Sep 03, 2026
On September 3, Nick Nemeth, investor and writer of Mispriced Assets, joined us to discuss the life and annuity industry’s growing exposure to private credit and the potential risks for insurers and the broader financial system. The full transcript, which has been modified slightly for accuracy, can be found below.
TEDDY DOWNEY: Okay. Hello, everyone. Welcome. I’m Teddy Downey, Executive Editor here at The Capitol Forum. Today, I am extremely pleased to be joined by Nick Nemeth, an investor, analyst, and writer of “Mispriced Assets,” where he covers equities, macroeconomic trends, and overlook market opportunities and risks. We’ll be talking all things private credit. I want to dive into our conversation. Nick, thanks so much for doing this today.
NICK NEMETH: Thanks, Teddy. Thanks for having me on. Excited to have this conversation.
TEDDY DOWNEY: I would love to, just really quickly, could you tell us how you started looking at this and your background, just how you came to be concerned about private credit?
NICK NEMETH: I’m an equities first guy, primarily. It’s venture capital or public markets. But the systems that drive stocks has been something I’ve had to learn. I love economics and my macro views drive some of my investing. From 2023 onwards, the growth of shadow banking was like “Wow I kind of have to figure this out.”
Over the past year, it’s escalated because in 2023, AI is just taking off and I figure I don’t need to worry about problems right now. Come 2025, all of the spend in AI is ending up off balance sheet, where off balance sheet oftentimes means insurers.
So, I felt like I had to really understand this. And I remember in October, I’m looking through the leverages and I’m like, holy cow. All of my economics history studying says that this is going to be a problem. So, it’s been about a year. Sometimes I am an interested bloodhound and I get a little bit obsessive. So, just studying something that originally is not quite—it was foreign. You’re looking at securitized products and you’re like, why does this work this way? There’s no real reason.
Ultimately, a lot of the reasons why things work is around regulation and capital efficiency, which is based off of regulation. So, it’s throughout the process become more worrying. Timing. It’s also the timeframe of when this is going to happen has crept up as my investment career has basically just been a bull market. I had a couple of stocks in 2008, but it’s been a long expansion. We had the longest economic expansion up until 2020 and then technically a quick recession, but we never really had the deleveraging. So, I consider it just one long credit cycle. And I wanted to be a student of the game as much as possible.
TEDDY DOWNEY: Yeah. What I love when I’m reading your stuff or listening to you is you’ve done a lot of homework. You’ve done a lot of due diligence. You have a lot of rigor with your investigating. Obviously, that’s what The Capitol Forum is all about too. I guess it’s no surprise that I’ve really enjoyed reading your stuff and listening to you talk about private credit.
I think most people at this point, they’re listening to this, they’re aware of some of the problems, some of the concerns around private credit. You’ve got private equity. They own portfolio companies. They lend to those portfolio companies. They stuff those loans into insurance companies. There’s huge questions about the value of those loans, potential lies by the private equity companies about the quality, value, riskiness of those loans.
What about this picture do you find most problematic? Because there’s clearly problematic incentive. The private equity owns all of these assets, all of these things, including the insurer. But if an insurer goes belly up, that gets put on the retiree, the taxpayer. So, I see some clear structural problems. I’m curious, do you see those as well? Where do you see the biggest problem in this ecosystem?
NICK NEMETH: Have you ever seen those math gurus that do the mental abacus when they’re doing multiplication? We have a complex financial system. To try to simplify it, there’s the banking system, there’s credit broadly, the ability for people to get loans in order to invest in businesses. That can happen from the banking system. But oftentimes is off the banking balance sheet today. And where that has ended is insurance.
Private credit, I think, has gone rogue. It’s been a really popular asset class. Private lending and leveraged buyouts—if we’re talking about direct lending—is not inherently bad, but it needs to be checked. In the public markets, if you come out with a thesis, you know in a quarter if it’s looking good or not looking good. In private markets, they can tell the pensions, and they can mark up their Excel models, and say the IRR is this. And they could take a dividend recap to goose it. I like to call it “goosing the IRRs.” These stories go on for a decade. And then all of a sudden, you have 32,000 companies, according to Bain, that haven’t been sold that are still marked on an Excel spreadsheet.
So, we have assets that I believe are mismarked. I’ve been writing about that on “Mispriced Assets.” And the size of them, I think, are a real economy and financial system risk, systemic if you will. And the banking system might not particularly be as exposed as they were when we had mortgage-backed securities, which were used as collateral. So, basically, that was a collateral system problem inside of the banking sector. Collateral is what you pledge to get more leverage.
But we do have an equivalent and potentially worse problem, in my view, in the credit system, which is not necessarily in the banking system. It’s in the shadow banking system. But the balance sheets are so big and the asset class is actually—the $2 trillion of direct lending, which is (inherently) leveraged—is bigger. And if you adjust it for inflation, it would be bigger still, or equivalent size, as the subprime mortgage total that took down the economy in 2008.
So, the big numbers, just because there’s big numbers doesn’t mean there’s a problem. But I think that when you break it down, there clearly is a problem based on bad incentives and regulation that’s really haphazard.
TEDDY DOWNEY: Yeah. I mean, the size of the problem, when you put it that way, alone, it’s just hard to get your head around if that goes the wrong way. There’s also a problem of, well, even if it’s not the banks, this is a very sensitive community of people that could be harmed if this does go south.
