What 100 Years of American Finance Tells Us About Today

Key Takeaway

The modern financial system operates through three distinct eras, each shaped by regulatory guardrails and market incentives. System 1 (1933-1999) prioritized stability through Glass-Steagall's separation of commercial and investment banking. System 2 (1999-2008) saw deregulation, rising leverage, and the Global Financial Crisis. System 3 (2010-present) introduced Basel 3 protections for commercial banks while private capital grew from $2T to $15T. However, since 2018, many firms adopted a 'factory model'—industrializing fundraising and deployment—creating asset-liability mismatches that echo past crises. The key lesson: financial crises stem from mismatched assets and liabilities combined with excessive leverage. Understanding these systemic patterns, not just symptoms, is essential for navigating today's capital markets.

Episode Overview

Alan Waxman, founder of Sixth Street, provides a masterclass in financial system evolution spanning 1933 to today. He explains how regulatory frameworks and market incentives have shaped three distinct financial eras. The conversation explores the Glass-Steagall Act's impact, the repeal that led to the 2008 crisis, and post-crisis Basel 3 regulations. Waxman introduces the concept of the 'factory model' in asset management—where firms prioritize rapid capital raising and deployment over selective, artisanal investing. This behavioral shift, accelerating post-COVID, has created concerning asset-liability mismatches in private markets. The discussion reveals how understanding systemic incentives and guardrails is crucial for investors navigating modern capital markets.

Full Transcript

Transcript of What 100 Years of American Finance Tells Us About Today from Invest Like The Best. Auto-generated from episode audio; may contain minor errors.

This is a unique conversation. It's my second with Alan Waxman, the founder and leader of Sixth Street, one of the largest private capital investment firms in the world. Him and I have been going back and forth about the history of financial guidelines and incentives and how those systems through time shape the system that we live in today and shape outcomes in the financial markets. We thought it would be a neat opportunity to walk through in great detail what he calls system 1 2 and three going all the way back to 1933 and the initial regulation glass desteagle which kicked off system 1.

We then go through system 2 from 2000 to 2008 and the global financial crisis and then go into great detail for the system that we're living in today. The reason all this history is interesting to me is that ultimately it's about the incentives and the ways that investors and investing firms make money. We have this great conversation in about what Allan calls the factory model of investing which has defined by the industrialization of both raising money and deploying money. Sort of the opposite of the old school artisal investment model that's entirely focused on earning outstanding investment returns.

His historical perspective and lens on what's driving outcomes I think is useful information and history for all of us as we try to navigate one of the most dynamic periods of creative destruction in capital markets history. Please enjoy my second conversation with Alan Waxman. We're facing one of the most interesting capital market setups of all time alongside one of the most interesting just world environments, geopolitics, technology, and you and I have talked a lot about the shaping forces that will determine how things play out from here.

And one of those things that I want to start with, we'll talk about AI, we'll talk about geopolitics, some other big things that that might be shaping the world, but there's one that is probably under discussed that you are in a very unique position to teach us about which is the uh what you call the guardrails and the incentives of the financial system itself. And the way that this the reason we're doing this today is so much discussion of private credit uh direct lending things happening in private markets that's getting a lot of attention in the news.

You can see it in stock prices of 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. And you are a deep historian of of this topic. And 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. So what is your kind of general frame for the financial system and how it impacts the world?

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

So I think we'll I'll talk about a little bit the history of how we got here. And then the second thing, and you hit this, is looking at everything through systems. And when we think about systems, we think about the incentive system, guardrails, and market structure. First of all, I'm not an economic historian. Okay? So, what I'm going to do is tell the story of history as it relates to the current moment. I think you got to go back to like pre929 crash. And when you think about the American financial system is basically like the wild wild west.

It was pretty unregulated. And there were many causes of the 1929 crash. There was, you know, poor monetary policy, agricultural recession, uh, margin lending. But one of the main parts that caused it is you had this idea of commercial banks. So think about commercial banks. So 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 bank. So these were all part of the same thing. And there's, as you can imagine, when that happens, there's a massive conflict of interest.

So really, the story starts for the current moment. Starts in 1933. So this is after the 1929 crash. This is after 9,000 banks failed. Think about that. 9,000 banks failed. banks failed. banks failed. Crazy. 1933 GlassSteagall probably one of the most important regulations that took place and also the establishment of the FDI which basically ensured deposits for individuals at banks up to a certain limit and glass basically said these commercial banks which was deposit taking institutions from individuals which got really burned in the 1929 crash basically become separated from the investment banks or at the time think about uh principal risktaking so think about in today's parlance private capital, investment banks, those got separated.

And that's kind of the first system. When I think about the first system that explains kind of where we got to the current moment, I let's just call it system one. Yeah. 1933 to 1999. Y and when you look at post World War II with this separation of commercial banks and investment banks, you basically have really after post World War II kind of 50 years a stable system other than the SNL crisis in the 1980s which was a big event. It was a pretty good system, but the system wasn't optimized for economic growth growth growth because you only had you really a pretty conservative with a lot of guardrails commercial bank providing finance.

Yeah. Just low risk appetite. Yeah. So, it's a lowrisk appetite and again because one the fixed income market hadn't developed which is part of the story here but also because investment banks were more in the moving business than the storage business meaning they were like pricing securities to basically sell to other people. they weren't pricing it to hold for their own balance sheet. Now, that started to change as we get into the 80s, but again, broadly speaking, for this first system from 1933 to 1999, it it was working.

