100年美国金融史告诉我们的当下

We're facing one of the most interesting capital market setups of all time, alongside one of the most interesting global environments—geopolitics, technology, and more. You and I have talked a lot about the shaping forces that will determine how things play out from here. One of those things that I want to start with—we'll talk about AI, geopolitics, and some other big things that might be shaping the world—is probably under-discussed, and you are in a very unique position to teach us about it: what you call the guardrails and incentives of the financial system itself.

The reason we're doing this today is that there's so much discussion of private credit, direct lending, and things happening in private markets, all of which are getting a lot of attention in the news. You can see it in the stock prices of certain companies, and I think the whole world's grappling with this, trying to figure out what the hell is going on and what to expect. You are a deep historian of this topic, so I thought it would be a really cool opportunity just to have you teach us all about this important factor in what's going to happen in the future. What is your general frame for the financial system and how it impacts the world?

There's a lot going on in the news, and what I'd say is that what you're reading in the news today are the symptoms, but not really the root cause. As an investor, when we start trying to figure out what's happening in the current moment—which is definitely a moment right now—we do 2 things. First of all, we think about it from the standpoint of, how did this get here? What's the history of it? How did we get here, to really figure out the current moment and also determine where we're going?

The second thing, and you hit this, is looking at everything through systems. When we think about systems, we think about the incentive system, guardrails, and market structure. First of all, I'm not an economic historian. What I'm going to do is tell the story of history as it relates to the current moment.

I think you have to go back to pre-1929 crash. When you think about the American financial system, it was basically the Wild West. It was pretty unregulated, and there were many causes of the 1929 crash. There was poor monetary policy, an agricultural recession, and margin lending, but one of the main causes was this idea of commercial banks.

Think about commercial banks: individuals go put their money into a bank as deposits. Commercial banks basically were in the same house as principal risk-taking activity, so the investment banks. These were all part of the same thing, and as you can imagine, when that happens, there's a massive conflict of interest.

The story for the current moment really starts in 1933. This was after the 1929 crash, after 9,000 banks failed. Think about that: 9,000 banks failed. Crazy. The 1933 Glass-Steagall Act was probably one of the most important regulations that took place, along with the establishment of the FDIC, which basically insured deposits for individuals at banks up to a certain limit.

Glass-Steagall basically said these commercial banks, which were deposit-taking institutions for individuals who got really burned in the 1929 crash, become separated from the investment banks. At the time, think about principal risk-taking—in today's parlance, private capital. Investment banks and commercial banks got separated, and that's the first system.

System 1, yeah. 1933 to 1999.

When you look at post-World War II, with this separation of commercial banks and investment banks, you basically have, after World War II, 50 years of a pretty stable system, other than the S&L crisis in the 1980s, which was a big event. Broadly speaking, it was a pretty good system.

The system wasn't optimized for economic growth because you really had a pretty conservative commercial bank providing finance, with a lot of guardrails.

A lower risk appetite, yeah.

So, it's a low risk appetite. Again, one reason is that the fixed-income market hadn't developed, which is part of the story here. Another is that investment banks were more in the moving business than the storage business. They were pricing securities to basically sell to other people; they weren't pricing them to hold for their own balance sheet.

That started to change as we got into the '80s, but broadly speaking, for this first system, from 1933 to 1999, it was working. It just wasn't optimized. The lesson from this is that with really good guardrails, you can get long-term stability, but you also have to think about job creation and economic growth.

I think if there's one criticism of the system—which, by the way, is why the Glass-Steagall Act got repealed in 1999—I can talk about why it got repealed and what sort of steps led up to that. It wasn't optimized, and as you go to a more globalized world and you're competing with, say, European banks, you become less and less competitive.

In a non-globalized world, it was probably okay, but as we got to a more globalized world, it wasn't really optimized to maximize economic growth for the country.

Okay, so we get to the mid-to-late '90s. What happens in addition to new competitive pressures? Just walk us through the transition into what becomes system 2.

At the time, we had separation between investment banks and commercial banks. All of a sudden, European banks, which weren't part of the same Glass-Steagall regulation, started to unite with each other. Commercial banks and investment banks in Europe started to come together, which put the American commercial banks at a big disadvantage.

Not only were they coming together, but they were also taking on more leverage than what was allowed under the guardrails of American commercial banks. As a result, all the commercial banks and many market participants were saying, “Hey, we can't really compete against some of these European guys.”

In 1998, Deutsche Bank bought Bankers Trust, and that was kind of a moment.

Like a moment.

That was definitely a moment. You had Citibank announce that it was merging with Travelers, which, at the time they announced the merger, actually wasn't allowed under Glass-Steagall and the current regulation.

That's what sort of led up to it. I think it's a couple of things: globalization, and the fact that all of a sudden you're competing against Europeans who could provide services, balance sheet, and capital. You were at a pretty big disadvantage. System 1 started to get less competitive as we moved into a globalized world, and that sort of led to 1999, when Glass-Steagall was repealed.

And so what comes in its place?

It's basically just deregulation. Literally after that, you saw a wave of mergers combining commercial banks and investment banks. You saw JP Morgan Chase. There were many others, but as with everything, there are always knock-on effects.

That came together and created these powerhouses that could compete with what was going on in Europe. But now you had all these investment banks that weren't commercial banks. Think about my old firm, Goldman Sachs, and many others. Now they had to start competing when they didn't have access to cheap capital because they weren't commercial banks.

They had to compete with combined investment banks and commercial banks because a lot of the commercial banks, both in Europe and the U.S., started to use their balance sheets to get investment banking business. So what did all the investment banks do? They started to leverage up.

That's one of the other stories leading into system 2: the development of the fixed-income market. Think about corporate bonds, mortgage-backed securities, asset-backed securities, and sovereign debt.