You’ve got all the companies that are propped up right now. They could have mass layoffs. You have the retiree, whose money is at risk in these insurance companies, getting only a small slice of their annuity or their life insurance policy if the insurer goes belly up. You’ve got the taxpayer that’s on the hook for a regulated amount, for some regulated amount in tax credits. But then you have the possibility of bailouts on top of that. I mean, how do people think that this wouldn’t get some bailout conversation given not only how sensitive the customer is—which ideally you would think that the government would care about that—but really how politically connected the private equity and private credit world is, and to your point, the AI space as well, which is now kind of intertwined there.
Usually we have regulatory oversight, rules, regulations, regulators, law enforcers to oversee all of this. You have insurance regulators. You have the SEC. You have state regulators, AGs, that would typically be monitoring this. What’s your sense of the level of scrutiny in the space and how things have gone wrong?
NICK NEMETH: I think you’re talking… just your prelude to the question, a massive amount of moral hazard. Additionally, you have the pension funds that are invested in the same assets. And the vast majority of retiring America needs their home prices to stay high. Everything is holding the line on assets being high while inflation is also high.
We’ve been trained that there’s always going to be a government bailout. Most recently it was SVB, $250 billion facility. Everyone is okay. I think this overwhelms all of that. And I hope to be able to describe it effectively. Because every time that we have a bailout, it needs to be bigger.
This one, I think, is a direct critique on the system, and that is unlike COVID. That was, holy cow we have a pandemic! What are we going to do? Fed says, buy. They jawbone assets. Everything unlocks, if you will, but it took a lot of money, more money than 2008, more money inflation adjusted than World War II.
Throughout my career, just to set the table, I’ve had the gold bugs, and the gold bugs are like dollar’s going to zero, everything (is). It’s all going to end. And I’m like, I don’t know if I want to be on that side of the boat. I like productive assets. I’m going to look for pricing power if I feel that way by investing in businesses with moats.
But I feel like it’s a “duck, duck, goose equation.” I think that truly, we’ve never really had a choice between the dollar or bonds that for a sustainable period of time that really made us choose. It was always like we’re going to choose to hold in bonds. Dollar might be weak for a little, but it’ll be fine.
When that actually push comes to shove, I’m worried about it in a scale where Europe’s doing the same thing. The developed world’s doing the same thing. So, we have all this paper that could really cascade in a way that central banks will lose credibility and have no ability to respond to. And there’s historical examples outside of all of our lifetimes of it. I just think the gravity there of like, well… worst case scenario: we have more debt, is not that. It’s worst case scenario: we have way more debt, and the debt is worth less, and the dollar is worth less because there’s just lack of trust.
The only reason we have fiat currency is because we trust it. So, that’s the worst case scenario in my view. And that could be a decade of economic malaise, quite frankly. You listed out what if people are relying on annuity or policy for their wife just to make sure that they’re okay if they pass away? They’re going to be spending less. That affects the real economy. If you have this upper middle class that thinks they’re good, all of a sudden, they’re spending less. They’re trying to sell their homes. Because they’re like, “I thought I had safety.” It could cascade in a real economy way.
Then the financial system, just the numbers we’re talking about, big numbers don’t necessarily mean an imminent problem, but the annuity in life balance sheet is $10 trillion. We’re talking about $9.6 trillion of liabilities. Those liabilities are present value. So, some of the safer players might be a six percent discount rate or something like that. Some of the PE backed insurers—I was shocked to learn this—they are discounting their liabilities by eight percent. So, you have to beat that hurdle—with cash, treasuries, mortgages, corporate bonds, and a lot of private credit, some asset-backed securities as well—eight percent.
If you don’t, the entire life policy in force—I believe it’s $22 trillion—that’s what you owe. You’re just discounting it back at eight percent. Which, if you understand compound annual growth, that’s like a double in liabilities every six and a half years or six years, according to the rule of 72. That’s a lot of money that we’re expecting to be there inside of this industry that has been co-opted. Private equity and the demutualization that’s happened for profit that are misaligned.
If you’re talking about a policy holder that’s doing a 10-year plus policy or a 30-year life insurance policy, someone might buy it for their kids. They might buy today for their newborn. So, it could be a hundred-year-old liability that’s discounted back to nothing, depending on the duration. It’s been taken to an extent where, as Granato has written, they’re just relying on this bailout that is potentially going to come, and the pseudo FDIC related to it.
It’s tremendous moral hazard—I guess, just to sum it up—that’s been co-opted. I don’t think regulators really understand what’s happening. They’ll hear, hey, “you can’t do this leverage (calculation) because we’re matched.” And the work you need to do to figure out if that’s true or not, typically, a commissioner has no idea how to do and has to rely on somebody else.
TEDDY DOWNEY: I have found I am deeply, deeply concerned about the willingness of these state insurance regulators to give these companies exemptions on what otherwise should be straightforward. No, you can’t do that kind of reinsurance agreement where you’re pushing off the risk but keeping the assets. This type of stuff is nonsensical to a lay person that you would approve something like that.
If the goal of these regulations is to provide transparency so everyone knows that the insurance company can actually pay the policies that they make, that they write, why should you allow all these ways of obscuring that picture of solvency? It doesn’t make any sense unless you’ve got a captive regulator or a regulator that just thinks that they work for the insurance industry, not work for the actual people. Something is deeply wrong.
When I listen to you talk and I read your stuff, a lot of what you say triggers my memory of 2008. I wanted to see what you think about today that reminds you of 2008, reminds you of the scenarios around 2008. I listened to a call with Steve Eisman recently where he said, well, there’s not enough data here to make everyone comfortable with it being like 2008. But then he does say, well, it kind of does.
