Is Private Equity Lending Creating A New Financial Bubble?

Performance Property Real Estate Question

Q: Is Private Equity Lending Creating A New Financial Bubble? Sam, New Brunswick, NJ

A: Let’s start by defining what a market bubble is: An asset bubble occurs when an assets price far exceeds the asset’s intrinsic value, which really is a calculated or measurable value. For example, during the real estate market bubble, NJ real estate prices in 2005 based on average annual appreciation reached 2020 levels. Since the global financial crisis there are many former bankers that have set up private equity shops that have been doing a lot of lending. These funds have filled the void left by banks who have tightened their lending standards. Asset values have risen quite a bit recently, but it makes sense that asset prices have risen so much because when money is cheap (interest rates have been low for some time) asset prices tend to rise.

One good thing about private debt filling in for traditional banks is that there should be less systemic risk, because unlike traditional banks which are dependent on depositors and shorter term funding, these newer players are raising money from longer term investors like insurance companies and pension funds who tend to be more sophisticated and should have a better idea of the risks they are getting into. Based on hype and investment, you could make a stronger argument that there is a bigger potential asset bubble as it relates to crypto-currency and high tech stocks than a private equity lending bubble (after all, the 5 companies with the biggest market cap are all technology companies).

Ultimately, we only know for sure when an asset bubble occurs after it bursts, but it’s a good question that should demand our attention.

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