That went literally from the '80s to the '90s. It went from about $7 trillion to $14 trillion. These are all financing mechanisms that could finance the investment banks and basically allow them to leverage up.

That's what started to happen. Literally, from the time Glass-Steagall was repealed, you had commercial banks uniting with investment banks, both in the U.S. and Europe. You had leverage going up—commercial banks in some cases were at 20 or 30 times leverage. All the investment banks were operating with leverage because they had to take on leverage to be able to compete with the combined commercial and investment banks.

And then, 9 years later, what happened? You had the GFC. Now, just to be clear, there's a polarizing debate about how much attribution the repeal of Glass-Steagall had on the GFC.

Yeah, what do you think?

I think there was definitely some attribution to it. I don't think that was the only reason. My view is that it's some combination, but ultimately it had to do with the system and the set of incentives. In that case, after putting all this together, it was a lack of guardrails that existed in the first system we spoke about.

And in system 2, is the reminder, I guess, or the lesson that it's the combination of liquidity, or asset-liability mismatches, and leverage that's basically the cocktail for every historical financial crisis? Like, one of those two or both are involved?

Leverage always plays a role, and they're all connected, but just the mismatching of assets and liabilities can be enough. You could be the best investor in the world, making the best illiquid investments, but if someone comes and asks for your money in a quarter when you haven't had time to actually have that investment play out the way that you underwrote it to do, you're going to be a bad investor. You're going to get caught out of your option, and you might have to sell it at a deep discount.

I think there are a few things. First, anytime you bring retail or individuals—think about people depositing into a bank—next to principal risk-taking activity, I think that's one thing. Second, it's anytime you mismatch assets and liabilities. Third, again, going back to what we talked about earlier, is what are the incentives, what are the guardrails, and what's the market structure?

1. The Rise of Private Capital

Okay, so then what happens? Obviously, we know about the global financial crisis. It's terrifying, and the reaction is many things, but what is installed post-GFC that sets the seeds for what we'll call system 3, the current system?

In 2010, 2 things happened. First, Basel III was passed by the G20 nations. I'll explain what that is. The second thing is Dodd-Frank.

When you think about Basel III, this applies across all commercial banks. By the way, a number of investment banks that were not commercial banks were forced to become commercial banks as a result of this. Those commercial banks—and this is really a Basel III thing—had restrictions on capital, which, for your audience, you can think about as leverage. There were restrictions on the amount that they could be leveraged up, so they didn't get leveraged up 30-to-1 or 40-to-1 like they did pre-GFC.

The second thing was restrictions on liquidity. Liquidity is basically, through a bunch of shock scenarios and a bunch of things going wrong, whether you have enough liquidity to meet all your obligations. I think that was a key part of it.

Dodd-Frank was more aimed at the Volcker Rule, and that didn't really last that long. It was really aimed at principal investing activity. I would say, for the commercial banks, it was more Basel III, but Dodd-Frank played a big role, certainly in the short term.

Yeah. So how would you explain system 3 and its guardrails and incentives to people out there?

System 3, in my opinion, is—and we've taken 125 years to get here—potentially the best system American finance has ever had.

Because when you think about commercial banks and deposit-taking institutions that are basically backstopped by the government and insured by the government through the FDIC, think about the GFC. There was a bailout, a taxpayer bailout. That's not good for society. That's not good for the middle class. That was not a good outcome for America.

For those institutions, having restrictions on capital, or leverage, and liquidity, where they're doing lower-risk-taking activity to finance a system, that's a good pillar of any financial system. Conversely, on the other side—and this is where the current moment starts to come in—you've got private capital coming in.

2. The Factory Model

When you think about private capital, think about pension funds, sovereign wealth funds, endowments, and insurance companies providing capital. In the beginning of this period, sort of called system 3, post-Basel III and post-GFC, that's what resulted in the growth of the private capital industry because it was filling in the gaps.

Think about principal risk-taking activities: private capital was filling in the gap. With the exception of hedge funds and really REITs, those were matched assets and liabilities. So, you think about private equity, private real estate, private infrastructure, and private credit—they never had someone who could literally ask for their money back, or they didn't have depositors saying they needed to get their money back. They can't get it back because of the illiquid assets.

Just to put it in context, private capital from pre-GFC to post-GFC was about $2 trillion pre-GFC. It's grown to about $14–15 trillion. It's insane. Private credit, which is in the news today, grew from $500 billion to about $2 trillion, where it is today.

That's massive growth in this sort of filling the gap for that principal risk-taking capital, providing risk capital to all parts of the American economy, which is a good thing. I would say that up until 2018, the system was working great.

You had commercial banks—deposit-taking institutions effectively backstopped by the government—doing safer things. Then you had matched assets and liabilities, where you, an investor with a set of assets, couldn't get caught out of your position while providing the risk capital. That's a pretty good system. It worked until we started to see behavioral changes in 2018.

Just to put a pin on an elegant, well-designed system of guardrails and incentives: the commercial bank model, where it's lower risk and protected or backstopped, and higher-risk-seeking capital, where the assets and liabilities are matched. It is a good system.

It's a good system.

Yeah.

All crises generally are caused not by credit issues or other issues. They might start with other issues, but it's mismatched assets and liabilities.

You mentioned 2018 as being a pivotal point. I want to explain that transition, but it feels important because you and I have talked about this notion of yours, the factory model, before. Maybe we're going to go into that in more detail, but just to plant the seed in people's minds, define the factory model briefly. Then I want to talk about what happened to get us kind of transitioned in the incentives toward that model.