NICK NEMETH: There’s plenty of data. Steve Eisman retired.
TEDDY DOWNEY: I would love to hear your response to that. How do you think this reminds you of 2008? And then we can talk about what are the next shoes to drop? But let’s talk about 2008 for now.
NICK NEMETH: Yeah, that was a formative time. I was 13 years old. My dad was in the industry. My uncle was in the industry. I remember spring break, my uncles getting up at my birthday dinner. And that was in the first private credit piece I wrote—this was like the beginning of the piece – “These People Are Not Investors.” And I’m like, hmm. He’s usually pretty present. And just that whole thing. And I had some stocks. I bought Ford at a dollar, sold it at 12. And then I watched the “Big Short”.
So, you’re talking about growing up, you’re reading this stuff. And Steve Eisman, via the character Mark Baum, was particularly one (that resonated). All of them were. And it’s almost too cliche. And that’s, I think, the problem. It’s the fact that some of these things are so similar on the rating side, for example, the lethargy side, the bad incentives that are so obvious that you want to be like, “guys, we’re doing this again!” And then people call you a kook because everyone that’s been bearish has been wrong. I’ve luckily not been bearish most of my life. Otherwise, it would have been painful.
But then you’re sitting there and you’re like, guys, this is like 2008. And people just think that you watched the movie and decided that. But you’re actually like, “no, I’m doing the work.” The data is here, the leverage, the incentives. If you look at the regulation, there are similarities. It’s not perfect. And the biggest difference that I think people get off is the collateral system was 2008. Today, it’s a broad credit problem. Both can have systemic risk (even though) banks—which banks have more exposure than people think—it’s just usually better risk, it’s still a lot of risk though. That doesn’t have to be there in order for you to have a systemic problem. So, once people realize that, I think it opens their mind to like, okay. Well, yeah. Maybe we should figure this out.
TEDDY DOWNEY: I think back to 2008 and I think what did they not solve? They did not do anything about the rating agency problem. And so, now you have—actually what they did was they said, let’s have more competition without coming up with a new system. And so, you now have Egan Jones of the world and other rating agencies that are in more of a frantic race to the bottom for fees to rate assets even worse than they did in 2008, in my opinion. Instead of having rules for competition, you just have more of these companies and they’re in a race to the bottom.
And then a lot of the rules, like you said, the Dodd-Frank rules, push risky activity into the shadow banking system. And so, you have a lot of activity around insurance companies instead of the banks. But obviously, that’s still a very sensitive space. And then subsequently, obviously, more recently, you’ve had huge attrition at the SEC, the state AGs having to focus on a huge number of other problems, just money not being there for the regulators, talent not being there at the regulators, at the federal and state level. And so, who’s keeping an eye on this?
So, I think of it in that way as not only are there a lot of similarities to 2008, but you can tell a story that, well, we really didn’t fix things. Dodd-Frank really didn’t fix some of these underlying problems here.
NICK NEMETH: Yeah, it shifted it. It’s really hard to have regulation that doesn’t have unintended consequences. I think the first thing we should recognize is that we have 51 different states trying to—they’re not all going to have people that can even remotely figure this out. And then they’re inundated with $2,500 an hour lawyers from these private equity-backed companies that are courtroom supreme and can win people over.
Things that don’t make sense, and then we can work back to them. Captive insurance in Bermuda, like work at the Caymans. One, why? Two, who’s allowing that? Who decided that was okay? And can we fix that please? Because we’re talking about Americans that are insured, that have credit risk in a way that even our regulators cannot see as is. It would be a super easy fix to be like, “you want to insure Americans it’s all going to be onshore.” We’ve got to know the assets. Knowing the assets, we still have an issue. If you look at the BDCs and private credit with the pricing of the assets, but that would close a major problem here. Because my thesis is regulatory arbitrage. They’re moving a lot of mortgages with duration risk. So, they seed liabilities. That’s what reinsurance is. They move liabilities to where we can’t see it. I just want to make sure that’s clear.
TEDDY DOWNEY: And I actually think the reinsurance problem is even like one step worse in that a normal reinsurance where you’re pushing out the risk and you’re tying often some assets to that. There’s some clear accounting and expectation that this can be paid for by someone else in a reinsurance deal. What I find problematic is you do it to Bermuda or you do it to another captive, the regulators are like, yeah, I guess we just don’t know if there’s enough money to pay for these policies. It obscures the accounting, the transparency, and then nobody knows.
And to your point, who thought that was fine ever to begin with? And now it’s like standard. Now it’s like we’ll be writing a story and a company will just be like, you know what? That’s standard in the industry. Why are you asking us about that? I’m like, well, it doesn’t make any sense. That’s why I’m asking you about it.
NICK NEMETH: Yeah, slavery was standard. What are we talking about here, you know? There’s so much of that. I think that needs to go. We need to focus on that. If you think about the two reasons, it’s either to not pay American taxes or to hold less capital, which is more risk on the policyholders. The extent of that, I can point to examples of how it’s way worse than people think. But we don’t know because if we wanted to subpoena it, we couldn’t get it.
And then the defense is, well, Bermuda is pretty good. They’ve been doing this for a while. And I’m like, “why do we let Bermuda do anything? Why are we letting the Caymans do anything?” This is the type of fix where it’s not like a wealth tax, where wealth can just go to the Caymans or whatever. You have American policyholders that are regulated in American states. Otherwise, you cannot sell an insurance policy. In order to get there, which is in America, you can easily regulate it.
