Pursuing better outcomes in private credit: Lessons from the Global Financial Crisis

Twenty years on from the Global Financial Crisis, it is worth revisiting not only what happened, but why. The crisis offers a useful reminder that poor outcomes often follow when organizational priorities override investment merit and when capital pours into overbought sectors.

While history rarely repeats, it often rhymes, and we see noteworthy parallels to the GFC in certain areas of today’s private credit market that make these lessons relevant. The opportunity for investors is in recognizing those parallels early and adjusting before the range of outcomes narrows.

From refinancing boom to risk expansion

One of the more interesting facets of the GFC is how few people saw it coming. While some canaries chirped in the coal mine, Wall Street consensus remained positive even into late 2007. Meanwhile, warning signs mounted in the mortgage space, with economists and strategists failing to see that issues there would eventually threaten the entire banking system.

Tracing the market’s evolution takes us back to the aftermath of the tech bubble crash, and then September 11, a period in which the Federal Reserve was on an aggressive easing campaign, lowering interest rates to spur economic growth. This led to a flurry of refinancing activity as borrowers looked to lock in lower rates. New mortgages allowed for massive growth in the mortgage-backed securities (MBS) market as investors sought lower-risk investments with higher returns.

Several banks began to vertically integrate the MBS process, meaning they didn’t just service one step in the lifecycle of an MBS security, but rather all of them. This model drove record profits for the banks, creating a multi-layered money-making machine. But that machine relied on mortgage originations to fuel its operations.

Mortgage originations grew from roughly $1 trillion in 2001 to almost $4 trillion in 2003, but by 2004, the makeup of the mortgages started to shift.¹ On the assumption that home price appreciation would continue to tick higher, banks made loans to subprime borrowers and negative amortization loans became mainstream. By 2006, roughly 70% of loans were unconventional.² In just a few years, the industry had reoriented itself, using nonconforming mortgages as fuel.

Rather than allowing the cycle to slow naturally, the industry found ways to extend it. Existing mortgage risk was repackaged, transformed, leveraged, and redistributed in forms that were rated much higher than the underlying loans supported. Then the banks decided to start buying the riskier assets for their own balance sheets.

When housing prices stalled and defaults began to rise, the weaknesses embedded in those loans became impossible to ignore. The lower-quality mortgages defaulted at a much higher rate than expected, causing massive losses on the banks’ books and setting in motion the collapse of some of those banks. It took until 2008 for the GFC to reach its full magnitude, but the dominos were in place by 2006.

Lessons learned

To learn from the GFC, we need to ask why banks took on so much risk and why they were so slow to escape it. The answer to the first question is that banks industrialized the mortgage-backed process, creating a money-making machine that could only be fed by continuing to add risk.

The second question is more difficult, but the most obvious answer is that once profits became the key input in the decision process, investment merits took a back seat to structural and organizational imperatives. Importantly, the product flow didn’t dry up along with the opportunity set for conforming loans; it merely shifted to non-conforming loans. In other words, the market evolved to solve the wrong problem: It adjusted for the lack of mortgages to fuel the machine, not the shifting risk/reward environment.

History rhymes

As noted at the outset, we know that history often rhymes. If we can identify some familiar rhythms, we might be able to learn from earlier mistakes.

Two primary lessons stand out from the GFC. The first is that bad outcomes follow when structural and organizational priorities take precedence over investment merits. The second is that continuing to pour capital into overbought sectors eventually creates negative outcomes.

Today, hints of bias toward structural outcomes can be seen in some market segments – particularly in alternative investments. Since 2008, for example, institutional investors have shown preference toward larger managers.³ In a 2024 working paper by Nori Gerard Lietz and Philipp Chvanov of the Harvard Business School, titled “Does the Case for Private Equity Still Hold?”, the authors note the increasing concentration of capital among the largest 20 private equity (PE) firms since the GFC. They also note that the concentration is not always rewarded, citing that 70% of these mega-PE funds did not appear in the top quartile more than once.

