The other day, my colleague Damiano, who runs the expert witness business with which I have chosen to affiliate, called me from London. He had just attended some sort of gathering of litigation professionals and had come away with a distinct impression that there is a crisis blossoming in the arena of private credit that will be leading to a substantial wave of litigation. It’s Damiano’s job to stay tuned into the financial markets and get out ahead of trends like that so that we as a firm can get properly positioned to take advantage of these sorts of waves. As I have always said, you can either get crushed by the waves in the financial world or you can learn to surf on top of them. The distinction in the two outcomes is rather stark. With one you find the agony of defeat and come up beaten and battered and with the other you become super-cool and, as Dire Straits said. “get money for nothing and the chicks for free”.
I am a regular reader of the financial press. I read the Wall Street Journal, as I have for more than fifty years, but I also read the Financial Times and the Economist. I think what I like about those publications is that while they give you the micro details you need to stay current, they mostly focus on the macro global issues that I tend to prefer rather than the “where can I next make a buck” issues that many financial journalists tend to focus on. I guess I fancy myself more of an economist than a trader. There has been a lot written lately about the burgeoning area of private credit. My career in banking has always revolved around disintermediation. In the earliest iteration it was about short term commercial bank loans, the bread and butter of the industry for many years, getting replaced by commercial paper.
Bank disintermediation is the process by which borrowers and savers bypass traditional banks and deal directly with each other through capital markets or alternative channels. It has reshaped global finance repeatedly over the past century and actually began well before my entry into banking in 1976. In a traditional banking model, banks sit in the middle — they take deposits from savers (paying them interest) and lend that money to borrowers (charging higher interest), pocketing the spread. It’s called spread lending and it is as old as the Phoenician money changers. Disintermediation removes that middleman, allowing savers to invest directly in securities and borrowers to raise funds directly from markets. The bank’s role as intermediary shrinks or disappears entirely, and with it goes the government’s tried and true mechanisms (like the Federal Reserve and bank regulation) for controlling the economy. The seeds of disintermediation were planted with the development of organized bond and stock markets. Large corporations and governments increasingly found they could raise money more cheaply by issuing securities directly to investors than by borrowing from banks. Investment banks facilitated these transactions but did not take the money onto their own balance sheets the way commercial banks did. They merely acted as agents for that flow. The railroads of the 19th century were largely financed this way with massive capital needs that exceeded what any single bank or multiple banks could fund.
The most consequential early episode of modern disintermediation was triggered by government regulation. Under Regulation Q, enacted after the Depression, U.S. commercial banks were prohibited from paying interest on demand deposits and were subject to interest rate ceilings on savings accounts. This worked fine in a low-rate environment, but when inflation accelerated in the late 1960s and especially the 1970s, market interest rates rose well above what banks were legally allowed to pay depositors. The result was predictable. Savers pulled money out of banks and put it into Treasury bills, money market instruments, and other securities that paid market rates. This was classic disintermediation with the banks lost the deposits and the savers going directly to the capital markets. Banks found themselves starved of the cheap deposit funding they depended on, creating a serious strain on the system. The money market mutual fund was the institutional innovation that formalized this first wave. Launched in the early 1970s, these funds pooled investor cash and invested in short-term instruments like Treasury bills, commercial paper, and certificates of deposit , all paying market rates that dwarfed what regulated banks could offer. By 1980 they held hundreds of billions of dollars that had migrated out of the banking system. They represented a direct structural alternative to bank deposits, and they have never gone away.
On the borrowing side, large creditworthy corporations discovered they could issue commercial paper (short-term unsecured debt) directly to money market funds and institutional investors at rates cheaper than bank loans. This eliminated the bank entirely from short-term corporate borrowing. It was in those days that we at Bankers Trust, bravely challenged the conventional wisdom and began selling and placing commercial paper for corporations, much to the chagrin of the regulators. I was part of that very effort in my early career. By the 1980s the commercial paper market had grown enormously, and banks found their best corporate customers increasingly bypassing them for direct market financing. Banks responded by moving down the credit quality spectrum, taking on riskier loans — a dynamic that contributed to the Latin American debt crisis and later the LBO lending boom. They also started syndicating loans rather than just holding them on their balance sheets.
Securitization was perhaps the most profound disintermediating force of the late 20th century. The concept was straightforward. Take a pool of loans (mortgages, auto loans, credit card receivables), package them into securities, and sell those securities to investors. The bank originates the loan but doesn’t hold it; the risk and the funding come from capital markets instead. Wall Street extended the model beyond mortgages to virtually every asset class. The result was that a bank could originate loans without needing deposits to fund them. It just needed to find investors willing to buy the resulting securities. This transformed banking from a hold-to-maturity model into an originate-to-distribute model, fundamentally changing the risk dynamics of the entire system and ultimately contributing to the 2008 financial crisis when the securitization machine produced instruments far more complex and risky than investors understood.
Michael Milken and Drexel Burnham Lambert demonstrated that below-investment-grade companies could also bypass banks by issuing high-yield bonds directly to institutional investors. This opened capital market access to companies that previously had no choice but to borrow from banks, further shrinking the universe of borrowers dependent on traditional bank lending. The term “shadow banking” captures the broad ecosystem of non-bank financial intermediaries like money market funds, hedge funds, private equity, mortgage REITs, and finance companies that collectively perform bank-like functions without bank regulation or deposit insurance. By the mid-2000s the shadow banking system in the U.S. was arguably larger than the traditional banking system measured by credit intermediation. The 2008 crisis exposed how deeply interconnected and fragile this system was, but it did not disappear afterward — it evolved. What it evolved into is called Private Credit.
The post-2008 regulatory environment with higher capital requirements under Basel III, stress testing, and leverage limits, all made traditional bank lending less profitable for certain categories of borrowers, particularly leveraged buyouts and middle-market companies. Private credit funds, initiated by the already over-ripe private equity players, rushed into the gap, providing direct loans to companies that previously would have borrowed from banks or the syndicated loan market. By the mid-2020s private credit had grown into a multi-trillion dollar asset class, representing perhaps the most significant ongoing structural disintermediation of traditional bank lending. Add to that the advent of cryptocurrency, which introduced the concept of a monetary system with no bank or central authority at all and decentralized finance (DeFi), which extends this to lending and borrowing, and you have some pretty significant market turbulence. Protocols like blockchains and smart contracts are starting to replace loan officers and credit committees and the transformation of credit and the credit cycle are monumental. While DeFi remains a small fraction of total financial activity and has had serious growing pains, it represents the most radical theoretical challenge to bank intermediation ever conceived.
The paradox of all of this is that throughout all of this history runs a persistent irony: every major wave of disintermediation has eventually pulled banks back in through the side door. Banks sold commercial paper, created money market funds, ran securitization desks, underwrote junk bonds, and now manage private credit funds. They have proven remarkably adaptive at finding new ways to earn fees from the very processes that were supposed to eliminate them. True elimination of the bank has proven elusive — what has changed is the form the intermediation takes and who captures the economics. One of the things that has kept this connection strong is the banking system’s continued control over the global payments system, something that is constantly under attack these days.
So, Damiano wanted me to write an article on private credit and I found that while I have not participated directly in the space, my whole career in banking was, in ore way or another, part of the pretext for where we are with private credit in the financial world today. I wrote the article and found it flowed quite naturally from all my experience and my feel for the macroeconomic trends which brought this new arena into existence. Sometimes being forced to consider something leads to a case of finding one’s financial heritage.