But we have 50 states, 51 districts, competing to the bottom for supposedly tax revenue, but the tax revenue is nothing. They give them tax credits. I don’t really understand why. I just think it’s slightly too complex for politicians to understand. And for politicians listening, it’s not that complex. You’ve got to sit down for six to 12 hours and go through, ask your questions. I have some Zooms and it takes an hour and a half, two hours, and you kind of get an idea ready to start. It’s ultimately bad incentives that are enabled by a lack of attention. Things like the money in Bermuda.
But one thing I want to focus on is that the NAIC is like a quasi-public-private guideline. It’s potentially unconstitutional. Their limits for this stuff actually do not make sense. Everything is based off of how much more than what the NAIC says you need. That’s called an RBC ratio. I would argue what you need is way too low.
And then the ratings agencies, if we want to talk about 2008—and Rod Dubitsky is a great person to talk to. I hope you have him on—they were like “this is AAA. This never, ever defaulted. There’s never been a problem. Therefore, we can lever it up astronomically.” It was based on the idea that nothing was correlated and had never happened before. Meanwhile, the shifting, the underlying collateral, the credit was going down. And obviously, the housing market is correlated.
I would say the same thing about these collateralized loan obligations that these insurers are loaded up on. A trillion dollars of private credit is on these insurers’ balance sheets. The majority of that’s structured in some way. Why? Because if I were to take a hundred loans and put it on a balance sheet and they were B minus or triple C, I would have to reserve 30 percent, which is appropriate for that risk level.
If you take those same hundred loans and you put it inside of a package, a sausage, just like the “Big Short” example, all of a sudden, you only have to reserve 14 percent, potentially three or four percent. It’s the same thing. How much relies in our system on ratings agencies?
One, as somebody who does fundamental research, forensically in some cases—but I’m looking through financial statements every time I look at a company. I’m like, “why can’t other people do this? Why don’t we just rely that it’s investment grade on some ratings agencies?” When I talk to them, I ask them questions. They have the right answer. And I say, “why is this not reflective in your report?” They’re paid to be dumb because of the incentive of rating agencies, especially when you have Kroll and Egan Jones come in. They’ve got to get business.
So, the fact that so much of our credit system is based on a letter grade, and these companies will move so slowly to upgrade or downgrade, both directions. It’s a very inefficient system.
TEDDY DOWNEY: Yeah. It’s almost like it’s designed that way, right? To fail in some respects. I mean, it wasn’t. But that’s sort of where we are now.
You mentioned there’s a lot more risks than people realize. I wanted to get your thoughts on where do you think people are getting it wrong? Where do you think there is more risk than they realize? And in that, what’s the next shoe to drop? Obviously, we’ve seen with Walter, with that whole situation, you just have scrutiny on one of the lies, right? One of the lies that is in these insurance deals is are they affiliated or not? That’s one type of lie. There’s others. I think it’s more sophisticated to just get the regulator to approve of something that’s quasi-nefarious. And then it’s like allowed lie or, in that respect, permitted lie.
But where do you see the next, the biggest, problems if you want to say? Because a lot of times people say, well, this is a problem that will just happen slowly over time. These don’t need to get paid for 15, 20 years. That’s the whole beauty of the system. You can always just get more money in and keep paying it. And the assets being illiquid is okay. Because, oh, you don’t need to pay up to 10, 15, 20 years down the line.
But obviously, that’s not true with Walter. They’re being compelled to be transparent. And that’s creating immediate problems, right? Asset sales, et cetera. So, how do you think this becomes more of an acute near-term problem? Or what do you see on the near-term horizon?
NICK NEMETH: I think the primary lie is the Mark Walter lie. The probability of default is not reflected in private credit broadly. But these insurers basically didn’t do no credit risk on their portfolios. They’ll look at spreads. Again, spreads are based off of ratings. The ratings are a problem. It’s not like the ratings change. If you look at software companies, very few of them have been downgraded, even though, I don’t know, if you want to be a software bull, 25 percent of them are way more likely to go bankrupt. What the ratings agencies do is they wait until they’re basically about to go bankrupt. You have to see the credit problems. Meanwhile, the probabilities do not reflect that. So, there’s that.
The leverage, right? People say, so when it comes to leverage, if you have assets and liabilities match perfectly, it kind of doesn’t really matter. That’s true. Unless you have so much defaults and impairments that you’re never going to be able to—the spread you make assets over liabilities will never compensate based on duration to liabilities. But we’re functionally based on what most math people would do. It’s like a 10, 15, maybe 25 percent plus, minus. It’s not the end of the world. But that gets multiplied when you have a lot of leverage.
So, if you have equity between your assets and liabilities of $4 billion, 25 percent of that—it’s not that much money. I mean, it is a lot of money. But it’s not that much money for a system. But if you multiply that by 30 and then a hundred different companies, that’s what you’re talking about as like, holy cow.
The match I question though. We’re seeing it in Guggenheim. Guggenheim would have said assets to liabilities perfectly matched. They’ll probably say that today. But they’ll say, well, regulators are unmatching it. I think it’s a lie. And for lawyers watching, eventually there’s going to be a discussion about the pari passu-ness of funding agreements. I hope you guys study up on that because I think there’s a great argument that they just took more risk on the policyholders for profit and absolutely is not pari passu. The people that bought that paper should have known better. The government never told them it was pari passu.
