The term “shadow banking” was coined in 2007 by a money manager named Paul McCulley to describe financial institutions that mimic what commercial banks do—money markets, mortgage companies, investment banks, hedge funds, and, yes, private equity—but are not regulated like banks. It’s called shadow banking because these firms lack banks’ transparency. Shadow banks furnish a higher return than banks typically do, but their investments are much riskier and lack government protections for investors. Much of the mischief in the 2008 financial crisis was caused by shadow banks, whose combined assets were as large or perhaps larger than those of commercial banks. Five years later, shadow banks’ holdings represented nearly 80 percent of global Gross Domestic Product. Nobody disputes this makes the global financial system less secure.
Although family offices have been around a long time—the Cabots and the Lowells had them in the 19th century—more than half of those now in existence, per Collins, were created in this still-young century. Jeff Bezos’s dad just expanded his. Sometimes family offices combine into multifamily offices, or family funds. Vacationing in Nassau last year I drove past what looked like a Walmart or Costco; on closer inspection, it was a big-box family fund. (It won’t surprise you to learn that family funds flourish in tax havens like the Bahamas.)
The trouble is that they’re at least equally likely to decline abruptly, taking the rest of us down with them. As The Economist observed in 2018, “Family offices could endanger the stability of the financial system. Combining very rich people, opacity, and markets can be very expensive.” When the family fund Archegos went bust in 2021, it cost Credit Suisse and Morgan Stanley more than $10 billion, with ripple effects in the stock market of $33 billion. If your retirement fund held stock in CBS or Discovery then it was hard cheese for you.
Another common criticism is that private equity puts the squeeze on certain enterprises—hospitals, retirement homes, even hospice providers—that were never intended to be profit-maximizers, weakening the quality of the vital social services they provide. Can’t afford to buy a house? In his latest book, Burned by Billionaires: How Concentrated Wealth and Power Are Running Our Lives and Planet, Collins demonstrates various ways in which private equity drives up housing costs. One Ohio firm invests in short-term and vacation rentals—Airbnb, Vrbo, etc.—to the tune of $1.5 billion, with capital from the Blackstone Group and other 800-pound gorillas in private equity.
McLean’s piece was about President Donald Trump’s executive order last month directing the Labor Department and the Securities and Exchange Commission to ease fiduciary requirements to encourage people to invest their 401(k)s in private equity and other “alternative assets,” by which Trump meant shadow banks. As it happens, Blackstone’s chief executive, Stephen Schwarzman, gave $37 million to Republican and conservative groups in the last election cycle. I’m sure that’s just a coincidence.
I phoned McLean to ask her whether that brick wall is something that you and I need to worry about. Might private equity take us down with it? Absolutely, she replied. “Private equity has become too big to fail,” she said, “which raises a whole question of whether it should be private at all.” The solution, McLean said, is to regulate private equity as we do commercial banks and public corporations, with comparable transparency and legal limits on what they can do with our money.
By 2022, nearly half of all the supposedly slimmed-down and tuned-up companies exiting private equity firms were sold to other private equity firms, prompting one investor to tell The Financial Times, “This is the start of, potentially, I’m saying ‘potentially,’ a pyramid scheme.” In January the FT columnist John Plender, writing about systemic risks in private equity, concluded: “No prizes for guessing where the next financial crisis will emerge from.”
Of course, Trump doesn’t help matters by urging us all to throw our money into private equity and other risky shadow banks. But barring strict regulation of this sector to a degree that seems politically impossible at the moment, these outlaw financial institutions are fully capable of crashing the economy on their own.
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