Oil prices and the woes of the alternative asset industry are closely intertwined. While the private credit and PE sectors alone may not trigger the next global economic crisis, when combined with higher oil prices, higher inflation and sluggish growth, the two might just push economies around the globe into the sort of crisis the world last witnessed in 2008.
Michael Hartnett, a strategist for Bank of America, last week warned that the combination of an oil spike and private credit concerns is making market activity resemble the lead-up to the 2008 global financial crisis when oil prices spiked to a record US$140 a barrel, coinciding with the first “subprime tremors”. If the Iran war drags on, Hartnett argued in his weekly “Flow Show” note, shadow banking risks will mount. The sustained risk of high oil prices to markets is earnings, not inflation, he noted. “There was no US recession after the 2022 Russia-Ukraine oil shock because US government spending had jumped from US$4 trillion to US$6 trillion in two years, US consumers had US$2 trillion of (pandemic) excess savings to spend, and the US labour market was adding an average of 400,000 payrolls per month,” he said.
That’s not the case today. US government spending is flat, the consumer savings rate is just 3.6%, and new payrolls fell to 92,000 last month. Moreover, in 2022, there were no credit issues in the unregulated shadow banking sector. “Asset performance in 2026 is more ominously close to price action seen from mid-2007 to mid-2008,” the Bank of America strategist said. Back then, the oil surge was demand-led (China and India), not supply-led, like the 1973 oil shock in the aftermath of the Israel-Egypt war.
Add those problems to the ongoing artificial intelligence (AI) bubble, and you start to see a deadly brew. Hyperscalers such as Amazon Web Services, Microsoft, Google, Meta Platforms and Oracle will spend US$700 billion ($897.2 billion) on AI infrastructure this year, most of it on AI chips made by Nvidia.
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As recently as 2023, the total annual AI infrastructure spending of hyperscalers was just US$90 billion. The US$1 trillion in AI-related expenditure next year would be a whopping 11-fold increase over just four years.
If oil prices remain elevated and private credit and PE firms continue to take hits, you may need to look no further than the AI giants for stress. Distress could initially appear as disruptions to semiconductor supply chains or AI-related infrastructure, which then cascades into system-wide failure. Here’s why that matters: AI infrastructure-related spending contributed as much as a third of US gross domestic growth last year. The private credit sector, opaque and clearly exposed to the AI boom, poses the biggest threat. Until the third quarter of last year, hyperscalers had been using their own cash hoard to fund AI infrastructure spending. Now they are transitioning to relying heavily on bond markets to pay for the “AI supercycle”. Five hyperscalers have so far announced US$175 billion in borrowings this year, with some estimates suggesting they would need to borrow US$240 billion more in 2026. Most of the lending is being done by beleaguered private credit firms.
I covered the travails and woes of the private lenders in my column “Private credit’s canary in the coal mine moment” (Issue 1230; week of March 9) three weeks ago. Private credit firms are part of a “shadow banking system” that offers high returns but carries significant risk of a credit crunch if portfolio companies fail. But before private credit is hit hard, its distressed cousin, the PE industry, will start reeling.
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The way it works is like this: Equity holders will get wiped out first; creditors are often among the last. PE firms like Thoma Bravo and Vista Equity Partners (both privately held) and listed TPG are reportedly three of the PE players most exposed to the troubled enterprise software business, which is being disrupted by tools from AI labs such as Anthropic.
Since the 2008 global financial crisis, private credit has largely replaced banks as the primary lender for PE buyouts, particularly for mid-market companies. When a PE firm wants to do a leveraged buyout (LBO), it is more likely to go to private credit funds such as those run by Blue Owl Capital or Ares Management rather than take syndicated bank loans. That means PE depends on private credit to finance deals. Without affordable private credit, the buyout model will essentially stall. The two industries have grown together — many large alternative asset managers such as Blackstone and Apollo now operate both.
Plunging shares
So, how bad is it for PE and the private credit players? Take a look at the share prices of the listed firms in the first 11 weeks of this year: Private credit giant Blue Owl’s stock is down 42.8% since the start of the year, while its main rival, Ares Management, is down 39.6% year to date. Blackstone, a PE firm that has emerged as a large private credit player, is down 32.5%, its peer KKR has fallen 32.4%, while Apollo Global, a private credit giant that also has a PE business, has slipped 29.5%. PE player Carlyle Group is down 23.8% while software-exposed TPG has plunged 39.9% in just two and a half months this year. Another key measure of a listed firm’s misery is its soaring dividend yield. Distressed companies are reluctant to drastically cut payout ratios, hoping to keep more investors from fleeing. Blue Owl stock now yields a whopping 10.3%, Ares Management 5.6%, TPG 5.3%, Blackstone 4.5%, Apollo Global 2% and KKR 0.9%.