But that funding agreement allows them to buy more assets, which increases the supposed—according to their projections—profit between the assets and the liabilities. There’s three ways that the match isn’t good.
One, the rolling over assets and liabilities too much. I believe when they talk about a match, they’re talking about average duration. They’re rolling a lot of funding agreements, short-term stuff. FHLB is another funding agreement that’s now—because Walter’s using it—a problem.
But also, there’s something called runoffs. So, a lot of people, when they’re looking at insurance for the first time, do not understand that you can actually take your money back and it’s not that expensive. There’s a good amount, depending on the company, that’s outside of the surrender window.
TEDDY DOWNEY: When you say that, you mean that you have an annuity plan, you could actually pull your money out because it’s past a certain number of fees. If you pull it out early, you get fees taken out of it. But if it goes past a certain window, you can just pull it out and there are no fees.
NICK NEMETH: Yeah. Functionally, it’s a small toll and people really do not understand what they’ll do to a leveraged insurer. It’s really bad.
TEDDY DOWNEY: And so, if they understood the risk that the insurer would go bankrupt, they would en masse pull their money out.
NICK NEMETH: That’s when it cascades, right. Good point. So, like SVB, when everyone’s like, “oh, there’s a problem with SVB”, what happens? Everyone’s like, “get your money to JP Morgan, right?” That is exactly the way that this, in my view, will go. And I feel like nobody gives me credit for that.
TEDDY DOWNEY: No, I think that was a big aha moment listening to one of your podcasts where you’re like, oh, well, everyone thinks that the beauty of insurance is that there can’t be a run on the bank. And you’re like, well, if a lot of this money is in annuities and you can pull the annuity money, it can act like a bank at some point.
I also think in addition to that, when you said that the first time, it also dawned on me like, there’s also all these other people. It’s like the individual policy holder is probably the last person to do a run on the bank. But what about, you’re already seeing the LPs in these funds sue for excessive fees. If you’re not the parent company, you don’t have the ability to have all the fees redound to you.
If you’re an investor in any of these other vehicles, you could be on the hook for losses, too high fees, under performance. It only really works for the parent company if you look at all incentives to extract fees out of the insurer and make the insurer insolvent.
There’s a lot of other sophisticated investors. You mentioned pension funds, other insurance companies, all this money out there, that I also think, hey, maybe I should take a closer look at this. And then also, at some point, can’t they take a closer look? We’ve had a problem getting documents. And, well, you’ve got to sign a non-disclosure agreement to be part of these private funds. But if you’re one of the investors in that, can’t you start taking a closer look also? And maybe even that starts to create more litigation. You’re already seeing some of this litigation. And then you get discovery, and then you start getting real transparency.
So, I’m curious if transparency from that window could also feed into this problem of—well, it’s not necessarily a run on the bank, but people wanting to get their money out or at least question the setup.
NICK NEMETH: Yeah, I think we’ve gotten so far away from mark to market that it makes absolutely no sense. And that’s the crux of the issue. People were worried about there’s going to be a run on the bank if interest rates go up, because they’ll have duration. And it’s like, why don’t they just hedge it? What are we talking about? Why don’t they just try to match their longer term liabilities to five-year and ten-year bonds or whatever? But we decided that hold to maturity was going to be a thing. And then it went basically everywhere, including in the insurance companies via permitted practices.
So, fundamentally, the marks are the problem. And also, when we’re talking about private credit, the loan docs, business performance, all of this stuff that would determine the marks aren’t there because it’s a private company. That’s an issue.
One thing I want to say is on these insurers balance sheets, I think commercial real estate is also a major problem. It’s been cooking since 2023. Every day there’s a new story about another Austin $125 million property that sold for $25m. If you’re lending, the whole stack might be 70, 80 percent LTV. That’s a huge wipe out. And that can happen on insurers, that can happen on banks. If you’re talking about $125 to $25, which is happening, the banks are eating losses. That’s where it gets through the first lien of that.
So, broadly, the opacity across these balance sheets is bad. And it affects the pensions through just their exposure to kind of the same stuff. It affects retail investors that are worth $1 to $5 million, have been aggregated by the thousands by these RIAs into products that the RIAs don’t understand. If you talk to the CIO of an RIA—maybe I’m judgmental – I’m like, you do not know what you speak. And that is something that has a real economic impulse while they’re also probably in insurance policies.
So, there’s going to be a double whacked. You typically just made it out of the middle class or upper middle class. During the past two decades, that has been hard to do that. And they’re going to get sent back to the stone ages. That’s who this is ultimately going to go on. And then there’s going to be inflation because the debt’s going to go higher.
TEDDY DOWNEY: One other thing that sort of is creating more near term scrutiny is some of these mergers acquisitions. Obviously, there’s been a history of private equity companies buying insurers.
Now we have a listener question here. Do you think the buyout of Bright House by Aquarian will move forward? Or the merger of Equitable and Corebridge will occur? And so, I think these transactions are a way to focus public attention, scrutiny. We’ve already had some critics of private credit weigh in or say they want to weigh in, in public hearings. But curious to get your thoughts on these two situations.
NICK NEMETH: I think that the Brighthouse deal does not go through. And if I’m putting my thinking game theory cap on, it is one indicated by the market. Market is agreeing. Full disclosure, I came out with a short report. I’m no longer short, but I was short on this thesis. It’s just the pricing has changed a little bit.
