I always am honored to get to speak with Howard. He was a deep thinker at a time where we need some deep thoughts. I want to start with your latest memo. You were talking about artificial intelligence and how it is definitely not a bubble as a technology. If anything, we might be underestimating its expectations. We'll get to that in a second. It's not the same thing to say about the actual investments in A.I., that they're not in a bubble. We're all here because a lot of people are very concerned about private credit right now. Do you think the concerns are warranted about private credit?
Yes. Well, I mean, you know, lending money to companies is a fundamentally sound activity. I've been engaged in lending money to sub-investment grade companies now for 48 years since I fortunately was asked by Citibank to start the high yield bond activity in '78, which was the beginning of that world. And, you know, our clients have done very well. I think it's 99% of the high yield bonds we bought paid off. So, you know, there's nothing wrong with it fundamentally, intrinsically. The problems arise when, from time to time, too many people want to do it. They're too eager to do it. They compete for deals, that bids down interest rates, that bids down safety. And then once in a while, everything in the investment business gets sold to the wrong people who aren't prepared and are shocked when the works show up.
Do you think that the introduction of artificial intelligence and the displacement of certain corporate activities, the sort of a disintermediation, the idea that software might be rendered obsolete, do you think that that changes the story of how you invest in any way?
Well, I think that the changes that are underway today, and in particular the introduction of AI, render the world much less predictable than at any time, probably any time ever, and certainly any time in my lifetime. You know, most people in the investment business decide their course of action based on what they think is going to happen. I argue that that's not enough. You need two things. I wrote a book about cycles in '18 and I said in there you need two things. One is a view of what's going to happen, and the other is a view of the probability that you're right. Not all predictions have the same probability of working out. And I think that life under AI is one of the most unpredictable things I've ever contemplated. And we just don't know it. And by the way, the same power that gives it its importance gives it its unpredictability. You know, what will it do? What won't it do? To what extent will it take over from us? To what extent will it put people out of work? What will a society be like if large numbers of people are put out of work? We've never contemplated questions like these.
Which is a reason why I think people are concerned about the concentration of certain types of investments by private fund managers, that the lack of transparency is making people uneasy, a sense of they're not sure how those loans were made. Is there anything in the way in terms of the leverage or the covenants that were used, that makes you think maybe we're getting to the end of a cycle or that feels a bit frothy and that people are right to say maybe there needs to be a wash out?
I've spent the last three days writing a memo that may not surprise you about private credit. You know, these days I speak a lot at occasions like these and to our clients and CFA groups and so forth and everybody has questions. But at any given point in time, the questions are usually the same for obvious reasons. And, you know, in the last few months or certainly the last six weeks, the main question has been, what about private credit? Well, a year ago I wrote a memo called 'Give Me Credit.' And I said in there, the only question I was getting was, what about private credit? But in a good sense, what about private credit? Do we have enough? Should we put in more? You know, is it the key to riches without risk? And today they're asking what about private credit? But in a different vein. And, you know, I've been around long enough to have seen many cycles of boom, bust, not economic boom, bust, boom, bust of an idea. And, you know, something new comes along. It's invariably something new because then the new thing fires the imagination and is easily sold to people. And because it's new, there's never been a chance to see its flaws in action. So these things, I mean, I don't think there's ever been a bubble in something prosaic. There was never a steel bubble, you know, or a hamburger bubble. But it's new technologies or new financial innovations. And so people buy in, you know, on the basis of promise without an understanding of the downside. And then something happens which causes their expectations to be disappointed. And then they find out that they didn't know 100% of what they were doing, that they hadn't understood the limitations. And, you know, they end up unhappy.
When you were writing 'Give Me Credit,' there was a discussion about how maybe at that time public markets might be more valuable or more attractive because of the enthusiasm around private credit. Are we at a place where there is enough fear to find this moment attractive, or does there need to be even more fear? Are people still greedy? Is there still sort of enough heat in that system to be worked through?
Yeah, I don't know. I don't know how the private credit is being priced today. Maybe Bob can tell us. You know, in 2011, when the banks, chastened and regulated because of the global financial crisis, pulled back from lending for buyouts, so-called non-bank lenders stepped in and started to engage in direct lending, lending for mid-sized buyouts. And, of course, since the demand for capital from the private equity industry was strong and the supply of capital from the non-bank lenders was limited, the non-bank lenders could demand high interest rates and good safety. But, you know, the greatest saying in our business is that the wise man does in the beginning, the fool does in the end. And what happens is the early success becomes visible. Other people emulate the entrants, bid for the thing in question, and the specialness goes away. So I think enough of that took place in private credit for the interest rates to be bid down and the safety to be down. And let's say three months ago, two months ago, I would say that public credit was yielding about seven. And direct lending was yielding about eight and a quarter. It struck me that 125 basis points for a liquidity premium was about fair. It was probably adequate, but certainly not lush. And so in my opinion, the specialness had gone away. It was adequate. Private was at equilibrium with public. It was a fair deal, but not more. And, you know, I said in the memo, everybody asked me, what about private credit? And I answered, What about credit? Now, of course, there's an activity in our world that's called Talking Your Own Book. And Oaktree has been in the public credit business for 48 years. So we want some attention paid to that. But, you know, I think that when A and B are priced at equilibrium with each other, rather than putting all your money into one or the other, you might as well buy both.