It just wasn't optimized. optimized. optimized. And your takeaway from this, the lesson from this is like with really good guard rails, you can get long stability. You can get long stability, but again, you also have to think about job creation and economic growth. And I think if there's one criticism of the system, which by the way started, which is why the GlassSteagall Act got repealed in 1999, I can talk about why it got repealed. What like sort of the steps leading up to that is 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. So in a non-globalized world, it was probably okay. But as we got to more globalized world, it wasn't really optimized to maximize economic growth for the country. country. country. Okay. So we get to the mid, you know, mid late 90s. What happens in addition to like, you know, new competitive pressures? Just like walk us through the transition into what becomes system. Yeah. So at the time again, we've got separation of investment banks and commercial banks.

All a sudden European banks started to who weren't part of the same glass deagle regulation. They started to unite with each other. So commercial banks and investment banks in Europe started to come together which started to put the American commercial banks at a big disadvantage and not only were they coming together but they were also taking on more leverage than what was allowed with the guard rails of American commercial banks. So as a result of that as you can imagine all the commercial banks and many market participants are saying hey we can't really compete against some of these European guys.

to 1998, uh, Deutsche Bank bought Banker Trust, and that was kind of like like a moment. That was definitely a moment. You had City Bank announced that it was merging with Travelers, which at the time when they announced the merger, it would actually wasn't allowed under glass deagle under the current regulation. So that's what sort of led up to it. So I think it's a couple things. globalization like now all of a sudden you're competing against Europeans who have think about they can provide services and balance sheet and capital you're at a pretty big disadvantage so the system one started to kind of get less competitive we as we moved into a globalized world and that sort of led to 1999 when glass deagle was repealed is repealed and so and so what comes in its place it's basically just deregulation deregulation deregulation it's it's deregulation and literally after that you saw literally a wave of mergers of combining commercial banks and investment banks.

So you saw JP Morgan Chase, there's many others, but there's always with everything there's knock-on effects. So that came together, 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. So think about my old firm Goldman Sachs and many others. Now they had to start competing where they weren't they didn't have access to cheap capital because they weren't a commercial bank. They had to compete with combined investment banks and commercial banks because a lot of the commercial banks both in Europe and the US they started to use their balance sheet to get investment banking business.

So what did all the investment banks do? They started to leverage up and that's one of the other stories is leading into the system is sort of the development of the fixed income market. So think about corporate bonds, uh, mortgage back securities, asset back securities, sovereign debt that went literally from the 80s to the 90s went from like 7 trillion to 14 trillion. So these are all financing mechanisms that could finance the investment banks to basically allow them to leverage up and that's what started to happen.

So literally from the time of glass deagle being repealed, you had commercial banks uniting with investment banks both in US and Europe, you had leverage going up like leverage went up for commercial banks in some cases 20 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 banks, investment banks. And then nine years later, what happened? You had the GFC. Now, just to be clear, there's a lot there's a polarizing debate of how much attribution much attribution much attribution the repeal of GlassSteagall had on the GFC.

GFC. GFC. What do you think? I think there was definitely some attribution to it. I don't think that was clearly not the only reason. Look, my view, it's it's some combination, but ultimately it had to do with the system and the set of incentives. And in that case after putting all this together a lack of guard rails that existed in sort of the first system we spoke about and in system two is is the reminder I guess or the lesson that it's the combination of liquidity or asset liability mismatches and leverage that basically is the cocktail for every historical financial crisis like one of those two or both are involved.

leverage always plays a role. Yeah. But the and they're all connected, but just the mismatching of assets and liabilities. You could be the best investor in the world making the best illquid 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 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 could might have to sell it at a deep discount.

So I think it's I think there's a few things. I think it's one anytime you bring retail or individuals. So think about people depositing into a bank next to principal risk takingaking activity. I think that's one thing. I think the second thing is just anytime you mismatch assets and liabilities. And then the third thing again going back to what we talked about earlier is like what are the incentives? What are the guardrails and what's the market structure? Yeah, most software companies try to maximize your time on their app to juice engagement.

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So in 2010 two things happen. First is Basel 3 was passed by G20 nations. I'll explain what that is. And the second thing is DoddFrank. Yeah. When you think about Basil 3, so this applies across all commercial banks. And 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 um commercial banks uh and this is really a Basel 3 thing had restrictions on capital which for your audience think about that as leverage.

So the amount that they could be levered up so they didn't get levered up 30 to1 or 40 to1 like they did pref GSC. And the second thing is restrictions on liquidity. And liquidity is basically through a bunch of shock scenarios, a bunch of things going wrong. Do you have enough liquidity to meet all all your obligations? So I think that was that that was a key part of it. DoddFrank was more aimed at in the vulkar role that that didn't really last that long. Was really aimed at the principal investing activity.

I would say it's more for the commercial banks. It was more Basil 3, but DoddFrank played a big role certainly in the short term. Yeah. So, how would you explain just system three and its guardrails and incentives to to people out there? out there? out there? So, system 3 in my opinion is and we took like 125 years to get here. here. here. Yeah. has the potential to be the best system American finance has ever had because when you think about commercial banks or deposit taking institutions by the way that are basically backs stop by the government insured by the government through the FDI so think about GFC there was a bailout the taxpayer belt 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 sort of lower risk-taking activity to finance a system.

