The cockroach in the mine
A “canary in a coal mine”, in keeping with the usual expression, or a “cockroach”, with many more to follow, as suggested by JPMorgan CEO Jamie Dimon? Whatever the metaphor, the bankruptcy of Tricolor Holdings looks very much like a warning signal. The firm was a second-hand car dealer offering subprime financing on which due diligence procedures were extremely limited. Neither a credit rating nor even a social security number was required in certain cases. Its decline was precipitated by an accumulation of bad debts, highlighting the financial difficulties confronting the less well-off fringes of the US population. It also echoes the bankruptcies of subprime real estate lenders in the run-up to the 2008 financial crisis.
A comparison with the Great Recession goes further. The bankruptcy of Tricolor Holdings and that of car parts supplier First Brands touched a couple of prestigious financial institutions, including JPMorgan, UBS, Barclays and Jefferies, reviving the spectre of contagion in the banking sector. The analogy with the 2008 crisis is refuted by many observers but not by Governor of the Bank of England, Andrew Bailey. He has warned specifically about the private credit market which is very active in lending to business such as First Brands and Tricolor Holdings. He points out that private credit lenders practise the same type of financial engineering as that found among banks in the run-up to the 2008 crisis, in particular the slicing and dicing and tranching of subprime loans.
Of course, the key question is whether the woes of these companies can be characterised as errors particular to private credit alone or signal deeper structural cracks in the financial system. Whilst, at this stage, there seems to be a consensus that these bankruptcies are idiosyncratic in nature, the size that the private credit market has reached is making some international bodies cautious, not least the IMF. Its managing director Kristalina Georgieva has warned of a “very significant shift of financing” into private credit funds that are subject to little regulation. The institution has also issued a reminder that global banks have exposure of around USD 4,500 billion to non-bank financial institutions – a figure large enough to qualify as systemic.
Are the collapses of Tricolor Holdings and First Brands isolated cases, merely symptoms of the end of the cycle, or do they indicate deeper imbalances? This debate cannot be settled for the time being. And as one crisis is never identical to a previous one, there will be a plethora of perfectly valid arguments to show that these events are quite different to those of previous periods. However, it is important for investors not to minimise these signals and to bear them in mind, especially in an extremely optimistic market environment where promises are highly rewarded and warnings mostly ignored.