Sure. So, the way that we define the factory model in our industry is, there's 2 parts to it, and then there's an output. The 2 parts to it are: the first part is the industrialization of the fundraising process, right? Say, liability gathering. So, literally raising as much capital as you possibly can, literally as fast as you can.

So, that's sort of the industrialization of the liability side, the fundraising side. That comes first, and then what comes second is, as a result of that, the industrialization of the asset side.

So, think about investing. If you're on an investment team and all of a sudden your firm has a lot of money to invest, and it's just sitting there, maybe there's a tick—maybe there's a timestamp on it. All of a sudden, your behavior has to start to change because you have to deploy that money much quicker. What's the best way to raise a lot of capital quickly? The biggest capital source is direct.

The raise is simple. So, make it very simple. Make it very narrow, because if it's wide, that's too hard to explain. You want to make it as narrow as possible.

You're also willing to make concessions on the type of capital you raise. So, meaning, maybe it's got a term where they can ask for your money back. You start—instead of perfectly matching assets and liabilities—maybe you're willing to not have perfectly matched assets and liabilities because you want to raise it as fast as possible.

Again, when people hear this, they're going to think I'm only talking about the bigger firms in our industry, but it filtered down to midsize firms and smaller firms for a whole bunch of reasons. This whole factory model behavior started to reveal itself in 2018.

Just to draw a visual, the visual that's coming to mind on the asset side—and again, we'll come back to both these ideas in more detail—I think of an artisan making a horse saddle or something by hand. Then I get an order for 100,000 horse saddles. I can't make it by hand. I've got to make a factory.

That is the exact way to think about it, because it's a different model when you're building that horse saddle versus when you get a massive order. But one point that's important is that it always starts on the liability side, then it goes to the asset side, and then you get to the current moment that we're in, which I know we're going to talk about.

And it starts on the liability side because why? Because if you just all of a sudden go to that example—it's a really good example of the horse saddle—and all of a sudden, if you don't have a factory that can produce 100,000 on the artisanal side, you're never having to think about it.

You could have an industrialization of the asset side, but if you don't have the liability—if you're liability-constrained—you're not going to change behavior because you don't have the capital to go do that. You'll run out of money in—

Yeah, yeah. 5 days. So, it's got to start on the liability side, where you raise all the money, then you have it, and then the behavioral change starts.

These 2 things—first, on the liability side, it starts the industrialization, and as a result of that, it goes to the asset side.

Yeah. Which is interesting because, basically, I don't know if you add up every conversation I've ever had with an investor, 98% of the time spent is on the asset side: What are you investing in and why?

3. The Wealth Channel

Exactly. And by the way, that's okay if you have perfectly matched assets and liabilities. It's okay. But let's imagine a world where every investor you spoke about had a term in their agreement where, after 3 years, the investor had the option to call their money back. That would probably be something you want to be talking about a lot.

By the way, prior to 2018, going back to the financial system, the private capital pool was pretty perfectly matched—assets and liabilities. Obviously, it would seem that if everything was frictionless and I was a GP, I would of course have matched liabilities. If I could just snap as much capital as I wanted into existence, yeah, of course. I want to have no problems.

So, what was going on? What's the series of events starting in 2018? What were the first examples of this, and how has it evolved?

So, the first signal is underwriting. Because investing or lending—you could invest as much money as you want. You could lend as much money. That's not the skill. The skill is investing. It's that artisanal behavior.

When you start to see—and again, it wasn't just private credit, as everyone talks about—we started to see it in every asset class. We started to see it in real estate. We started to see it in infrastructure. We started to see it in private credit.

It wasn't actually bad, but we started to see behaviors like terms that you would never do, because obviously, when you lower your underwriting standards, guess what happens? Your deployment pace can go up.

You have an origination engine. You're sourcing all these deals, and let's say you're an artisan, you might have a hit rate of half a percent. You look at it: If you lower your underwriting standards, your hit rate on deals that you might do might go to 2% or 3%. It's literally all in your control.

I think we started to see it, but it wasn't full-fledged factory model industrialization. It was just something we started to notice—changes in behavior—but it wasn't full-fledged factory model industrialization.

COVID happened, and then post-COVID, it was game on for the factory model, both on the liability-raising side and also on the asset side. Literally, that behavior started to accelerate in incredible ways right after COVID.

And was that mostly—I know the capital, the liability, has come from lots of different pockets—but my mind goes to the wealth channel that everyone's talking about now, the institutional channel as well. Maybe put a little more color on where it actually came from, where it's coming from.

So, what started to change in 2018 is there are these things called SMAs, or separately managed accounts. Prior to 2018, for the most part, the private capital ecosystem was basically funneled through funds.

Think about commingled funds: Lots of investors come into 1 fund to pursue a certain strategy. All of a sudden, every conversation with every LP was basically, “We want an SMA. We want more of a fund of 1 just to do XYZ for us.”

You go to an LP and basically say, “Hey, we're going to raise $500 million or $100 million, and we're going to do direct lending or private equity or real estate.” All of a sudden, there started to be a proliferation where, literally, 3 years prior, it wasn't any conversation. Every conversation was an SMA.

What it was, was just the industry starting to raise capital from the institutional channel. So, not wealth—the institutional channel. Pension funds, sovereign wealth funds, to some extent endowments, raising as much capital as possible in the simplest form.

It started on the institutional side with SMAs, but the growth in institutional SMAs started really tapering off. So, the next place where the industry started to go was the wealth space.

The wealth space in general, just from a historical perspective, is typically the easiest to raise, the simplest to raise. It's typically the cheapest. That doesn't mean that they're not smart, just the cheapest.

But the other characterization of the wealth space is that it's always easiest to raise in pro-cyclical environments, when things are going really well. When things start to not go well, the wealth space—or retail, or individuals—want their money back quickly.