That's a good pillar of any financial system. Converse on the other side and this is where the current moment starts to come in is now you've got private capital come in. So when you think about private capital, think about pension funds, sovereign wealth funds, endowments, insurance company providing capital in the beginning of this sort of this this this period so called system 3, postbasel 3, post GFC, that's what resulted in the growth of the private capital industry because it was filling in the gap. So think about principal risk-taking activities.

private capital was filling in the gap and with the except exception of hedge funds and really REITs, those were matched assets and liabilities. So you think about private equity, private real estate, private infrastructure, private credit, they never had someone that could literally ask for their money back or they didn't have deposits saying they need to get their money back, they can't get it back because of the liquid assets. So that just to put it in context, private capital from PGFC to postGFC was about two trillion preg.

It's grown to around 14 15 trillion. It's insane. It's insane. It's insane. Private credit which is in the news today um grew from 500 billion to about 2 trillion what it is today. So massive growth and this and this sort of filled the gap for that principal risk-taking capital to provide risk capital to all parts of the American economy which is a good thing. And I would say up until 2018 2018 2018 the system was working great. You had commercial banks, deposit taking institution effectively backs stop by the government doing safer things and then you had matched assets and liabilities where you an investor a set of assets couldn't get caught out of their option providing the risk capital.

That's a pretty good system. And until we started to see behavioral changes in 2018, 2018, 2018, just to like put a pin on uh an an elegant, well-designed system of guardrails and incentives, the commercial kind of model where it's lower risk um and protected or backs stopped and higher risk-seeking capital where the assets and liabilities are matched is a good system. It's a good system. Yeah. All crisises generally are caused from not credit issues or other issues. There's they might start in other issues, but it's it's mismatched assets and liability.

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

Sure. So the way that we define the factory model in our industry is there's two parts to it and then there's an output. The two parts to it are first part is the industrialization of the fundraising process or I would say liability gathering. So literally raising as much as much capital as you possibly can possibly can possibly can literally as fast as you can. So that's sort of the industrialization of the liability side or the fundraising side that comes first and then what comes second is then as a result of that the industrialization of the asset side.

So think about investing. So, if you're on an investment team and all of a sudden your firm has a lot of money to invest and you know like it's just sitting there and maybe there's a t maybe there's a time stamp on it all a sudden your behavior has to start to change because you have to deploy that money much quicker and what's the best way to raise a lot of capital quickly. Biggest capital source is direct. It's raise simple. So make it very simple, make it very narrow because if it's wide like that's too hard to explain.

You want to make it as narrow as possible and you're also willing to take uh let's say 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. So it starts to you start instead of like perfectly mass assets liabilities, maybe you're willing to start to not have perfectly matched assets and liabilities because you want to raise it as fast as possible. And 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, smaller firms for a whole bunch of reasons. But this whole factory model behavior started to reveal itself in 2018. and and just to draw like 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 but I think of like an artisan making like a horse saddle or something by hand and then I get an order for 100,000 horse saddles like I can't make it by hand I got to make a f that is the exact way to think about because it's a different model when you're building that horse saddle versus you get a massive order but one point's important is that it starts always on the liability side and then it goes to the asset side and then you get kind of the current moment that we're in that I we're going to talk about.

And it starts on the liability side because why? because why? because why? Because if you just all of a sudden go to that example, it's a really good example of the the horse saddle and all a sudden if you don't have like a factory that can produce 100,000 on the on the artisal side, you're not ever having to think about it. Like you could have an industrialization of the asset side, but if you don't have the liability, if you're not liabil constrained, you're not going to change behavior because you don't have the capital to go do that.

you run out of money in money in money in five days. five days. five days. So it's got to start on the liability side where you raise all the money then you have it then the behavioral change starts. So these two things it's first liability side it starts the industrialization and as a result of that it goes to the asset side. Yeah. Um 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 and why and why exactly? And by the way, that's okay. If you have perfectly ass match assets and liabilities, it's okay. But let's imagine a world where every investor you spoke about had a term in their term in their agreement. After 3 years, they 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 just the the the financial system, the private capital was pretty perfectly mass assets and liabilities.

Yeah. And obviously like it would seem if everything was frictionless and I was a GP, I would of course have matched liabilities. Like if I could just snap as much capital as I wanted into existence. Yeah, of course. Like I want to have no problems. So what was going on? What is the like what's the series of events starting in 2018? What were the first examples of this? And then how has it like evolved? So the first signal is underwriting because investing or lending, you can invest as much money as you want.

you could win as much money. That's not the skill. The skill is investing. It's that artisal behavior. So when you start to see and again it wasn't just everyone talks about private credit, but 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 wasn't actually 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 artisal, you know, you might have a hit rate of, you know, half a percent. You look at 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. So I think we started to see it but it wasn't it it was just like something we started to notice like changes behavior but it wasn't like full-fledged factory model industrialization industrialization industrialization co happened and then postco it was like 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 co and was that mostly I know this has come from every the capital the liability has come from lots of different pockets but like my mind goes to like the wealth channel that everyone's talking about now um institutional channel as well but yet maybe put a little more color on like like where it actually is came from is coming from so what started to change in 2018 is there are these things called SMAS so separately managed accounts so prior to 2018 18 for the most part the private capital ecosystem was basically funneled through funds.

So think about co-mingled funds lots of investors come into one fund to pursue a certain strategy and all sudden there started to be every conversation with every LP was basically we want an SMA. So we want fund a one just to do XYZ for us. You go to an LP, you basically say, "Hey, we're going to raise $500 million or $100 million and we're going to do direct lending or we're going to do private equity or we're going to do real estate." And all a sudden there started to be a proliferation where literally three years prior it was not in any conversation, every conversation was smas.

