Panics Do Not Destroy Capital, They Reveal What Booms Destroyed
The worst loans are made when times feel safest, after caution gives way to fear of missing out.
Oaktree Capital · Cockroaches in the Coal MineHoward Marks, who has spent 47 years working with risky company debt, was addressing worries about a recent string of companies failing to repay their debt. The concern centered on risky company debt, also called junk bonds, and included the bankruptcies of auto parts supplier First Brands and subprime used car lender Tricolor. Investors wanted to know if the failures pointed to a breakdown in lending, especially in private credit, meaning lending by investment firms outside banks and public bond markets. For an answer, Marks reached back more than 160 years, to a remark by Manchester banker John Mills in 1865, cited by financial historian Edward Chancellor.
Mills said that "as a rule, panics do not destroy capital" and that panics "merely revealed the extent to which it has previously been destroyed by its betrayal into hopelessly unproductive works."
What Marks means is that the damage is done in the boom, not the bust. When the economy is humming, company earnings are growing, and prices are rising, he says investors declare "Risk is my friend."
After a long stretch of wins, worry about losing fades and worry about being left behind takes its place. In that mood Marks argues that risk tolerance grows and attention shifts from checking deals carefully to bidding aggressively to win them. Standards fall.
Economist Friedrich Hayek had a word for the result, Marks notes, malinvestment, meaning flawed bets made when money felt plentiful and caution felt unnecessary.
The panic only brings those bets into view. When the economy turns down and markets slump, Marks says the refrain flips to "bearing risk is just a way to lose money," and investors demand to "get me out at any price." People regret the checking they skipped and the shaky deals they approved, and requirements for making loans and investments get much stricter.
That is why Marks keeps returning to an old banking adage, "the worst of loans are made in the best of times."
Questions people ask
What is subinvestment grade credit?
Subinvestment grade credit is debt issued by companies with lower credit ratings, meaning lenders judge them more likely to default than blue chip borrowers. Because the risk is higher, the debt pays higher interest, which is why it is also called high yield or junk debt.
How is private credit different from an ordinary bank loan or bond?
Private credit is lending made outside banks and public bond markets, usually by investment firms making loans directly to midsize companies. It grew after the 2008 financial crisis when banks faced stricter limits on risky lending. The loans are harder to sell quickly because they do not trade on an open market.
If panics only reveal old damage, does that mean a bigger crisis is coming?
Not necessarily, in Marks's view. He argues these episodes look systematic, meaning careless loans and fraud predictably cluster after long good periods, rather than systemic, meaning something is broken in the financial plumbing that will cascade. A few dozen defaults a year among thousands of issuers is normal for risky debt.