I just want to level-set on that. It's an important concept, and that's where it started to go. That sort of got us to one of the symptoms of where we are today.

But the one thing I want to point out, and we'll talk about the current moment, is that the SMA was a symptom. What's going on in the wealth system is a symptom.

When you think about some of the stuff you see in stuck private assets, there are so many assets around the world in private real estate, private infrastructure, and private equity that were literally companies or assets bought post-COVID, in sort of 2021 and early 2022, for which people paid way too much. They're stuck assets.

All that stuff is symptoms. The root cause of this is the change in behavior patterns of the factory model. That's the root cause.

Again, one of the things that's not frustrating, but unfortunate, is that everything covered in the media is just talking about the symptoms and not actually getting to the root cause.

When you think about history, people talk about the symptoms, but when you start to diagnose what happened and how we got there, it had to do with the root cause. I think that's something that hopefully this conversation provides some greater clarity on.

So, if I think about this model, and we've talked about—maybe you can mention—the multiples that markets had been putting on asset management companies. We can look at public markets and see everything transparently: how much markets were willing to pay for the equity on a multiple basis, and what multiple the market put on that, which drives the incentive to raise money.

That just feels like an important point.

It's good to step back on what the system is. What are the incentives? What are the guardrails? What's the market structure?

The incentives in this story, the story of the factory model, start to correspond with FRE multiples. What is FRE? FRE stands for fee-related earnings. Fee-related earnings is basically your management-fee profit.

You raise a fund, it's got a management fee on it, you've got a set of expenses, and what's left over—that is your fee-related earnings. These things, for our industry, started trading in, let's say, the early 2010s at 10 to 15 times FRE.

In 2018, when all this started, it stepped up to 15 to 20 times. Obviously, it depends on the comp set. Before this current moment, we're at 25 to 30 times plus. That's where it is.

By the way, if you go back to the early passage of Basel III and Dodd-Frank, there was a massive secular opportunity to fill the gap that was left from commercial banks being constrained. Then the system found its steady-state place, but in order to keep growing—and again, it's the whole industry—what do they do? Many participants adopted the factory model.

And is this maybe the crass way to say it? In the factory model, the GP, the founder of the firm, stands to make a lot more money from the equity of their GP than from the carry they would earn through investing, or something like this?

What I'd say is that, look, to be a CEO of one of these larger firms, it's hard. You have a lot of different constituents. It's really hard. As an investment firm, sometimes it's good to grow and sometimes it's not good to grow. It depends on the investment environment, the quality of your liability structure, and the flexibility of your investment model to migrate to where the best opportunities are.

It just depends, but I think it boils down to what's your clarity of purpose. There are a number of people that are public that I would say have not adopted a factory model. There are a number of people that are not public that have adopted a factory model. Maybe they want to get bought by one of the larger guys, or maybe if you're a midsize firm, you want to be one of them.

4. Asset-Liability Mismatches

The issue is, just because you're large and just because you're public, it doesn't mean you've adopted the factory model. It's about your clarity of purpose. If your clarity of purpose is to be an investment bank, then maybe that's what you want to be—a factory model. But if you're going to do it, you better have really good risk management.

That's why, if you look at commercial banks, Jamie Dimon is probably one of the best risk managers of all time. What he can do from a risk-management perspective—you saw it in the GFC, and you see it at other times in his career—is that he's a better risk manager. But the rest of the industry that follows suit because they want to be Jamie Dimon might not be as good at risk management as he is.

It's the same thing over here. It's not just the larger guys, because remember, the industry always follows the larger guys. But it's not certain that just because you're public, just because you're large, you've actually adopted the factory model.

What are the most common, in your mind, telltale signs of a firm that's in this model? What does a firm that's adopted the factory model look like that's distinct from an investment-model-based firm or something?

First of all, you know it when you see it. You can see it in the underwriting of the deals. We're in a bunch of different asset classes, and you can see it. There are terms, particularly if you're a fixed-income investor or a credit investor, because you have capped upside, that you just don't give. A lot of those terms have been given.

Given to facilitate deployment of capital.

To fill up. So, to your point, you should not do those terms because it's all good when you're in a post-cycle environment. But if you have capped upside and you're earning a 10% return, all the collateral that your 10% is based on can literally be taken out of your collateral package overnight.

For that 10% return, you can be levered up because, let's say, there's an AI disruption and some software company needs to reposition its business. They can basically leverage you up, so you go from 50% loan-to-value to 120% loan-to-value. Those are just things that you shouldn't do for a 10% return.

Yeah, so the first time we did this, we talked a lot about return per unit of risk.

Yeah.

And so it basically sounds like the thing happening in the factory model is that that has fallen out of whack. The objective function becomes more deployment of capital because that ties to the size of my business, the multiple on the business, how much money I'm making as a shareholder, or whatever. It's fundamentally divorced from the investing equation, which is return per unit of risk, or something like that.

So map this onto the news cycle today. What is happening? Where are there asset-liability mismatches? What is the nature of them? What are the implications?

So, again, go back post-COVID. That's when the wealth space took off. The democratization of alternatives, or private capital—which, by the way, just to be clear, I'm not against that—

Yeah.

What I think is that some of the factory models that are out there have raised money in the wealth channel in irresponsible ways. First of all, in general, you're taking an illiquid asset and giving investors the ability to get their money back quarterly. They say semi-liquid. There's no semi-liquid. There's no such thing as semi-liquid.

Anyone who's an investor who's been through a bunch of cycles knows there's liquid and then there's illiquid. Again, going back to the history of the wealth channel, or individuals, or retail, the one thing we know is that it's very pro-cyclical. When it's a pro-cyclical environment, it's easy to raise money. When there are problems or dislocation, like there is today, they want their money back.