And what it is, it was just the industry starting to raise capital from the institutional channels. So not wealth, the institutional channel. So pension funds, sovereign wealth funds to some extent endowments raise as much capital as possible in the simplest form. So it started on the institutional side with SMAs but the growth in in institutional SMA started to really taper off. So the next place where the industry started to go was the wealth space. And the wealth space in general just for for just from a historical perspective, it is it 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 the procyclical environments when things are going really well. But 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's an important concept and that's where it started to go and that's sort of got us to again it got us to one of the symptoms that are in we're here 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 what the wealth system is is a symptom. You know, when you think about, you know, some of the stuff you see in stuck private assets where there's so many assets around the world in private real estate, private infrastructure, private equity that literally were were were companies or assets that were bought in really postcoid of sort of 2021, early 22, paid way too much like they're stuck assets.

All that stuff is symptoms. The root cause of this is the change of behavior patterns of the factory model. That's like the root cause. And again, one of the things that's not frustrating, but um unfortunate is that everything that is covered in the media is just talking about the symptoms and not actually getting to the root cause. And again, when you think about history, like 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.

And I think that's something that hopefully uh hopefully this conversation provides some greater clarity on. So if I think about this model and we've talked about maybe you can mention like the the multiples uh that markets had been putting on asset management companies that we can you know look at public markets and see everything transparently everything transparently everything transparently like how much markets were willing to pay for the equity in a in multiple basis and what multip what the multiple is of that drives the incentive to to raise money that this feels like an important point.

important point. important point. So it's good to step back on what's what's the system. So what what are the incentives? What are the guard rails? What's the market structure? So the incentives and this sto the the story of the factory model starts to correspond with FRE multiples. What is FE? FRE stands for fee related earnings. Fee related earnings is basically your management fee profit. So you raise a fund, it's got a management fee on it, you got a set of expenses and what's left over that is your fee related earnings.

These things for our industry started you know traded between in let's say early 2010s call it 10 to 15 times FRE in 2018 when all this started it stepped up to call it 15 to 20 times obviously depends on the comp set and before this current moment we're at you know 25 to 30 times plus that's where it is and by the way if you go back to the the early passing of Basil 3 DoddFrank there was a massive secular opportunity to fill the gap that was left from commercial banks being constrained and then sort of it found the system found its sort of 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 and is maybe the crass way to say this like uh in the factory model the GP the the founder of the firm stands to make a lot more money from the equity of their GP than from like the carry they would earn through investing or something like this what what I'd say is that look to be a CEO of one of these larger it it's hard.

You have a lot of different constituents. It's really hard and and actually would as an investment firm sometimes it's good to grow and sometimes it's not good to grow. It depends on what's the investment environment, what's the quality of your liability structure, what's the flexibility of your investment model to sort of migrate to where the best opportunities are. Like it just depends. But I think it boils down to what's your clarity of purpose. Like there are a number of people that are public that I would say have not uh adopted a factory model.

There are a number of people that are not public that have adopted a factory model. Maybe because they want to get bought by one of the larger guys or maybe of the one of the larger guys or maybe if you're a midsize firm and you want to be one of them. The issue is like just because you're large and just because you're public, it doesn't mean that you've adopted the factory model. It's like what is your clarity of purpose? Now, if your clarity of purpose is to be an investment bank, then maybe that is what you want to be a factory model.

But if you're going to do it, you better have really good risk management. I mean, that's why you if you look at commercial banks, I mean Jamie Diamond is one probably one of the best risk managers of all time. What he can do from a risk management perspective and you saw it in GFC and you've seen it other times in his career. he's a better risk manager, but the rest of the industry that follows suit because they want to be Jamie Diamond. They might not be as good a risk managers as him.

And it's the same thing over here. So, 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, that you've actually adopted the factory model. What What are the most common in your mind telltale signs of a firm that's in this model? like what what what what does a firm that's adopted the factory model look like that's distinct from like an investment model based firm or something? something? something? First of all, you know it when you see it.

You can see it in the underwriting of the deals. Like we're in we're in all a bunch of different asset classes. You can see it. There's terms particularly like if you're a fixed income investor, credit investor because you have capped upside there's terms you just don't give. give. give. A lot of those terms have been given to facilitate deployment to facilitate deployment. You should not do those terms because it's all good when you're in a post cyclical environment, but if you have capped upside and you're earning a 10% return and all the collateral that your 10% is based on can literally be basically taken out of your collateral package overnight or 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 their business and they can basically lever up.

So you go from, you know, 50% loan to value to 120% loan to value. Like those are just things that you shouldn't do for a 10% trim. Yeah. So the first time we did this, we talked a lot about return per unit of risk. Yeah. risk. Yeah. risk. Yeah. And so it 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 size of my business, multiple in the business, how much money I'm making as a shareholder, whatever.

and it's sort of fundamentally divorced from the investing equation which is like return units per unit of risk or something like that. So map this on to like the news cycle today like what is happening where where where are their asset liability mismatches like what what are the nature of them yeah what's the implications so again go back postco that's when the wealth space took off so the democratization of alternatives or private capital which by the way just to be clear not against that what I think some of the factory models that um are out there have raised monies in uh or raised capital from the wealth channel in irresponsible ways.

