The Origins, Evolution, and Solutions of the U.S. Credit Crisis

As the core engine of the global financial system, the U.S. credit market has, over the past half-century, consistently walked a tightrope between ‘breaking boundaries’ and ‘risk spiraling out of control.’

From the breakthrough concept of high-yield bonds to the mass-market euphoria of direct lending, each wave of financial innovation has been accompanied by capital’s fervent pursuit, yet also sown the seeds of cyclical bubbles.

The aftershocks of the 2008 subprime mortgage crisis had barely subsided when the software debt turbulence triggered by AI technology in the 2020s arrived, validating Howard Marks, co-founder of Oaktree Capital’s assertion: ‘The risks in the U.S. credit market stem more from investors’ irrational behavior than from the assets themselves.’

Looking back at history, the evolution of the U.S. credit market is essentially a cyclical narrative of ‘innovation-bubble-burst-restructuring,’ driven consistently by human greed and optimism, as well as the sharp fluctuations in interest rate environments.

Six Decades of Evolution in the U.S. Credit Market: The Hidden Risks Behind Innovation

Every major breakthrough in the U.S. credit market began with addressing financing pain points but ultimately fell into risk vortexes due to overexpansion, leaving clear imprints of its era.

1970s: Breaking the Ice with High-Yield Bonds – A Double-Edged Sword of Risk Pricing

Before the 1970s, non-investment-grade companies (those rated below BBB) in the U.S. were almost completely excluded from the public bond issuance market, with speculative-grade debt limited to originally investment-grade bonds that had been downgraded.

Michael Milken’s concept of ‘risk-return matching’ completely overturned this landscape – he argued that as long as the coupon rate sufficiently covered default risk, non-investment-grade companies could also have reasonable access to financing.

This innovation directly gave rise to the U.S. high-yield bond market, which now boasts a scale of $1.5 trillion and serves as a vital channel for SME financing.

However, the hidden dangers sown at that time have already surfaced: investors’ blind pursuit of ‘high yields’ laid the groundwork for subsequent loss of control over leverage.

The 1980s: The frenzy of leveraged buyouts, the rise and underlying concerns of private equity

The popularity of high-yield bonds provided ‘ammunition’ for leveraged buyouts (LBOs), enabling small companies and acquisition funds to swallow much larger enterprises through highly leveraged financing.

This trend fueled exponential growth in the scale of leveraged buyout transactions, eventually evolving into the ‘private equity’ industry in the 1990s, ushering in an era dominated by institutional capital in mergers and acquisitions.

However, the vulnerability of the high-leverage model was evident: corporate debt burdens surged dramatically, and any deterioration in cash flow could lead to default crises, planting seeds for future market adjustments.

The 1990s: Expansion of securitization, risk traps in structured innovation

In the 1990s, the U.S. credit market experienced a wave of structured innovation: broadly syndicated loans broke through interbank distribution limitations, allowing large-scale allocation to institutional investors, which expanded the leveraged loan market to $1.5 trillion, rivaling the high-yield bond market.

Tranching techniques used in mortgage-backed securities (MBS) were extended to various debt assets, segmenting risk levels to meet the needs of different investors.

However, this ‘risk dispersion’ design actually masked flaws in asset quality, laying structural risks for the subprime crisis in the early 21st century—banks packaged subprime loans into AAA-rated securities through complex structures, misleading global investors.

The 2000s: The bursting of the subprime bubble, the American roots of the global financial crisis

Following the burst of the Nasdaq bubble in 2000, American investors shifted towards ‘alternative investments’ such as hedge funds and private equity, further propelling the growth of the private equity industry.

However, during the same period, the reckless expansion of the U.S. subprime mortgage market was brewing a catastrophic crisis: banks introduced ‘liar loans’ featuring ‘zero down payment, no income verification,’ which were then packaged into Residential Mortgage-Backed Securities (RMBS) and marketed through inflated credit ratings.

In 2007, the default rate on subprime loans surged, RMBS ratings collapsed, ultimately triggering the 2008-2009 global financial crisis. U.S. housing prices plummeted (with declines reaching 60%-70% in some cities), Lehman Brothers went bankrupt, unemployment soared, marking one of the most painful lessons in U.S. credit history.

2010s: Private Credit Steps In, Market Restructuring Amid Tighter Regulation

After the financial crisis, American banks faced multiple constraints including increased capital adequacy requirements and tighter regulation, leading to a sharp decline in lending willingness, creating a funding gap for the private equity industry.

Investment management firms stepped in to fill the void, with ‘private credit’ businesses rapidly emerging, among which direct lending became the core—focusing on providing customized loans to mid-sized, non-investment-grade companies backed by private equity, quickly becoming the mainstay of the private credit market due to flexible terms and efficient approval processes.