PE essentially pools money to invest in undervalued or underperforming private or listed firms only to take them private. It takes a controlling stake in an operating business with the hope of increasing the firm’s value over time by whipping it into shape and selling it for a lot more than what it was originally purchased for a few years later. PE players use LBOs to acquire firms using high debt, which is placed on the target firm rather than the investors. A key part of their operating model is to cut costs, fire a lot of workers, strip the pension and healthcare benefits of remaining staffers and prepare to sell the acquired firm in five to seven years.
PE’s latest crisis is caused by weak exit activity, declining fund-raising and underperformance against public markets. Higher-for-longer interest rates have made debt-fuelled acquisitions costlier, according to Bain & Co. PE firms are currently sitting on 32,000 unsold companies worth US$3.8 trillion in unsold assets, “zombie” funds that are 10 or more years old and still have not liquidated all of their portfolio companies and distributed the proceeds to their investors, as well as increased bankruptcy risks for portfolio companies. Moreover, investors such as university endowments have been slashing their exposure to PE.
During the near-zero interest rate era, institutional investors like insurance firms chased alternative assets such as PE because they believed traditional assets like equities, bonds or real estate could no longer give them the kind of returns they needed to match their long-term liabilities. PE stepped into that void and began luring in university endowments, pension funds, sovereign wealth funds and family offices. More recently, it has aggressively courted individual investors to long gestation and higher-risk opaque investments with the promise of outsized returns.
Here’s the ugly truth: PE no longer generates outsized returns for its long-term investors. Over the past decade, total returns, net of all fees and taxes, have consistently been lower than the 11.9% annualised return, inclusive of reinvested dividends, that the US benchmark S&P 500 has delivered over the past 15 years. PE makes money mostly from fees. PE fund managers earn 2% of assets under management annually, and they get to keep 20% of the profits. But that’s just the start. It’s often fee upon fee upon fee. For example, PE firms charge the companies they acquire huge “monitoring fees” as well as fees for their oversight and management expertise. They also force the companies they own to pay their directors huge fees. Monitoring fees are often structured as long-term contracts, so a PE player might acquire a firm only to sell it five years later but legally continue charging it monitoring fees for another five years. They also burden their investee firms with a ton of debt. In the era of near-zero rates, none of that mattered. With rates staying elevated, the game has since changed.
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Lack of transparency
Here is the other problem. Over the past decade, PE players mostly overpaid for the firms they acquired. As technology disrupted the business model of those firms, the PE guys couldn’t unload them fast enough. Now they are sitting on entities like enterprise software firms that are probably worth half of what they paid for, or in many cases even less than that. Yet PE firms continue to tell investors how well the software firms in their portfolio are doing every quarter. Instead of selling their investee firms five or seven years later, PE players waited too long for the market to turn in the hope they would eventually get a better price. Now the window to sell these businesses is largely shut.
Traditionally, PE funds have had a lifespan of 10 years, exiting all of their investments by the 10th year from their launch. These days, it takes up to 15 years for many funds to sell all of their firms and return the cash to investors. Exits are the engine that drives fundraising, dealmaking and returns to investors. Sales of portfolio companies provide investors with cash to meet their obligations — pension liabilities or, in the case of university endowments, to fund student scholarships.
How did the PE industry get here? A big issue that has helped PE firms hide their real performance is the lack of transparency. Sure, investors do get quarterly statements, but rarely are PE assets marked to market. PE firms can just make up a number and tell their clients that’s what their assets are worth. There are no regulations to ensure that PE firms are truthful about their quarterly marks.
Another huge unfair advantage PE players enjoy is the carried interest loophole, which allows PE and hedge fund managers to pay lower taxes on performance fees. This has long been seen as a distortion that makes the tax system feel “rigged” to the public. PE firms, as well as venture capital firms and the real estate industry, spend tens of millions of dollars every year lobbying politicians not to remove it.
JPMorgan CEO Jamie Dimon has recently talked about “cockroaches” to warn about broader, hidden financial problems. “When you see one cockroach, there are probably more,” he warned.
“Is this a ‘canary in the coalmine’ moment, similar to 2007?” former PIMCO CEO Mohamed El-Erian wondered. Former Goldman Sachs CEO Lloyd Blankfein, who is touring the US this month for a book, said he was getting a whiff of 2008 post-traumatic stress disorder. “It sort of smells like that kind of movement again,” Blankfein told a podcast last week. “I don’t feel the storm, but the horses are starting to whinny in the corral.”
Assif Shameen is a technology and business writer based in North America
