MNI INTERVIEW: Private Credit Poses Systemic Risks - Ghamami

A lack of transparency in the rapidly-expanding market for private credit raises risks to stability, particularly as it deepens links between different parts of the financial system, former Securities and Exchange Commission economist Samim Ghamami told MNI. 

“Private credit has deepened the interconnectedness of the financial system in times of stress,” Ghamami, also a former economist at Treasury and the Fed board, said in the latest episode of MNI’s FedSpeak Podcast.  “Under large negative shocks, a highly interconnected financial system can actually become highly fragile.”

The bankruptcies of auto-sector firms First Brands and Tricolor last month provide warning signs about opacity, noted Ghamami, adding that investors were forced to rely on industry statements to gauge risk.

“We can’t construct a systemic risk measure to monitor potential vulnerabilities in the financial system in the presence of private credit,” he said.

Ghamami recently co-authored a study on the slice of private credit about which there is the most available data, Business Development Companies or BDCs. Among its findings was that the rapid growth of private credit, which he says has expanded by more than 20% on an annual basis in the last five years or so, has increased the linkages between various corners of financial markets ranging from insurance to banking. 

The levels of interconnectedness – and thus the possibility of synchronized losses when downside risks materialize – grew considerably between the 2008 Global Financial Crisis and the Covid episode, Ghamami said.  

“This happened in the presence of unprecedented growth in the private credit sector,” he said. “BDCs are becoming the main contributors to these common components that explain risk and variability in the financial system.”

Ghamami said the private credit market is now a substantial USD2 trillion versus a non-financial corporate bond sector of around USD14 trillion. This growth requires greater access to data and supervisory power for regulators, he said. 

The paper argues that “proactive measures on regulation, transparency and macroprudential preparedness can substantially reduce the systemic risk posed by private credit markets as they quickly grow and become increasingly intertwined with the regulated financial system and public markets.”

FED POLICY OUTLOOK

Talking about the Fed, Ghamami said that while it has been overshooting its inflation target for quite some time, it’s not such a bad thing to have consumer price growth hanging out around 2.5-3% – above the 2% target – as long as it’s stable around those levels. 

The trouble is that the current environment of high government deficits and robust growth mean that there’s a risk inflation could keep rising beyond those levels, Ghamami said. (See MNI INTERVIEW: Fed Easing Constrained By High Inflation-Sahm)

“I’m in the camp that thinks there is no hard science behind the inflation target of the Fed being 2%. So if inflation remains stable around 2.5-3%, that’s acceptable,” he said, noting that Fed officials cannot admit this publicly. 

Yet because the neutral rate has also likely risen post-Covid, lowering rates too far could cause inflation to reignite beyond those levels. 

“But in the medium- to long-run, I strongly believe that compared to the pre-Covid era, we are in an environment that is more inflationary. Inflation could come down to something around 2% but on average we are going to have episodes of bursting inflation at a minimum.”

As for a December cut, Ghamami believes a divided FOMC indicates officials are still on the fence about further moves.

“There is less consensus because of the complicated economic environment that we live in. I’d be more worried about inflation than cracks in the labor market," he said. Still, Ghamami thinks there are enough hawks on the committee to keep the fed funds rate, currently at 3.75-4%, from going below 3.5% in 2026.