You basically had a mismatching of illiquid assets and liabilities. That's one part of it. The second thing is that they would raise these very narrow strategies. By narrow, what I mean is that it's just direct lending. It's not that you can invest in direct lending, real estate, infrastructure, or asset-based finance. No, it's just direct lending, or just asset-based finance, or just this strategy. That's a narrow strategy.

Maybe that's okay if you raise the right amount of capital. But if you raise an unlimited amount of capital, where your investing is dictated not by good investments in the market but by how much money you can raise, there's never a governor on how much money to raise.

The thing about these wealth vehicles is that when they raise money, they have to invest it right away. We call it inflow investing. They have to invest it right away. They raise as much money as they can, and if they don't invest it right away, it dilutes the return of that vehicle.

Yeah. To ground this in actual reality as much as possible, we've talked about all these guardrails, all these incentives, the 3 problems, all this stuff where the system structure begins to determine fate. What is fate? What is actually happening today?

What are the implications?

So, what's happening today is that there are these vehicles called perpetual private BDCs. These have been raised in the wealth channel. So, individuals, wealthy, mass-affluent ones—they've been raised. In some cases, not all cases, they're in very narrow strategies: just direct lending or just private equity.

Really, the catalyst was software and AI, and also some of the market volatility, which led people to start questioning the quality of their portfolios. It could have just been market volatility because of what's going on outside of this, where people want their money back.

There's a limit on how much money people can ask for. Basically, in the perpetual private BDC space, the amount of money people have asked for has exceeded the 5% limit.

Yep. And that's creating all the noise that you're reading about. What's the range of implications of all this? I can imagine one where it's tough—you can't have your money back and the world keeps spinning. Another is something dangerous and scary and systemic, because past financial crises have tended to be downstream of some domino, like private BDCs or whatever it is. Each time it's different. What do you think the range of implications of all this is before we talk about what healthy is?

Yeah, I don't think this is a systemic issue yet, for 2 reasons. One, we're only 5 years into this, so it's early. The second thing, at least for now, is that there's a pretty strong economic backdrop. There's definitely risk to it, so I don't think this is systemic. It could turn out that way, but I don't think that's actually what's going to happen.

I do think there needs to be a major recalibration of behaviors and the way that people approach this wealth channel. If you go back to what we talked about earlier, anytime society or the financial system puts wealth or retail individuals next to principal risk-taking, if you look throughout history, that's where problems start to happen.

Most of it has been with commercial banks, because that's been the primary pillar of the financial system. But now, with this new pillar in private capital, it's starting to touch risk capital, and it's starting to become more of an asset-liability mismatch.

When you look at the quantum of the problem, at least as it specifically relates to this, it's pretty small in the grand scheme of things. What's going on is that, in private markets in the wealth channel, there have historically been very small allocations to private investments—1% to 2%. That channel is smart. They see that value creation and returns are happening without them in private markets, and they want access to it. Seems fair. That 2% is expected to go to, whatever, 10% plus in the decade to come.

So I guess the question is, how can we do it responsibly?

Let me say it this way: if you are going to raise a narrow strategy, like just direct lending or just private equity, you need to govern the amount of inflows that come in. Sometimes you just say no. Maybe you have a waiting list, but again, because flows come in in pro-cyclical times, if you only have a $100 million vehicle, maybe it's always a good time to invest.

But if you have a much larger vehicle, it just gets really hard because maybe it's a good time to invest, maybe it's not. That's why I think where this will go responsibly, you're going to have to have very wide apertures. Ultimately, in every ecosystem, whether it's direct lending, private equity, real estate, or infrastructure, they go through supply-and-demand dynamics.

Sometimes the supply of capital is really high and demand is low. That's probably not a good time to invest. Sometimes demand for capital is really high and supply of capital is really low. That's again—not certainly, but probably—a pretty good time to invest. It oscillates within each ecosystem all the time, so I just think you want a wide aperture.

5. Career Eras & Success

But if you're going to do that, you can't just all of a sudden show up, which is probably what's going to happen in this recap. Everyone's going to show up and say, “Oh, I'm a multistrategy private capital fund. I'm going to do whatever.” Well, yeah, you've got to be able to do it, but you also have to have the capabilities to be able to do that. There are a number of people that do, but you can't just all of a sudden do it. It's a style of investing.

I think those are the key attributes that will make up responsible investing. But the biggest thing is just being very upfront: when you want your money back, you have to assume it's like the 2008 crisis or 1929. If you're comfortable keeping it invested, then you're probably a suitable investor.

You said before that maybe system 3 could be the Goldilocks scenario. I've always been interested in moral hazard around financial crises—the socialization or spreading of this risk that one person takes to make more money, and then they get bailed out or something like this.

It seems like this asset-liability mismatch in the current system may be cyclical, and it waxes and wanes, but people are selfish. People are going to take advantage of the ability to raise more money forever unless the responsibility is mandated, regulated, or more clearly laid out. Do you think we still have some evolution to do to create the Goldilocks scenario?

I think that's what really needs to be thought about. I think that's going to happen as part of this recalibration process, but that is a much better outcome. There can be good legislation, but there's a risk that it's not the right guardrail, that it's not good for competitiveness, and that it creates the next crisis.

The best answer is a market mechanism, like you have within institutional investors, where if you do irresponsible things, you're not a good investor, or you change your business model, they're going to punish you by not giving you money for your next fund.

If I turn all of this into ideas or guidelines for people running investment firms, or who want to launch an investment firm, what are the right principles to take away? Obviously, one is to keep your liabilities and your assets well matched. That's a major one that anyone can do, and maybe you have to work a little harder to raise money, but you'll be thankful for it.