So first of all in general you're taking an illquid asset and you're giving investors quarterly an ability to get their money back quarterly. They say semi-liquid. There's no semi-liquid. Okay? There's no such thing as semi-liquid. like anyone that's an investor that's been through a bunch of cycles, there's liquid and then there's illquid because again going back to the history of sort of the wealth channel or individuals uh or retail, it's the one thing we know it's very postle when it's pro we're in a proc environment like it's easy to raise money and when you're not and when there's problems or dislocation like there is today they want their money back.

So you basically had mismatching of illquid assets and liabilities. So that's one part of it. The second thing is that they would raise these very narrow because narrow narrow what I mean by narrow is it's like just direct lending. Yeah. Yeah. Yeah. So it's not like you can invest in direct lending and real estate and infrastructure or in asset based finance. No, no, it's just very narrow like just direct lending or just asset based finance or just this strate that's a narrow strategy. And maybe that's okay if you raise the right amount of capital.

But if you raise an unlimited amount of capital where your investment investing is dictated not on good investments in the market but basically dictated by how much money you can raise there's there's never a governor on how much money they raise and and the thing about these wealth vehicles they when they raise it they have to invest it right away. right away. right away. It's we call it inflow investing. They have to invest it right away. So they raise as much money as they can and if they don't invest it right away it dilutes the return of that vehicle.

So to ground this in actual reality as much as possible. as possible. as possible. We've talked about all these guardrails, all these incentives, uh the the three problems like all this stuff where sort of the system structure begins to determine fate. determine fate. determine fate. Yeah. Yeah. Yeah. Like what is fate? What is actually what's happening today? Yeah. What's happening today? So what what's happening today is there are these vehicles called perpetual private BDCs. These have been raised in the wealth channel. So individuals, wealthy, mass affluent, they've been raised and again in some cases, not all cases, in very narrow strategies, so just direct lending or just private equity.

And really the catalyst was this like was software and and AI and also some of the market volatility but started to question you know the the quality of their portfolios or it could have just been market volatility because of what's going on outside of this where people want their money back and there's a limit on how much money people can ask for and basically a lot of in the in the perpetual private BDC space the amount of money people have asked for has exceeded what is the 5% limit.

Y Y Y and that's creating all the noise that you're reading about. What's the range of like so whats here? Like I can imagine uh one so what is like tough [ __ ] like you can't have your money back and the world keeps spinning. Another is like something dangerous and scary and systemic because you know past financial crises have tended to be downstream of some domino you know like private BDC's or whatever it is you know each time it's different like what do you think the range of implications of all this is before we talk about like what the healthy yeah I don't think this is a systemic issue yet for uh two reasons one we're only 5 years into this so it's early and the secondly second thing, at least for now, 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 that's actually not what I think is going to happen. I do think there needs to be a major recalibration of uh behaviors in the way that people approach this wealth channel. Because if you go back to what we talked about earlier, anytime society or finance system puts, you know, wealth or retail individuals next to principal risk-taking, if you look throughout history, there's that's where problems start to happen.

Most of it's been with commercial banks because that's been the primary pillar of the finance system. But now with this new pillar in private capital, it's starting to sort of touch risk capital and it's starting to become more asset liability mismatch. But when you look at the quantum of the sort of the the problem is at least it specifically relates to this, it's pretty small in the grand scheme of things. So what's going on is in private markets in the wealth channel very small allocations to to private investments historically 1 2%.

And that channel is smart. They see that value creation and returns are happening without them in private markets. They want access to it. Seems fair. Seems fair. Seems fair. That thing that 2% is expected to go wherever 10 plus percent in the decade to come. So I guess the question is like 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.

So sometimes you just say no, maybe you have a waiting list, but again because flows come in in procyclical times, if you only have a $100 million, you know, vehicle, maybe it's always a good time to to 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. And that's why I think where this will go responsibly, I think you're going to have to have very wide apertures because ultimately in every ecosystem, whether it's direct lending or private equity or real estate or infrastructure, they go through supply demand dynamics.

Sometimes there's supply of capital is really high and demand is low. That's probably not a good time to invest. And sometimes demand of capital is really high and supply of capital is really low. That's again, not certainly, but probably a pretty good time to vest. And it oscillates within each each ecosystem all the time. So, I just think you want a wide aperture, but if you're going to do that, you can't just all a sudden show up, which is probably what's going to happen after this recal.

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 got to be able to do it, but you also got to have the capabilities to be able to do that. And there's a number of people that do, but you can't just all a sudden do it. It's like a style of investing. And I think those are kind of the key attributes that I think will make up responsible investing. But I think the biggest thing is just being very upfront when you want your money back.

Like you have to assume it's like 2008 crisis 1929. And if you're comfortable keeping it invested, then you're probably suitable investor. As your business scales up, everything gets more complex, especially your compliance and security needs. With so many tools offering band-aids and patches, it's unfortunately far too easy for something to slip through the cracks. Fortunately, Vanta is a powerful tool designed to simplify and automate your security work and deliver a single source of truth for compliance and risk. There's a reason that Ramp, Cursor, and Snowflake all use Vanta.

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See what Ridgeline can unlock for your firm. Schedule a demo at ridgeline.ai. ridgeline.ai. ridgeline.ai. You said before that maybe system 3 could be like the Goldilocks like scenario. It seems like uh I was always interested in around financial crisis like moral hazard, you know, as a topic and the socialization or uh spreading of this risk that one person takes to make more money and then and they'll be bailed out or something like this. It it seems like this mismatch, this asset liability mismatch is something that in the current system, maybe it's cyclical and it waxes and wes, but like people are selfish people are going to take advantage of the ability to raise more money forever unless the responsibility is like I don't know mandated or regulated or more clearly laid out like do you think we have some evolution still to do to create the Goldilocks scenario?