While this innovation addressed the market funding gap, it also deepened the ties between private credit and private equity, laying the groundwork for subsequent risk transmission.

2020s: Mass Participation and AI Impact, A New Crisis Looms

Entering the 2020s, the U.S. direct lending market underwent a ‘democratization’ transformation, with investment tools opening up to individual investors and retirement accounts, driving a massive influx of capital that caused assets under management (AUM) to swell dramatically.

Excess capital led to cutthroat competition: lenders began lowering yield requirements, weakening risk covenants, and relaxing due diligence, planting seeds for potential risk outbreaks.

To make matters worse, the disruptive impact of AI technology has broken the debt logic in the software industry—Anthropic’s programming models and automation plugins have significantly reduced the demand for manual coding, resulting in a concentrated sell-off of software-related loans, which account for 20%-30% of the direct lending market. This deleveraging-induced sell-off was one of the main reasons for the sharp decline in market capitalization of some software companies led by Adobe.

More critically, Bank of America has begun raising borrowing costs for private credit funds, further compressing profit margins for these funds and exacerbating liquidity pressures in the market.

The Cyclical Iron Law of U.S. Credit Bubbles: Human Nature-Driven Booms and Busts

Looking at the evolution of the U.S. credit market, every innovation follows a similar bubble cycle, with greed, optimism, and herd mentality at the core of this cyclical dynamic.

1. Starting Point: Early Enthusiasm Driven by Novelty

Any new financing instrument in its infancy attracts attention due to its “untested nature.” High-yield bonds, securitized products, and direct loans are no exception—advocates can tout their advantages without facing scrutiny from historical risk data; investors’ desire for excess returns makes them easily swayed by “innovation stories.” The “profit effect” of early investors entering at low cost then triggers a rush of subsequent capital, driving the initial formation of a bubble.

2. Evolution: Capital Inflows and Deteriorating Standards

Capital euphoria inevitably leads to lower risk thresholds. The U.S. high-yield bond market once saw chaos characterized by “ignoring corporate qualifications and blindly chasing yields”; the subprime mortgage market introduced extreme products like “zero down payments and no income verification”; and in the 2020s, the direct lending market witnessed competition marked by “relaxed collateral requirements and tolerance for higher leverage.” As Howard Marks noted, “The riskiest thing in the world is when people generally believe there is no risk.” When markets confuse “possibility” with “certainty,” risks accumulate quietly.

3. Collapse: Chain Reactions Triggered by External Shocks

The bursting of U.S. credit bubbles is often triggered by external factors: the 2008 crisis was ignited by soaring default rates on subprime loans, while the 2020s saw the dual impact of AI technology and rising interest rates. Once market sentiment shifts from extreme optimism to pessimism, panic selling and concentrated redemptions ensue. The mismatch between “illiquid assets and short-term redemption demands” in the direct lending market becomes particularly pronounced—funds unable to quickly liquidate underlying loan assets resort to restricting redemptions, further intensifying market panic and creating a vicious cycle of “redemption surges, liquidity shortages, and valuation collapses.”

4. Validation: The Repeated Lessons of History

From the Great Crash of the U.S. stock market in 1929 (90% margin leverage, maturity mismatches) to the subprime mortgage crisis in 2008 (false securitization, lack of regulation), and now to the turbulence in the direct lending market, history has repeatedly demonstrated that excessive behavior in the U.S. credit market always originates from human frailty. Even as the regulatory framework continues to improve and investor education advances, bubbles will still emerge in different forms—what changes are the financing instruments, but what remains constant is the cycle of ‘greed-euphoria-collapse’.

Current Predicament: AI Disruption, Rising Interest Rates, and Liquidity Crisis

At present, the U.S. direct lending market is facing a convergence of multiple crises, while the deep integration between private credit and private equity further amplifies risk transmission effects.

1. Software Debt Risk: AI Disrupts Industry Logic

Over the past decade, U.S. private equity funds have acquired numerous software companies, with direct lenders providing massive financing, as software firms were considered premium targets for their ‘stable cash flows and high competitive moats’.

However, technological breakthroughs by AI companies like Anthropic have fundamentally altered the industry landscape—with significantly reduced demand for manual programming, the business models of software companies have been disrupted, triggering concerns among investors about software debt and leading to concentrated sell-offs.

Notably, the current pressure is more driven by sentiment: internal memorandums from Oaktree Capital show that most software companies continue to operate steadily, but the ‘blanket’ selling attitude of investors has exacerbated market volatility.