There’s a lot of pressure on Navarro of Delaware, who’s a former cop, who’s all of a sudden like, “I probably I need to figure out what these guys are saying.” He made a statement to bring in people to tell them what’s happening besides the insurance companies and their lawyers. Because that’s also where the entire Guggenheim group went through, which is a good example of the affiliate paper nonsense, the reinsurance. It’s worse. As much as I want to criticize KKR and Apollo, they’re doing it for firm gain, not personal gain, which I do draw a distinction. But that all runs through Delaware.
So, if he’s going to do anything, it’s probably going to be to increase the capital requirements for Brighthouse. And then when he does that, Aquarian can walk, which is backed by Mubadala, which is the UAE asset manager, who also is exposed to the entire Guggenheim group. So, they’re probably trying to de-risk. I think that one does not go through.
The Equitable/Corebridge merger, I think does go through. But from Corebridge’s viewpoint, I don’t know why they’re taking on that balance sheet in order to get a couple of product lines that they could just do themselves and “120-year history” on their website. I think it’s a bad idea. Corebridge’s balance sheet and risk is superior to Equitable. It’s now being diluted. And I think it’s just a bad idea, but I do think it goes through.
TEDDY DOWNEY: One thing people have said, some people who maybe want the Aquarian deal to go through, is, well, they approved the Guggenheim stuff. So, don’t they have to approve this as well? I think that’s just not how things work. I mean, Guggenheim is under such tremendous scrutiny right now. I think that just from a human being perspective, you just decide differently when things are under that level of scrutiny and you’re looking at a similar transaction.
But what do you think about that point, that while there’s a history of approving similar types of transactions, you mentioned that it was worse that one. I’m curious to get your thoughts on why and what you think of that argument.
NICK NEMETH: Yeah. I mean, I think that argument’s like, OJ Simpson got acquitted for murder. So, everyone should get acquitted for murder. It doesn’t make any sense to me. We’re realizing what happened when we allowed this stuff, right? Hopefully, there’s better arguments than that. I need to be intellectually stimulated.
TEDDY DOWNEY: Well, I’m sorry. I’m having a laughing fit. I guess, well, let’s focus on what you said, which is that this deal is worse than that one. Maybe we can focus on that. Because that’s an intellectual aspect, not sort of like a nonsensical point.
NICK NEMETH: Yeah. So, a lot of people looked at the company, Aquarian, which is (other) Guggenheim guys, came in with a price way over everyone else. And they put in the contract that if the regulator requires any additional capital, we can walk.
There’s permitted practices inside of Brighthouse that shouldn’t be there. We’re talking about, you don’t have to mark the market. You can be over the affiliate paper limit. So, if those are solved in order for the deal to go through, Aquarian can walk, right?.
TEDDY DOWNEY: Right. So, if they say, hey, we made all these special exceptions for you. But we’re looking at this merger. We actually can’t make those special exceptions once the merger goes through. Then the merger is done.
NICK NEMETH: We can’t just be passing through this favor. You have to post $2 billion, which is not enough based on my analysis of the balance sheet to de-risk it enough for me to be like, okay. I should be focused on other stuff. This was spun off from MetLife. It’s kind of just been a dog the whole time. But anything like that, Aquarian is probably just going to walk. That’s why.
Whether it should or should not happen is another question. I think it should not happen. It’s just bad incentives. But if I’m a market person, that’s my odds. Now it’s not a hundred percent, but I think it’s in the decent majority odds.
TEDDY DOWNEY: Majority that it will not, that there’ll be some kind of requirement that kills the merger.
NICK NEMETH: Yeah. Somewhere like 70, 75, 80 percent.
TEDDY DOWNEY: Got an audience question here. If you have questions, put them in the chat, put them in the Q&A panel. We’ll get to them. Now, the rating agencies downgrading MBS in unison is what ultimately froze the already slowing market during the global financial crisis. What would it take for them to downgrade the FABN notes en masse? One or two insurers running into liquidity issues. Which insurance companies do you see with the greatest liquidity issues? These FABN notes, maybe you can explain those to listeners that aren’t familiar with them. And then if you can answer the question.
NICK NEMETH: Those are the funding agreements they say are pari passu. In 2007, it was different. It was the CDOs that were downgraded. Rod Dubitsky calls it the day of reckoning or something like that. Everyone should learn Rod Dubitsky. He’s not as good at marketing as some other people, but find him on Substack. The guy’s awesome. And he would have a better answer. And honestly, just through working with him, I get this translated.
The way I would articulate it is it’s duck, duck, goose. And I see this all the time in markets. A stock will stay overvalued for a long, long time. And people think that it will always be overvalued. And all of a sudden, it’s time for goose.
That is generally how I think that it’s going to happen for regulators who have allowed it for a while and ratings agencies that are ignoring a certain thing. I mean, I’ve talked to these rating agencies and they’re like, well, we don’t really know what private credit will do in a downturn. And I’m like, politely—I kind of want to yell a little bit. But I’m like, you guys have ample and sufficient evidence of seven times levered businesses. And these are smaller ones and there’s less of a moat than even what your data says. Why can’t you just apply that framework to this asset class? No answer. They have no answer.
So, at some point it’s going to switch. And they’re actually making exceptions in order to be like, this is an A versus a double B insurer. The honest answer is I don’t know. But the more that people are talking about it, the more that regulators are poking around and asking questions, lawyers as well, probably the sooner.
TEDDY DOWNEY: It’s like having investors and federal home loan bank system provide all this money, kind of short-term money, to these companies. What is going on here? Why do you need this? I thought the whole point was that you have these long-term illiquid securities to pay for these, but then you have this short-term funding needs. Something doesn’t really seem right there for me as well.