A similar trend exists in private credit. The average fund size for first-time managers has been declining in dollar terms since 2008, and the trend has accelerated in the last few years.⁴ This contrasts with the significant growth in capital flowing into the private credit market over the same time – assets which increasingly go to larger managers. In 2019, the top 10 credit funds collected 28% of the private credit capital raised. That number grew to 60% by 2024.⁵

Several factors have driven the flow into larger managers. First, prior to 2008, the persistence of top-quartile performance among alternative investment managers meant staying with managers who had early investment success made sense. While that was no longer true in most sectors post-GFC, managers with early success continued to raise assets based on reputation.

Second, institutions realized that managing a large portfolio of multiple managers took time and resources. They began to cull their rosters and allocate to fewer firms, which concentrated capital into fewer managers. Fewer managers meant larger allocations, causing the universe of available options to shrink as institutions sought to avoid being an outsized percentage of any fund.

The third reason boils down to human nature. Institutional investment teams tend to face consequences when bold calls return less than favorable results. Given larger firms’ track records, resources, and operational scale, there is simply less reputational risk in investing in name-brand managers that are attracting capital from other large institutions.

These reasons are rational, and one can’t fault any one institution for following the path to larger managers. But when so many of them apply the same logic, it can distort market dynamics and lead to less-than-optimal results.

A crowded space

Too many dollars courting too few opportunities typically leads to one of two things: Either there is a compression of returns as the excess alpha gets competed away, or there is a bias toward riskier assets with fewer protections. From a purely investment perspective, this would suggest that capital should be going to smaller managers in less crowded areas. But the opposite is happening because organizational and structural considerations continue to play an outsized role in investment decisions.

Case in point, direct lending’s share of private credit fundraising jumped from 54% in 2023 to 79% in 2024⁶ – a period when many investors were actively questioning whether too much capital was going to direct lending. And the lion’s share of that capital went to a handful of firms that invest not just in the same large-cap space but, increasingly, in the same deals.

Fortunately, 2025 headlines like the bankruptcies of First Brands Group and Tricolor Holdings are most likely in the rearview. But while initial talk of a contagion event was clearly overblown, these stories suggest some of the larger firms may have lowered underwriting standards to put capital to work. When so much capital is raised by a handful of mega-firms to invest in a reasonably small space, this pattern is likely to continue. Some firms have industrialized the direct lending markets, consolidating origination, investment, securitization, and fundraising operations, as well as captive insurance entities. Certainly, there are firms that have remained disciplined, but it is a difficult posture to maintain when capital must be put to work.

Adjusting for better outcomes

The current environment may provide an opportunity for investment committees to adjust for potentially better outcomes. The first step is understanding what factors are driving investment decisions. Once that’s better understood, other adjustments can be made.

For example, greater freedom from benchmark hugging might allow institutional investment staff to make long-term bets that align with underlying fundamentals rather than merely following the crowd. That will take some courage, as will incentivizing proper risk-taking and providing security for the risk-takers. Solid opportunities exist in private credit, private equity, and other alternative investment areas, but attention should be paid to the amount of capital flowing into specific sectors and how those flows affect the risk/reward attributes of an opportunity.

Ideally, the capital raised for an opportunity matches its needs and investments are made on their own merits. These are simple principles, but they can be lost in the complexity of an organization and the noise of the moment. The GFC brought many painful days, but perhaps if we look closely enough, it can also bring a few lessons.

IMPORTANT INFORMATION

Alternative investments include, but are not limited to, commodities, real estate, currencies, hedging strategies, futures, structured products, and other securities intended to be less correlated to the market. They are typically subject to increased risk and are not suitable for all investors.

Private Credit refers to direct lending or debt financing outside of traditional banking, typically involving non-publicly traded companies, and comes with increased risk including limited liquidity, reliance on the borrower’s financial health, and less regulatory oversight compared to traditional bank lending. 

Securitized products, such as mortgage- and asset-backed securities, are more sensitive to interest rate changes, have extension and prepayment risk, and are subject to more credit, valuation and liquidity risk than other fixed-income securities.