And I think that's what really needs to be thought about where you won't and by the way I think that's going to happen as part of this reccalibration process but that is a much better outcome. There can be good legislation but there's a risk that it's not the right guard rail and it's not good for competitiveness and it creates like the next crisis. The best answer is a market mechanism like you have within institutional investors where if you do irresponsible things or you're not a good investor, if you change your business model, they're going to punish you by not giving you money for your next fund.

next fund. next fund. Yep. If I turn all of this into ideas or guidelines for people running investment firms or who want to launch an investment firm or something, what are the right principles to take away? Obviously, one is keep your liabilities and your assets well matched. Like that's a a major one that's like anyone can do and maybe you have to work a little harder to raise money but like you you'll be thankful for it. A second is like you know maintain an underwriting standard that's extraordinary or however you want to define it.

Any other like major advice that you'd give to people running investment firms or just like principles you have for building Sixth Street that kind of flow from all this history and thinking. thinking. thinking. First is like what's your clarity of purpose? Yeah. purpose? Yeah. purpose? Yeah. You know what's your day one clarity of purpose? Is that say consistent over time? Like 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 you can do that.

Maybe some firms can do that. But what is your clarity of purpose? And this is something we talk a lot about at Six Street is that if you look at all the great companies that have been around for a long time, they got one thing right is they never forgot what their purpose was, which is to serve their customers. It's enticing to uh you know to raise a bunch of money. It's it's enticing once you raise it to invest a lot of money. That doesn't mean that you have to do it.

I mean Six Street we're multi strategy private capital firm. We do a bunch of things. One of the things we do is directing. We have one of the best track records. We've been here longer than in directing. Like I started the directing business at 2001 um when there was only two of us. So we've watched this and we could have gone to the wealth channel and raised all the same vehicles because of our track record and we have you know how many dollars of you know perpetual private BDC's we have zero.

zero. 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 and that's why we didn't do it. It's easy to get FOMO. I just think you just got to block out that noise. And it always comes back to first principles of clarity of purpose. What are your values? And if you stay consistent with that, judging by the best companies that have been around for a long time, that's sort of your pathway to, you know, building a great company that's going to be here for a long time, not short- termism.

termism. termism. Again, back to the news cycle, there there's sort of this thing of lots of firms that manage lots of uh private credit strategies, SMA exposure, etc. some of their stock prices are really hurting and we've talked about all the reasons ad nauseium for the mismatch etc. What do you think happens in private credit land? I think and hope that this is going to be a a recalibration um people are going to read you know more prudent underwriting. I think people uh in the industry um will change behaviors and by the way in some cases the market will change their behaviors because you may not be able to raise more capital so the market mechanism I think will will work and then obviously and this is a hopeful I think it'll stabilize and hopefully the one the best thing about the current moment is that this happened not in a deep recession deep recession deep recession it happened when the economy is pretty relatively healthful there's definitely risk out there to be worried about.

But this would be a much different if you think about redemptions on a lot of these wealth vehicles. If it were a like a distressed environment, the redemptions will be 2 3x what they are. Yeah. Yeah. Yeah. So to me, this is a gift to the industry to recalibrate. And there's a lot of smart people in our ind industry, a lot of great investors and I think the industry will recalibrate. And then if you think stepping back for the American financial system, commercial banks, you could have a really powerful system fire, you know, supporting economic growth with commercial banks providing one pillar, safer, you know, good guard rails 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 be for really optimized uh economic growth. And that's that's what I'm hopeful about. you alluded to uh AI and software being one of the you know early dominoes that kind of 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 US experiment you know since its inception inception inception we are we are facing talk about facing a tiger we are facing like a hardcore period of creative destruction.

Yeah. How do you think about that given the openwide mandate of Sixth Street, your ability to go put your capital and your customers capital in so many different places? How just talk through like the opportunity set today? Of course, I want to hear what you think about like AI and software. I can't help myself. Um yeah, what do you This just feels like such a uh what a time to be alive, but also, you know, opportunity and danger. and danger. and danger. I mean, there's lots of opportunity.

I mean, I I live on the LLM. I play with them an hour. Actually, my wife makes fun of me because I'm constantly playing with my friend Claude or my friend Chad or my friend Gemini. Uh, I'm always not your friend Grock. No, I I actually play with them all. Um, because I like to just see how I I like to ask him the same question to see how they answer it differently and just just to try to get a feel for it. But, you know, big believer on uh the productivity opportunity.

Um there's a lot of good with it but there's definitely risk on the transition but getting you know you mentioned software like everyone's you know that was one of the catalysts that sort of got us into the current moment but everyone's f so focused on software I think what people having lived in Silicon Valley and I know you spend a lot of time there this is not just software this is every industry um because once company in any industry figures out how to actually use it as a tool and really figures out how to use their agentic capab capabilities and drive 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. But look, it's the best thing, one of the best things about the the American project is creative destruction because it allows for prudent allocation of capital to the right places that are going to drive the the right outcomes. If you think about the uh 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 just like one's own development.

And the highly adaptable people seem like they're going to be set up for lots of success in in this environment. What how do you think about your team and making sure and I know you have a team that's like 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 like they are all dynamic as things change really fast? Like I know you're playing with the LMS all the time, but like h this is an important part of your job, your team.