Another question here. BHF has a plain vanilla portfolio with no private credit and has an audited RBC ratio between 430 and 450 percent. Why do you think they need more capital?
NICK NEMETH: The permitted practice, right? So, the RBC ratio is affected by the permitted practice. A hundred percent is what you need. I have a problem with the number of what you need. These guys, they sit on an RBC ratio like it’s golden. Why don’t we talk about, I don’t know, how much assets can go down? How much surrenders would spike for this thing to break? It seems like better numbers to focus on.
TEDDY DOWNEY: What’s the real world way in which this company becomes insolvent, not the pretend regulatory way that’s like approved all these exemptions. That’s how I think about it.
NICK NEMETH: Yeah. I mean, you take away the permitted practice, technically it’s insolvent. But it’s hard to ignore it, right?
TEDDY DOWNEY: I mean, it is technically, And we get a pushback when we’re trying to write about this stuff. Technically, it’s allowed because it’s a permitted practice by the regulator. But I think the real world question is (a) why was it allowed? And also, why are these rules here in the first place? If they’re just exempted all the time from following them. The rules are there so that the public has transparency about whether or not people’s insurance policies can be paid back.
And I come back to this over and over again. There’s two things. You made a promise to a policyholder and then you have to pay it. And now we just have tremendous amount of uncertainty and obscurity around whether or not you have enough money to pay those promises. Like, to your point, if it’s a permitted practice, it looks like you have tons of extra money available. When in fact, you may not have nearly enough, right? That’s the main disconnect here to me. I don’t know if that’s a fair way to say it.
NICK NEMETH: And then for people to say there’s no private credit when it’s a structured product or whatever, it’s just mental gymnastics from my point of view. But let’s talk about what it would take to break. If that permitted practice was like actual cash, true capital, if their capital was true, hard, loss-absorbing capital, I would say 5 percent hit towards their assets. In addition, rates are higher already. There’s probably some runoffs, a spike of three to four percent on surrenders. You’re in trouble. You’re in a lot of trouble. That would be you take away the permitted practice, that happens in half the time. And that’s why the permitted practice shouldn’t be allowed.
Now, five percent on bonds, we have to understand that’s a good amount of defaults, right? But the more you go into structured seven times levered businesses, and you’re owning the mezzanine debt that easily can be cleared and commercial real estate and all of that, it becomes more and more likely, especially where you sit on the cap table, right? If the bank has the first lien on commercial real estate and an insurer has the second lien, when the office property goes from $125 to $25, you’ve just lost everything. Zero recoverability.
TEDDY DOWNEY: So, you’re saying it’s not necessarily the definition of is there a private credit in the portfolio, but is it structured? Is it in that ecosystem? Is it money coming out of that ecosystem?
NICK NEMETH: There’s huge varying degrees on it. Anything that’s structured, I generally have to hold my nose and poke into it, but some of it’s money good, right? The AAA of the mechanics of it, the AAA of even direct lending CLOs, nobody thinks there’s any risk. I think there’s low risk. I think there is still risk, but I’ll admit that, right? That’s way more safer than if you’re running the mezzanine.
Like you have equity above you and you might have like a tiny sliver of triple B minus and then your triple B, that can go to zero, right? And these guys think that it might lose 10, 20 percent. The difference in assumptions there is massive going back because of that. This is allowing their discount rate to be eight or nine percent because they think that that’s money good. And the loss given default is 30 percent. I think it could be more like 70 percent.
You can drive an ocean through outcomes on that. Across an industry that’s been competing, there’s competition, right? Executives need to hit numbers, stay employed. They have a mandate. Everyone’s been doing this for so long. Those risks are taken broadly. And then people are kind of assuming that the Fed can always come in with $2 trillion and jawbone the market and credit will unseize.
My view is it’s going to take five or ten. And then we’ve got to worry about what is a dollar even worth? The easiest way to de-lever is to have inflation. We did it after World War II. The war bonds went down to 50 cents on the dollar. And that’s a great way to delever, but that’s really not good for middle America.
TEDDY DOWNEY: You mentioned the scrutiny that the state insurance regulators that are overseeing these mergers are under now. Do you think that’s a meaningful change from how a lot of these private equity deals have gone through in the past? No one was really paying attention. No one was really talking about risk. Guggenheim has been doing this for 10, 15 years, and they’re only now getting scrutinized for it. But there is a lot of scrutiny now. And so, is the level of scrutiny being enhanced making it harder, in your opinion, for these regulators to allow for some of these broad exemptions that seem much more problematic now than they might have been when they were initially agreed to years ago?
NICK NEMETH: Yeah, there’s been a sea change. Guggenheim historically, if we go back ten years, was considered a good CLO manager. But in a long bull market, somebody gets promoted. They remember a couple of deals where they did affiliate deals or were kind of like “Can we get this deal through? Yes.” Then they get promoted again. The person underneath them has seen their boss co-sign a lot of stuff. Nobody has really lived through 2008 that’s below a VP or below basically, at least not professionally.
So, over time, you give an inch, a mile is taken. And it’s really hard for regulators to be like, hey guys. We’ve gone too far. We’ve got to step in here until something actually breaks. Just like it’s hard for me to talk about it. And people are like, “Ah, it’s fine. Be cool.” What are you talking about? No! The incentives are really bad and this is going to end poorly. I don’t know if it’s going to be this year or next year. I would be shocked if it was not in two years.