2. Liquidity Mismatch: Illiquid Assets Face Concentrated Redemption

The ‘illiquidity’ of direct lending is inherently at odds with the ‘redemption promise’ of funds.

When a redemption wave is triggered by software debt, fund managers are unable to liquidate assets in time and can only suspend redemptions or impose restrictions, which in turn raises investors’ doubts about the accuracy of asset valuations, leading to broader panic.

This dilemma is identical to the 2008 money market fund ‘breaking the buck’ crisis, exposing structural liquidity flaws in the U.S. credit market.

3. Rising Interest Rates: Breaking the Symbiotic Cycle of Private Credit and Equity

Over the past four decades, the U.S. private equity industry has benefited from a long-term decline in interest rates—bank lending rates fell from 22.25% in 1980 to 2.25% in 2020, with low-cost leverage driving a virtuous cycle of ‘financing-acquisition-value enhancement-exit.’

However, since 2022, the Federal Reserve’s interest rate hikes to curb inflation have caused the federal funds rate to soar to 5.25%-5.5%, directly resulting in a sharp increase in interest expenses and declining profits for companies under private equity portfolios, alongside lower exit prices.

MSCI data shows that from 2022 to the third quarter of 2025, the annualized return of U.S. private equity funds was only 5.8%, far below the 11.6% of the S&P 500 Index.

The plight of private equity directly affects the direct lending market: reduced acquisition activity leads to decreased loan demand, while rising corporate debt repayment pressures elevate default risks.

Pathways to Resolution: Historical Lessons and Risk Management Wisdom

In response to the cyclical challenges of the U.S. credit market, practices by institutions such as Oaktree Capital offer valuable insights—only by respecting cycles, adhering to risk controls, and balancing optimism with skepticism can one navigate through recurring risks.

1. Core of Risk Control: Moderate Restraint and Boundary Management

As a benchmark in the U.S. credit sector, Oaktree Capital has consistently adhered to the principle of ‘not chasing short-term trends.’

During the boom period of the direct lending market, Oaktree Capital limited its direct lending portfolio to less than 15% of total assets under management due to concerns over ‘low returns and weakened covenants,’ maintaining software-related loan exposure significantly below industry averages.

This restraint of ‘knowing what to do and what not to do’ has allowed it to take the initiative amidst current turbulence, underscoring the belief that ‘the best risk control is making sound investment decisions.’

2. Psychological Foundation: Respect for Cycles and Lessons from History

The ongoing adjustment in the direct lending market bears striking resemblance to the turmoil in the high-yield bond market in the late 1980s—both cases involve excessive expansion of new instruments followed by external shocks. Historical experience suggests that such adjustments are not the end of an industry but a necessary return to rationality.

As Bob O’Leary of Oaktree Capital noted, after weathering cycles, the high-yield bond market regained stability; similarly, the direct lending market will weed out subpar institutions and optimize its structure for healthier development.

For the U.S. market, remembering the lessons of the subprime crisis and avoiding repeating the mistakes of ‘relaxed regulation and excessive leverage’ is crucial.

3. Long-Term Logic: An Investment Philosophy Balancing Optimism and Skepticism

Amidst the wave of innovation in the U.S. credit market, optimism serves as a driving force, but blind optimism can lead to uncontrolled risks; skepticism acts as a safeguard, but excessive skepticism may result in missed opportunities.

Successful investors must strike a balance: remaining open to innovation while staying vigilant against irrational exuberance, believing in the long-term value of quality assets without ignoring short-term risks.

Oaktree Capital’s practice demonstrates that by resisting the temptation of ‘short-term scale expansion’ and adhering to ‘high-standard due diligence and conservative structuring,’ although short-term gains may be missed, stability can be maintained through market cycles.

Conclusion: Seeking the long-term approach amidst the cycle of risk.

The century-long evolution of the U.S. credit market has consistently revolved around the interplay between ‘innovation and risk.’

From high-yield bonds to direct lending, from subprime mortgages to software debt, the rise of every new financing instrument has been accompanied by new forms of risk. However, the core logic of ‘bubble cycle patterns, human-driven behavior, and survival based on risk control’ has never changed.

Currently, the impact of AI technology and rising interest rates has intensified market volatility, but it also presents an opportunity for self-correction within the market.

For the U.S. credit market, only by remembering historical lessons, adhering to the bottom line of risk management, and maintaining rational restraint can one stand firm amidst the vortex of debt risks and achieve long-term success across cycles.

After all, the ultimate goal of financial innovation is to serve the real economy, not to be a game of capital revelry — this is the wisdom the U.S. credit market should most absorb amidst its cycles.