backdrop, it highlights the risks of illiquid assets being paired with short-term redemption windows. Waxman believes a recalibration is necessary. Responsible investing in the future will require governing the amount of inflows, especially for narrow strategies. He advocates for wider investment apertures to navigate the natural supply-demand dynamics within different asset classes. Firms must also possess the capabilities to manage diverse strategies. Transparency about redemption terms and a clear understanding of investor suitability are crucial. Ultimately, Waxman emphasizes the importance of clarity of purpose, strong values, and a long-term perspective. He contrasts the "factory model" with a more principled approach, highlighting Sixth Street's decision to avoid certain vehicles like perpetual private BDCs due to their misalignment with the firm's core purpose. The principle of "facing the tiger" – confronting challenges head-on with resilience and a commitment to excellence – is presented as a guiding ethos. The conversation concludes with reflections on personal development, measuring success beyond traditional metrics, and the enduring power of relationships and experiences. The accelerating pace of change, driven by AI and other forces, necessitates continuous learning and adaptability for both individuals and organizations to navigate the ongoing era of creative destruction.