A second is to maintain an underwriting standard that's extraordinary, or however you want to define it. Any other major advice that you'd give to people running investment firms, or just principles you have for building Sixth Street that flow from all this history and thinking?

First is: what's your clarity of purpose? What's your day-one clarity of purpose? Is that staying consistent over time? Is your clarity of purpose to raise a bunch of liabilities, or is it to drive good returns for your investors? Maybe it's both. Maybe some firms can do that, but what is your clarity of purpose?

This is something we talk a lot about at Sixth Street: if you look at all the great companies that have been around for a long time, they got one thing right. They never forgot what their purpose was, which is to serve their customers. It's enticing to raise a bunch of money. Once you raise it, it's enticing to invest a lot of money, but that doesn't mean that you have to do it.

6. AI & Creative Destruction

Sixth Street is a multistrategy private capital firm. We do a bunch of things. One of the things we do is direct lending. We have one of the best track records. We've been here longer than anyone in direct lending. I started the direct lending business in 2001, when there were only 2 of us.

We've watched this, and we could have gone to the wealth channel and raised all the same vehicles because of our track record. Do you know how many perpetual private BDCs we have?

Zero.

Exactly zero. It's not that we couldn't have; we just didn't think it was the right thing, and we didn't think it was consistent with our clarity of purpose. That's why we didn't do it.

It's easy to get FOMO. I just think you have to block out that noise, and it always comes back to first principles: clarity of purpose and what your values are. If you stay consistent with that, judging by the best companies that have been around for a long time, that's your pathway to building a great company that's going to be here for a long time, not short-termism.

Yeah, again, back to the news cycle, there's this thing where lots of firms that manage lots of private credit strategies, separately managed account exposure, and so on, are seeing their stock prices really hurt. We've talked about all the reasons at length for the mismatch and so on. What do you think happens in private credit?

I think and hope that this is going to be a recalibration. People are going to readopt more prudent underwriting. I think people in the industry will change their behaviors. In some cases, the market will change their behaviors because you may not be able to raise more capital. I think the market mechanism will work.

Obviously—and this is hopeful—I think it will stabilize. Hopefully, the best thing about the current moment is that this happened not in a deep recession. It happened when the economy is relatively healthy. There are definitely risks out there to be worried about, but this would be much different if you think about redemptions in a lot of these wealth vehicles. If it were a distressed environment, the redemptions would be 2 or 3 times what they are.

To me, this is a gift to the industry to recalibrate. There are a lot of smart people in our industry, a lot of great investors, and I think the industry will recalibrate.

If you think about stepping back from the American financial system, with commercial banks, you could have a really powerful system supporting economic growth, with commercial banks providing one pillar—safer, with good guardrails—and private capital providing the risk capital. That's a pretty good system, and I think if we get that right, it's really going to set up America to really optimize economic growth. That's what I'm hopeful about.

You alluded to AI and software being some of the early dominoes that got this whole discussion rolling, and people's redemptions and reactions and things. It seems like, if you think about creative destruction as a force driving the U.S. experiment since its inception, we are facing a hardcore period of creative destruction. How do you think about that, given the open, wide mandate of Sixth Street and your ability to put your capital and your customers' capital in so many different places?

7. Personal Organization System

Talk through the opportunity set today. Of course, I want to hear what you think about AI and software. I can't help myself. This just feels like such a time to be alive, but also an opportunity and a danger.

There are lots of opportunities. I live on the LLMs. I play with them an hour. Actually, my wife makes fun of me because I'm constantly playing with my friends Claude, Chad, and Jim.

I’m always—

Patrick O’Shaughnessy

Your friend Grok.

No, Grok. [laughter] I actually play with them all because I like to ask them the same question to see how they answer it differently, just to try to get a feel for it. But I’m a big believer in the productivity opportunity. There’s a lot of good with it, but there’s definitely risk in the transition.

But again, you mentioned software. That was one of the catalysts that sort of got us into the current moment, but everyone’s so focused on software. I think what people who have lived in Silicon Valley—I know you spend a lot of time there—understand is that this is not just software. This is every industry. Once one company in any industry figures out how to actually use it as a tool, really figures out how to use its agentic capabilities, and drives higher margins, if you’re one of the companies that’s a slow adopter and you’re not active, you’re going to have some of the same problems that people perceive the overall software industry to have today.

So it’s not just software. It’s across everything. Look, one of the best things about the American project is creative destruction, because it allows for prudent allocation of capital to the right places that are going to drive the right outcomes.

Patrick O’Shaughnessy

If you think about the unfolding set of opportunities that it creates, one of the categories that you and I always talk about, that I’m so interested in, is one’s own development. The highly adaptable people seem like they’re going to be set up for lots of success in this environment.

How do you think about your team and making sure—and I know you have a team with very long tenure that tends to be at Sixth Street for a career—how do you think about their development and new things that you can do as the leader to make sure that they are all dynamic as things change really fast? I know you’re playing with the LLMs all the time, but this is an important part of your job: your team. How are you thinking about it?

The good thing is, when we hire someone, we’re looking for a lot of things. But 2 of the things that we’re looking for are: are they an open-architecture person? Can they play tennis—what we call playing tennis—bounce different ideas, even when you disagree with someone? And the second thing is, are they a learner?

Surprisingly, we track all the AI usage on the LLM models. Our usage across our entire firm is off the charts, partly because of the types of people we hire, but I just think in general, stepping away from Sixth Street, that if you’re not adaptive in this environment and you’re not a learner—literally committed to learning every day and improving yourself every day—you have the risk of getting lost in what’s happening and about to happen in a more accentuated way.

Patrick O’Shaughnessy

I have an off-the-wall one for you. It’s been deeply impactful on me. Can you explain this paper, one-sheet system for how you get everything done and track what you do?