TEDDY DOWNEY: I want to close with a question about do you have a message for—we’ve got some policymakers listening here—do you have a message for the people who are listening, who are going to have to make decisions about bailouts?
Obviously, in 2008, the banks got bailed out. The homeowners, for the most part, were left out in the cold. Here it’s a similar dynamic. You’ve got, instead of banks, it’s private equity, private credit on the one end, and then you’ve got taxpayers and retirees on the other in the place of the homeowner.
If this goes south the way that you envision—and I have deep concerns that it will happen as well—what’s your message to the policymakers about bailouts and how they should think about getting out in front of what’s about to happen?
NICK NEMETH: I would say to make that decision better today, the decision is ask for less opacity and try to make these companies get down to 10 percent, 20 percent, level three assets. The more you can just move today, everyone can—you don’t need to understand much, quite frankly, to understand that you want to limit level three assets and you want more transparency. And then during the bailout is probably the time that we can do this. No more offshore stuff. That’s crazy. We’re going to learn how bad that is, unfortunately, far too late.
What I would say is equity investors, bond investors, that supported this deserve zeros. You can’t bail them out. And ultimately, there’s going to be problems. There’s always going to be problems. When you’re dealing with the decision, who are you trying to bail out?
Well, do we have to bail out the pensions? We’ve been bailing out pensions a lot. It seems like every single time that we encourage the allocators over there to do the same stuff and not really think critically. But I guess we’ve got to bail out the pensions. Because if you think about who that affects, it’s middle America.
Then the policyholders are first. The policyholders were looking for security. They did nothing wrong. The people that corrupted all of this, even the Fidelity of the world, they’re buying a funding agreement. Now, are they buying the funding agreement, having the full understanding that this is increasing risk directly on the policyholders? I don’t think so. But there’s got to be pain, and someone’s got to learn. If we’re all of a sudden bailing out every single risk taker, it’s going to be a societal problem, as people are going to understand it better this time.
The alternative asset managers, the ratings agencies, the regulators, if we’re going to get a bailout—which I think you should let everything de-lever and we’ll pick up the pieces and we’ll be a phoenix from the ashes—that’s just my capitalistic view—you have to find and make recourse what should be recourse, the appropriate parties, whether it’s the asset managers, the ratings agencies.
And we have to really break up the system. Because a rating being the determining factor will always be a problem. There’s no way that—as we’re talking about the free market, that’s kind of like a central plan-ish committee. That’s not capitalistic. Money should be flowing freely towards the best opportunities for capital, not based on a team at Fitch and Moody’s. They might do well 80 percent of the time. But the 20 percent that they don’t, then all of a sudden, that’s sucked into an investment grade thing. Where, if there was more analysis going to this allocation, it would be far superior. I guess that’s my answer.
TEDDY DOWNEY: That’s amazing. That’s super, I think, helpful for this audience. Actually, I do have one last question. Then I’ll let you go. Walter’s got in trouble because the DOJ has taken a closer look. Do you think there’s a role for law enforcement to look into allegations of fraud? Obviously, there’s some of these permitted lies that we talked about. But do you think that there’s an opportunity for law enforcement, either civil or criminal, to go in and see if there’s intentional fraud here throughout this system?
Because we’ve had a lot of conversation about incentives. A lot of these incentives are to mislead, are to obscure the truth, and you mentioned investors are harmed. There’s investment. There’s laws not to lie to investors. These policymakers are being harmed. Do you think there’s some law enforcement scrutiny that could be here when it comes to potential fraud?
NICK NEMETH: Yeah. I think, technically, the CIA could activate a campaign in Bermuda and the Caymans and figure out how much money is actually there in a covert way. Can’t do that in the United States.
As far as the SEC goes, any sort of state securities regulators ask questions. You get something, a statement on record. And I think it absolutely can be done. It’s easy to be overwhelmed. But if you start the process, it’s going to pay back later. Even if you don’t feel like you have the ability to build a case and you have to do it privately and you have to ask these questions because there’s a whistleblower, that’s not complete. But it’s enough to be curious.
Yes, absolutely there’s a role for law enforcement. It ultimately relies on legislature. And we have to understand that it’s never going to work to have 51 different regulators competing for business, race to zero. This should be federally regulated. It just honestly should. Whether we set up another massive agency to do it or Congress just writes in specific rules to go on top of what the state regulators do, which could probably be, quite frankly, ten pages, that would be extremely beneficial.
And I encourage policymakers to put two aides on this. Potentially, if you have a committee set up, a couple million dollars and make sure that there’s some insurance nativity. But also, just some really smart, hungry young people that are going to be like, “how does this work?” Because when you ask the question about how it works for your first time, you will have the experience of why does it work that way? Then when it doesn’t make sense, take a note. That is the most important part versus somebody who’s this is just the way we do things. We talk about RBC ratios. Why? That question needs to be asked a lot more when we try to break this down.
TEDDY DOWNEY: Well, Nick, this was an absolutely incredible conversation. I know people out there, you’re probably going to want to listen to it again. It’ll be out next week on The Capitol Forum podcast. I look forward to reading your stuff, following your work, Nick. Truly tremendous, tremendous stuff here. Love your rigor, love the way you get into the weeds. Can’t thank you enough for your time today.
NICK NEMETH: Thanks, Teddy.
TEDDY DOWNEY: Thanks to everyone for joining the call today. This concludes the call. Byebye.
