Private debt began as a niche financing approach, but has ballooned into a $2 trillion industry over the past 15 years, funding everything from local home-repair shops to AI data centers.
Regulators and investors are taking note. Earlier this year, private debt evergreen funds that give retail investors a flexible way to back private companies made headlines for limiting withdrawals. And the Federal Reserve has cited increased pressure on the industry’s private credit segment as a risk that could “result in a tightening of credit conditions that could spill over into broader credit markets.”
How did private debt, an umbrella term for certain financing sources that emerged outside of traditional banks, grow so fast? And what does it mean for the rest of finance?
We talked with Victoria Ivashina, the Lovett-Learned Professor of Finance at Harvard Business School, and an expert in private debt. We discussed how that market expanded alongside private equity, why it’s attracting top-tier talent, and what policymakers are considering now. Here’s what we learned.
Private debt gained steam after the financial crisis
“The reason behind the growth of private debt in the 15 years following the 2008 financial crisis, first and foremost, is the increasing allocation to private equity and its consequent expansion. There was a systematic shift in allocations to private equity across a pension fund system, for example.
So as private equity gets flooded with money after the financial crisis—and that is in the context of a super-low interest rate environment—it starts pushing into the areas where it wasn't that dominant before. In this case, the middle market, specifically.
If you think about movement of financial markets generally, it always starts in more obvious places like large public companies. And then starts moving into smaller, not public [companies]. And so private equity started pushing into this larger middle-market.
However, private equity—and this is not hidden fact—delivers you a leveraged return. So the way they hit a 20% promised return in part comes from their ability to handle higher leverage [or using borrowed money to acquire, operate, and eventually sell companies].
Now that PE is pushing into this middle market, well, that's all great, but you need leverage—access to capital to borrow—to get to the desired return. That creates this massive demand for debt, specifically highly levered, risky debt.”
High leverage means high yield—risks that banks won’t take
“High leverage—loans with higher loan-to-value ratios that bring more credit risk—is something that banks never used their balance sheet for, even before the financial crisis. Banks are not the right candidates to do that.
They can be intermediaries. They'll be happy to place you in high-yield bonds. They'll be happy to arrange and syndicate your leveraged loan, but they are not the ones who want to put their balance sheet up for it. So, you need somebody's balance sheet.
This is why a law passed in the ‘80s created ‘business development companies’ (BDCs)—specialized funds for investing in small, medium, and distressed companies.
In the years following the financial crisis, if you were familiar with the PE industry, you could see the size of the opportunity that private debt represented. PE capital was already committed and looking to be deployed, increasingly into the middle market and technology sectors, but those investments needed leverage.
Once there was sufficient scale, it made sense to start building these massive private debt firms and investing capital. All the firms that are either alternative conglomerates, like Blackstone or Carlyle or new firms like Blue Owl, saw the size of this opportunity, and built on the technology that already existed. It just needed to be perfected and scaled.”
Private debt is eyeing new opportunities, including in AI
“Private debt was tracking private equity, it was lending to private equity for over a decade. But over the past five years, private equity fundraising stabilized. I have written about this becoming an issue back in early 2022. Private debt starts pushing into the new territory partly because of that.
So the data centers are one place. Private debt has been very active in engaging in that space through large transactions. That's an example that illustrates how the private debt industry understands the broader dynamic of the alternative asset management space, and they're looking for the big opportunities where private capital—this active, informed, expensive asset class—can make a difference.”
Private debt is attracting highly-skilled financial talent
Ivashina’s research estimates that the private debt industry has added at least 4,000 employees between 2000 and 2024, bringing people from many segments of finance.
The private debt model is “much closer to what a leveraged loan desk does, or what M&A bankers do, in terms of type of skills that they deploy. Those are complex skills to develop—they have a moat because you build them over time. It takes practice.
If you were going into banking, M&A was always the top job, right? Similar to what it takes to become an excellent M&A banker, in private debt you need years of your own experience, talent, and relationships.
Private debt has that element of thinking creatively about finding financial solutions to clients' needs. That dynamic of the job sounds very interesting, and draws talent from all corners of the financial industry.”
Policymakers are evaluating private debt’s economic impact
“There are a lot of ongoing efforts to try to understand what might be a stress scenario, so that’s something I think we’ll have a much better grasp on within the next year or so. While it’s not regulated in a strict way, there is definitely goodwill and communication among market participants and regulators.
Keeping an eye on how it’s all interconnected is important because a small problem in one place can become a huge problem that could be amplified by something else.
Overall, I'm not alarmed, as I've written in the past. Two things I’ll note:
One is we need better transparency, better standardization of valuation practices. Uncertainty about valuations is very dangerous as it introduces jumpiness to capital flows.
On the other side, it's super important to keep an eye on what private debt connects to. So even though I'm not particularly concerned about magnitudes of private debt challenges per se, it can be interconnected with parts of financial system that are more explosive. This is what happened in 2008 with subprime lending. On this point, I'm seeing a lot of effort and openness to digging deeper and understanding potential risks better, and engaging the industry in that dialogue and collaboration.
Policymakers, academic economists, and the industry have been doing the right steps to understand the interconnectedness. And we'll know more in the next year as a result of these efforts.”
Photo credit: Evegenia Eliseeva