I actually did a presentation to our entire firm on personal organization systems, because I think, as an investor and as a businessperson, the scarcest thing you have is time. One of the most important skill sets is your dynamic prioritization of that time on the highest-impact things. We always talk about return on time.

My personal organization system—I call it “the brain”—literally tries to get the way my brain is structured onto 1 sheet of paper, so that I can get all my important priorities—people, businesses, investment themes. It changes over time based on what’s needed for me, because my job changes every year and I have to evolve. I try to get my brain onto 1 sheet, and it allows me to dynamically prioritize where the highest return on my time is.

The second thing it allows me to do is capture things so that I never have loose ends. I try to always follow up on everything and be proactive about things. I just think proactive is a key thing. It allows me to see clearly what my top 5 strategic priorities are, along with all the tactical stuff.

I’m constantly looking at it and updating it. I do it all by hand, because for me, I have to actually put pen on paper. Once my sheet fills up with all my tactical stuff—the small stuff I have to do—I start a new sheet. Then I write literally all of it, and it takes me about an hour. I generally do it on a Sunday.

There’s never a time I go through that process on a Sunday where I don’t connect 2 or 3 dots or think of a new idea. That’s why, on the second sheet—which I can’t remember if I showed you this—

Patrick O’Shaughnessy

The right brain, right?

I then have my left-brain sheet. That’s my left brain. And then I have my right-brain sheet, which is the second page, and that’s all my creative ideas, themes, business-building ideas, people, better leadership—just whatever comes to mind.

Thinking about the current moment, I literally started thinking about, “Why are we here? How did we get here?” That’s how I started to really dive into history. I just write stuff down and track it, and I’ve done that for 25 years. I have all my right-brain thoughts over 25 years.

What happens is, I’ll go back and look at them. Every year, at the end of the year, I go back and read all my right-brain thoughts. Sometimes there are ideas that I had 10 or 15 years ago that surface today and become relevant today.

I try to get my left brain on the first page and my right brain on the second, and then I try to get them working together. Again, it just helps me see things I want to have clear thinking on, so I can try to see the world not only for what it looks like today and what it’s been, but also where it might go and how Sixth Street can be part of that.

Patrick O’Shaughnessy

One of the things that stuck out to me, seeing the actual sheet—I’m thinking about the left-brain sheet—was that there were different boxes. I’m curious what the different boxes are. One of the things that I found very powerful was that, when you run out of space, one of the segments is a list of people to call. It was a crazy list. It was a shitload of people, and then tons of strikeouts.

Yeah. When you run out of space, you copy it to another page, but you also copy over all the stuff that is lower turnover, I guess I would call it.

Patrick O’Shaughnessy

And that act is a big part of the process.

The process of that—and looking is part of it—but the best ideas come out of actually going through the process.

Patrick O’Shaughnessy

So what are the other segments of that first page? There’s a list of people to call. What are the other segments? There are 5 or 6 boxes, and I can’t remember what they are. What are those boxes?

I think I told you this last time: we have everyone in our firm do a personal business plan. My personal business plan at the end of the year—I’ve done it for, I don’t know, 25 or 30 years, forever. It takes me about 3 weeks to do my personal business plan.

That’s why I was saying to you last time, we spend all this time evaluating companies: do they have a business plan or not? And then most people, when you ask, “Do you have a business plan for yourself?” they don’t have one. That’s why we make everyone in our firm do personal business plans.

From the personal business plan I do at the end of the year, I get a lot of clarity just from going back and reading stuff I wrote. What are my top 5 priorities for how I can drive the most impact to our firm and our investors? Complete clarity on what those 5 things are. I have a box for each of those 5 things, so that’s kind of 5 boxes.

Then I have high priorities, because again, those have a different cadence to them. Everything has a different cadence, which is why I think you have to see everything together. The boxes on the page change every year, just like our themes every year change. Everything has to change every year, because it goes back to adapting: the world is always changing so quickly. If you’re not adapting yourself, then you’re going to get lost in this world.

I’ll have my 5 strategic priorities, my time, and people I really want to focus on. This could be internal or external. I also have my health on there, because despite drinking this, I think about it. I actually think I have to be healthy to be able to do my job.

Patrick O’Shaughnessy

What would be an example of something in the health section that gets written down?

I’ve got vitamin D on there. I’m very focused on vitamin D. I’ve had an old soccer injury, so I’m focused on left-hip mobility. This year is a big year for my hip mobility.

Patrick O’Shaughnessy

But it’s something you just see every day.

Yeah, everything. It’s also the personal side, so I keep balance. I think it is an intention system, but it’s also a return-on-time system and an ability to dynamically prioritize.

If you talk to younger people who are just coming up through the business, even some older people still don’t know how to prioritize their time. It’s really hard to do, because you literally could spend all your time on 1 thing.

Patrick O’Shaughnessy

Yeah, so managing the time and being able to see that in your brain or in the matrix—I think that’s kind of how I think about it.

Another thing that you really talked about last time that stuck in my head was that I just turned 40, and we were talking about the sort of opportunity you have from age 40 to 50, which got me wondering about 20 to 30 and 30 to 40.

If you think back on the major eras of building and managing a life's work and a career, tied to specific ages, what have you learned?

20 to 30, for me, was education—almost like business school, because I didn't go to business school. Just learning as much as I could and asking as many dumb questions as possible. In your 20s, you think you know stuff, but if you haven't been through cycles, made a lot of mistakes, seen other people make mistakes, seen people make good decisions, and seen what a good long-term decision and a short-term decision are, you don't really know anything in your 20s.