How are you thinking about it? The the the good thing is because when we hire someone, we're we're looking for a lot of things, but two of the things that we're looking for, are they an open architecture person? Like, 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. Like our usage across our entire firm is it's off the charts.

one because of the types of people we hire, but I just think in general in stepping away from Six Street is that if you're not adaptive in this environment and you're not a learner, like literally committed to learning every day and improving yourself every day, you're going to you have the risk of getting lost in what's happening and about to happen in a more accentuated way. I have a off-the-wall one for you. It's been deeply impactful on me. Can you explain this like paper one sheet system for how you get everything done and and like track what you do?

I actually uh did a presentation to our entire firm on personal organization systems because I think as an as an investor um as a business person the scarcest thing you have is time and one of the most important skill sets is your dynamic prioritization of that of that time on the highest impact things. So we always talk about return on time and what my personal organization system does I call it the brain is I literally try to get the way my brain is structured on one sheet of paper so that I can all the all my important priorities you know people businesses investment themes I mean it changes over time based on what's needed for me because my job changes every year because I have to evolve um I try to get my brain on paper and it allows me to dynamically prioritize where the highest return on my time is.

And that's number one. And the second thing it allows me to do is I capture so that I never have loose ends. I try to always like follow up on everything. Uh be proactive about things. I just think proactive is like a key thing. It allows me I I like it's very clear what my top five strategic priorities all the tactical stuff and I'm constantly looking at it updating it and I I do it all by hand and because I think some people like for me I have to actually put pen on paper and I do that about once my sheet fills up of all my tactical stuff like the small stuff I have to do I start a new sheet and and then I write literally all it in it takes me like an hour I generally do it on a Sunday and there's never a time I go through that process on a Sunday where I don't connect two or three dots or think of a new idea.

And that's why on the second sheet, which I can't remember if I showed you, you did the right brain, right? I then I have my right brain sheet. That's my left brain. And then I have my right brain sheet, which is the second page, which is all my creative ideas, themes, business building ideas, people, better leadership, just whatever comes to mind. This, you know, thinking about, by the way, the current moment, like I literally start thinking about like why are we here? how do we get here?

That's kind of how I started to really dive into history and I just write stuff down and I track it and I've done that for, you know, 25 years. So, I have all my right brain thoughts over 25 years. And what happens is I'll go back and I'll look at them. I literally go every year at the end of the year, I go back and read all my rightrain thoughts and sometimes they're ideas that I had like from 10 years ago, from 15 years ago that surface today and become relevant today.

So I try to get my left brain on the first page, my right brain on the second, and then I try to get them working together. And again, it just helps me like see things. I want just a clear thinking on so I can try to see the world not only for kind of what it looks like today, what it's been, but also kind of where it might go and how can Six Street sort of be part of that. One of the things that stuck out to me seeing the actual sheet where there's sort of I'm thinking about the left brain sheet where there's sort of like different boxes.

different boxes. different boxes. I'm curious what the different boxes are. And one of the things that I found very powerful was that when you run out of space, like one of one of the segments is a list of people to call. So there's like it was a crazy list. It was like shitload of people and then like tons of strikeouts. Yeah. And when you run out of space, you then copy it to another page, but you also copy over all the stuff that is like lower turnover, I guess I would call it.

Um, and that act is like a big part of just like embedding it in your brain. The the process of that. And so looking as part of it, but the best ideas come out of actually the process. So So what are the other segments of that first page? So there's a list of people to call there. What are the other there's like five or six boxes. I can't remember what they are. Like what are those boxes? those boxes? those boxes? I think I told this last time we have everyone affirmed to a personal business plan.

plan. plan. Like my personal business plan at the end of the year I've done for I don't know 25 30 years like forever. It takes me like three weeks to do my personal business plan. And that's why I said to you last time, I was like, we spend all this time evaluing companies. Do they have a business plan or not? And then most people, 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.

But from that personal business plan I do at the end of the year, I figure out I get a lot of clarity just from reading going back to stuff I've wrote. What are my top five priorities of how I can drive the most impact to our firm, our investors? what are those absolute complete clarity on what those five things are and I have a box for each of those five things. So that's kind of like five boxes on each of those things. Then I have like high priorities because again those have different cadence to them.

them. them. Yeah. Yeah. Yeah. You know 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. Like everything has to change every year because it goes back to adapting because the world's always changing so quickly. If you're not adapting yourself, then you're going to get lost in this world. So I'll have my five strategic priorities of my time. I'll have people like really people I really want to focus on.

This could be internal, external. I also have on there my health because I despite drinking this I think about because I actually think I have to be healthy to be able to do my job. Yeah. What would be an example of something in the health that gets written down in health? I've got on there um uh vitamin D. Like I'm very focused on vitamin D. I've had an old soccer injury so I'm focused on left hip mobility. So this year's big year is like my my hip mobility.

I miss but it's something you just see every day concept. Yeah. Everything. It's also the personal side. So I keep balance. I think it is an intention system, but it's also it's also a return on time system and an ability to dynamically prioritize. You talk to younger people, you know, who are just coming up through the business, even some older people can't still don't know how to prioritize their time. It's really hard to do because literally you could spend all your time on one thing. Yeah.

So, how to like manage the time and just getting being able to see that and you know in your brain or in the matrix. I think you know that that's kind of how I think about it. Another thing that uh you really the last time we talked really stuck in my head was um 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 if you think back on the major like eras of building and managing a life's work and a career and and tied to specific ages, what have you learned?