One of the other problems that people have identified in the private credit space is that increasingly there is an effort to reach out to retail investors. There is an effort to bring in people who might want periodic liquidity on some level. Do you think that the transparency of some of the assets or the marks, the pricing, the values, needs to be more standardized in order to really make this worthwhile?
Well, obviously, my guess would be that, well, first of all, certain parties of which we are not exempt, decided that they could do some business by selling private credit vehicles like BDCs to retail investors or retirement investors. And they did so and I'm going to venture a guess that not all of the buyers were fully informed or took to heart the ramifications of illiquidity and the absence of a market to market. And but they invested anyway, probably out of ignorance rather than knowing all about it and saying it wasn't a concern. And you know, I was thinking about this yesterday to another group of investors, and I said it reminded me of Casablanca. Has everybody seen the movie Casablanca? And the Gendarme goes into the bar that he's been taking bribes from for the last 20 years. And he says, I'm shocked, shocked to see that gambling is taking place. And, you know, the point is the things that investors have discovered and aren't happy about are nothing new. These vehicles were always illiquid. They were never priced mark to market, etc. But, you know, things are overlooked in happy times when people are eager to invest that then are the source of consternation when the stuff hits the fan.
People have identified private credit, in part because what you can't see makes people nervous. There are, though, these sort of questions about the software industry or other industries that could be affected by artificial intelligence. Do you think that some of the stress that you're seeing in some of these private credit funds or even the discussion around it is representative of a larger stress that will percolate out in a bigger default cycle or something more significant throughout the credit market?
Well, look, Lisa. There are credit cycles. There are times when everything's going well. It's really easy to borrow money. When things are going poorly, it's hard to borrow money. When it's easy to borrow money, people compete for the deals. And as I described before, the interest rates tend to contract. In the tough times, people aren't that eager to lend. So the few who will lend can demand higher interest rates. And this is the cycle that goes on. And, you know, back in the fall, when First Brands and Tricolor shocked everybody with their bankruptcy and their probable fraud, I wrote and Jamie Dimon said what he said about there usually not being just one cockroach. I wrote a memo entitled 'Cockroaches in the Coal Mine,' mixing metaphors. And I said, you know, when the music's playing, the money's available freely. And that causes the lenders to compete for deals by lowering their standards. And it creates a climate in which an undeserving credit can get money and a fraud has a higher probability of being perpetrated. And one of the long-standing sayings in the banking business is that the worst of loans are made in the best of times. And it's for this reason. And so we went through 17 years of good times. You know, the stock market bottomed, March, I think it was, of 2009, 17 years ago this month. And there hasn't really been a tough time in the financial markets since then. Okay, 2015 wasn't great. We had three bad weeks in March of 2020 with the pandemic, and then '22 was a poor year. But, you know, since roughly September 30th of '22, I would venture that the S&P has doubled. I mean, company values haven't doubled, intrinsic values, but prices have doubled. So it's been a great time and great times encourage the desire to put money to work and discourage analysis, discipline, high standards, skepticism. And FOMO takes their place. And when FOMO is ruling rather than skepticism, bad deals get done. And so this is nothing new. And we've had 17 years of low defaults. And, you know, the actions of the Fed made the global financial crisis, which was probably the most destructive environment I've ever lived through, have only one year of elevated defaults on high yield bonds rather than the normal two to three. In that instance, it was the worst incident and it had fewer defaults than any of the crises I had lived through. And then, of course, people were talking about 15% default rates in 2020, and I think it came in at five and a half. So people just have gotten used to the absence of defaults. Defaults are a normal thing, and especially after you go through a period in which credit is readily extended, then you go into a period where the water recedes. You know, Buffett says everything the best. And he says it's only when the tide goes out that we find out who's swimming naked. It's only in tough economic times that we find out who lent money stupidly. And to whom. And that period lies ahead.
Is the corporate debt market more broadly pricing in an elevated default cycle in any way, shape or form?
Well, as I said, I don't know. We have a bench here of one of the guys that could tell me what the rates are today. Okay. But, you know, you would say not. I mean, what people mostly have been asking about is why are yield spreads on sub-investment grade credit at the low end of the normal range. So if the yield spreads are at the low end of normal range, you would have to say that the fear of elevated defaults is not present. And compensation for an elevated default rate is not available.
We're talking about how AI and technology can transform some of our expectations just simply because it's so unpredictable. And as you were saying, it's the most unpredictable environment that you've been in. Does it make sense to you that Google, Microsoft, Amazon, behemoths, very strong companies are selling debt for 30, 40, 100 years at a time when we can't game out the next five?
Well, I think that is exemplary of what I'm talking about here. I mean, I don't think if you think about what Lisa just described and I think Google issued 100-year bonds paying 5.8%, I think you would have to say, you know, optimism, not pessimism, credulousness, not skepticism are in the ascendancy today. And when optimism and credulousness are in the ascendancy, it gets hard to make investments that will produce what we call excess returns. That is to say, returns which are more than commensurate with the risk.