From 30 to 40, you're incredibly ambitious. You're still learning, but you're trying to prove yourself. You're out there, and I started Sixth Street with my partners when I was 33 or 34, so I didn't know what I didn't know. I mean, I knew a lot, but you're going through that, and you haven't made enough mistakes yet to really refine your craft.

And you get to 40 or 50, and 40 or 50 is like—it's all together. If you've spent time learning and continuing to learn, you've made enough mistakes that you really know who you are at that point—who you are as an investor and how you approach things. It's like prime time. Then you get to 50, and you're trying to really focus on being a mentor, developing the next generation, and just trying to provide that voice in the room—not only in terms of investing, but also leadership and management, and really just trying to be a teacher to your team, but also a learner, because I still learn a lot from them. But, you know, 40 to 50, you're in the prime time. It's go time.

Patrick O’Shaughnessy

8. Face the Tiger

Yeah, it's go time. One of the questions that I've been asking everybody, because I'm just selfishly curious about it—and at this age, it feels like the right time to ask—is around the measurement of success. Kevin Kelly, one of the founders of Wired magazine, has this amazing idea: your definition of success should be extremely bespoke to you. Traditional measures of success are traps—money, power, fame, et cetera.

And I heard a founder recently say something like he measures success through the degree of radical self-respect. Success means complete self-respect, and obviously that then means lots of other things. But I'm so curious how you think about it. If I'm going into prime time, I don't want to waste that. And so the objective function of prime time needs to be success.

That's a good way to sum it. Let's hit the mistake that people fall into: this whole idea of money, fame, and fortune. That's a cup. Once you start to prioritize that, that's a cup that will never get filled. You keep trying to fill the cup, and the cup keeps getting bigger and bigger. That cup never gets full.

So I think that's one of the problems people make in our industry. I even have people say, “Oh, it's easy for you to say where you are now.” This is something my dad taught me when I was 10 years old, so this is not new. I can say this was never the thing for me. For me, I just want to do great things, be excellent, and do it with great people who share my values and do things the right way. And that's on the business side.

And I want to do all that in a way where I'm excellent. It's not competing against anyone else; it's competing against ourselves, but doing so in a way where I'm the best dad and the best husband. But getting one without the other, I just think you're going to be 80 years old, looking at yourself in the mirror and asking, “What was the purpose of life?” There's no purpose.

The purpose of life for me—and again, it's certainly not about the cup. That's definitely never been it. It's about all those relationships you form and those experiences you go through with people. When you're 80 or 85 years old, you're looking back—hopefully I'm healthy, because I looked at my sheet a lot of times—and it's those relationships and those experiences that, I think, drive a fulfilled life.

Obviously, it starts with your family, but I have a lot of Hawaiian friends. Your hui—hui is a term for your group, your posse. It's like having those experiences of climbing up the mountain together, and that's, to me, what it's all about. If you are around the right people, you have the clarity of purpose, the right values, and the right culture, and you're going up the mountain together, it's so fun.

And you never have to question first principles—how you're going to do business, trying to do it the right way—and it's what we call clean living. But, again, doing that at the expense of not spending time with your family, I think that would be pretty unfulfilling to me.

Last time I got to ask you my traditional closing questions, so I have to come up with a new one this time. One of my favorite things from our first discussion—you sent us the visual, which I love—is the concept of facing the tiger. Maybe you can remind us what that means. Literally, when you—I thought you were kidding in the conversation—but literally, off the elevator is a giant tiger in your office, which is so funny. I like the principle a lot, but I'm also curious what it means to apply that principle for you and Sixth Street today in this fascinating, dynamic environment.

“Face the tiger” is one of the core ethoses of Sixth Street. There are hard things in this world; we're going to make mistakes, and we're going to have problems. But when those problems happen, instead of pointing fingers, we have a saying from day one of our firm: we look at the problems head-on, we look at them together, and we don't run from them; we run to them. We run right at them. That's what “face the tiger” is.

And I think for the environment we're in—and this is what I literally told our entire firm—we're in a world where the pace of change is rapidly accelerating. If you think the pace of change is accelerating now, it's just going to continue to accelerate, which is why, by the way, from an investing standpoint, going back to what we said earlier, the idea that you're going to have a narrow investment strategy when the world's changing so much—

Patrick O’Shaughnessy

Crazy.

You're going to have oscillating supply-and-demand dynamics in good times and bad times. That's just crazy: to have a too-narrow strategy, unless you put a governor on the amount of capital you raise. But I think the biggest thing when you look at human beings is that human beings in general don't like change. There's a small percentage of people who thrive in chaos and love it and step up, like Michael Jordan. He loved chaos; he'd go down, his heart rate would be low, and he'd hit a game-winning shot.

But most human beings don't like change. As we start to go through this pace of change, there's obviously a lot of anxiety. Is AI going to take my job? Is it not? And our whole thing is, you can sit there and be anxious about things or worry about things. You can say, “Hey, this is what it is. The world's changing. We got to face the tiger. It's going to change whether we like it or not. It's going to happen. Yeah, there's stuff from AI, but what are you going to do about it?”

And that's what we say to people. It's like, “Look, we got to face the tiger. And just remember, you get one life. Do you want to be average, or do you want to be excellent?” That's how we talk to people. We just keep talking about it enough, and they get in the right headspace. So when change happens, or there's disruption, or something goes wrong, they've got a tool that they can use—let's say “face the tiger”—to be able to approach it. And we try to just get that in our firm.

And again, I think I said this last time: when problems happen or something is wrong, we're unlike most people—we're like, “Good. Let's go.” It's game time. Let's go. That's just the way we've been since day one, and I like, to some extent, the way we are as people.

I wish I could do this with you every year. I hope we do. Thank you so much for your time.

Thank you so much, Patrick. Appreciate it.