20 to 30 for me was uh education. Uh just almost like business school cuz I didn't go to business. Just learning just as much as I could. Um asking as many dumb questions as possible. Literally, you're 23. Don't you think you know stuff, but if you haven't been through cycles or made a lot of mistakes and seen other people make mistakes and see people make good decisions and what a good long-term decision, short-term decision is, you don't really know anything from your 20 to 30. Uh 30 to 40, you're kind of, you know, you're you're incredibly uh ambitious.

You're still learning, but you're like trying to prove yourself. you know, you're out there and you're, you know, we start, I started Sixth Street when with my partners when I was 33 or 34 or so. I didn't know what I didn't know. I mean, I knew a lot, but it's like you're you're going through that, but you haven't made enough mistakes yet to like really sort of refine everything sort of your your craft and you get to 40 or 50. And 40 or 50, it's like it's like like like it's all together.

you've made if you've if you've spent time, you know, learning and again continue to learn, you've made enough mistakes, you've kind of really know who you are at that point. Know who you are as an investor and how you approach things. It's like prime time and then you get to 50 and then you know you're you're you're you're you know you're you're you're trying to really focus on uh 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 management and really just trying to be a teacher to your team.

Uh but also a learner because I still learn a lot from them. Uh but you know 40 to 50 you're in the you're it's go time. Yeah, it's go time. In go time, one of the questions that I've been asking everybody because I'm just selfishly curious about it at this age feels like the right time to ask is uh around the measurement of success. And uh Kevin Kelly, the former the one of the founders of Wired magazine has this amazing idea which is like your success definition should be extremely bespoke to you.

Like traditional measures of success are are traps, money, power, fame, etc. And I heard someone a founder recently say something like he measures success through like the degree of radical self-respect. Like success means complete self-respect. And obviously that then means lots of other things. But I'm so curious how uh if I'm going into prime time or something, I don't want to waste that. And so the objective function of prime time needs to be like success. That's good wisdom. Let's hit the mistake that you know people fall into is this whole idea of money, fame, fortune, fortune, 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 I think people make in our industry is that they think the the the the cup and I even people say, "Oh, it's easy for you to say where you are now." This is something my dad taught me when I was like 10 years old. So this is not new.

I can say this now. This is what I it was never the thing for me. It's like I I just want to do great things, be excellent, and do it with great people that 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 and be excellent is not competing against anyone else, competing against ourselves, but do so in a way where I'm the best dad, the best husband, and you know, it's getting one without the other.

I just think you're going to be 80 years old, you're looking at your mirror and what was the purpose of life? There's no purpose. Like the purpose of life for me, and again, it's certainly not about the the cup. That's definitely never been it. It's about all those relationships you form and those experiences you go through with people. Like when you're 80, 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 to a fulfilled life.

And obviously it starts with your family. But you know, I have a lot of Hawaiian friends. Your hoie hoie is like a term for like your your group, your posi. It's like having those experiences of climbing up the mountain together. And that's to me what it's all about. And if you are around the right people, you have the clarity of purpose, you have the right values, you have the right culture, and you're going up the mountain together, it's so fun, and you never have to like question first principles, how you're going to do business, trying to do the right way.

And it's it's called, you know, 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. to me. to me. Last time I got to ask you my traditional closing question, so I have to come up with a new one this time. One of my favorite things from our first discussion, we you sent us the visual, which I love is the is the concept of facing the tiger. Maybe you can remind us what that means, but literally like when you I thought you were kidding in the conversation, but like literally off the elevator is a giant tiger in your office, which is so funny.

Um I like the principle a lot, but I'm also curious what it means to apply that principle for you and Sixth Street um today in this fascinating dynamic environment. Face the tiger. It's one of like the core ethos of of Six Street, which is there's hard things in this world. We're gonna make mistakes. We're gonna have problems. problems. problems. But when those problems happen, instead of pointing fingers, it's like we have just a saying from day one of our firm is that we look at the problems headon.

We look at them together and we don't run from them, we run to them, we run at right at them. Um, and 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 is that we're in a world that the pace of change is rapidly accelerating. And if you think the pace of change is accelerated now, it's it's going to just continue and it 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, crazy, crazy, crazy, you're going to have oscillating supply demand dynamics of good time, bad time, like it's just crazy to raise a two narrow strategy unless you like put a governor on the mount of capital raises.

But I think the biggest thing when you look at the human being is human beings in general don't like change. There are a small percentage that like thrive in chaos and love it and step up like Michael Jordan like he loved chaos. He go down like it's like his heart rate's low and you know hit hit a game-winning shot. But most human beings don't like change. And as we start to go through this pace of change there's obviously a lot of anxiety. Is AI is going to take my job?

Is it not? And our whole thing is like you can sit there and be anxious about things or worry about things. You can be like 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? And that's kind of how we talk to our people. So, we just you keep talking about it enough and they sort of get in the right headsp space. So, when change happens or there disruption or something goes wrong, they've got sort of 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. So, and again, I think I said this last time, when problems happen or something, we're like most people, we're like, good, let's go.

It's like game time. Let's go. And that's kind of just the way we've been since day one. And I think to some extent the way we are as people. people. 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. Your finance team isn't losing money on big mistakes. It's leaking through a thousand tiny decisions nobody's watching. Ramp puts guardrails on spending before it happens. Real-time limits, automatic rules, zero firefighting.

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