The capitalist system works best when willing buyers meet willing sellers and a free-market price is negotiated. In the real world of today, this market mechanism is imperfect. It falls down when governments get involved, with their unlimited funding from taxpayers. It also falls down if huge funds appear with their management’s incentives tied to something other than profit maximization for the fund’s investors. In 1929, 2000 and 2007, obvious “bubbles” appeared in particular classes of assets, respectively stocks, tech assets such as fiber optic cable and dot-coms, and housing related subprime debt. Today’s bubble appears an eldritch compound of all three types. Its Von Misesian collapse is inevitable and will doubtless be very painful and not long delayed.
To begin with an asset class not normally thought of as part of the capital market, student loans. Since a disgraceful Obama-era piece of legislation of 2010, these have been issued directly by the government. (This was only the last of a succession of disgraceful pieces of legislation in this area, the worst of which was the Bush-era 2005 Higher Education Act, extending government-guaranteed loans to graduate and professional students, thus raising the amounts of debt incurred per student to infinity with the rise of the perpetual student – a folly extended by the 2007 College Cost Reduction and Access Act, which allowed income-based repayments, thus removing the incentive for borrowers to get a proper job on graduation.) Of the $1.7 trillion of student loans currently outstanding, only 30% are being serviced according to their terms, making them lower quality assets than all but the most grotesque subprime mortgages or automobile loans.
This is not entirely the fault of the students concerned. If you were going to college from 2010 on, it was almost impossible not to incur a student loan—they were pushed hard even to students whose families did not need the money. However, the real reason for the program’s high default rates was the utter dishonesty of the Biden administration, which extended a payments moratorium far beyond the period when it was justified during the COVID epidemic. This payment moratorium caused the accrued interest on student loans to pile up. Biden then dishonestly proposed all kinds of “relief” schemes for student debt, none of which had any chance of being legally authorized by Congress. Such schemes, being subsidies from ordinary people without college to rich kids with useless degrees, were morally utterly repugnant and economically damaging.
In those circumstances, borrowers who suddenly did not have to pay their student debt monthly, naturally found the extra $500 per month (say) would allow them to lease a fancy automobile even though their income was modest and likely to remain so. This was unsound finance of course, but in what educational institution, even business schools which teach the joys of leveraged buyouts, are young Americans now taught the principles of sound finance?
The amount eventually lost in student loan defaults will probably be around $1 trillion of the $1.7 trillion now outstanding, which amount will be added to the Federal debt. That is not staggering, but as Senator Everett M. Dirksen (R.-IL) did not say (because he was dealing with mere billions) “a trillion here, a trillion there, and soon you’re talking real money.” There will also be a painful but necessary reform needed to stop this systemic bleeding in the future; ideally this should involve closing down about three quarters of the nation’s colleges, forcing the rest to cut back their wasteful expenditure sharply, and sending only around 15% of the population rather than the current 60% to suffer the wasteful indoctrinations of college.
Student loans are only one source of future catastrophic debt losses. According to a recent Allysia Finley piece in the Wall Street Journal, the percentage of Federal Housing Administration loans where debt payments to income exceed 43% — generally considered risky – has risen to 64% in 2024 compared with only 36% in 2007, the year the subprime mortgage crash occurred. About 1 in 7 FHA loans originated between 2022 and 2025 defaulted within a year. Under the Biden administration, the taxpayer’s interests as creditor were grossly neglected in every area they could be; the property rights of ordinary taxpayers are always vulnerable under Democrat administrations, but the Biden administration was extreme.
As in 2007, there is thus a glut of government-sponsored bad debt just waiting to land on the economy. In this sector, Wall Street is less involved than in 2007, but there is, in addition, a plethora of subprime automobile loans, of perhaps $400 billion, since lending standards for auto loans were lowered and maturities lengthened after 2009 (many especially toxic auto loans have of course been incurred by those given a payment holiday on their student debt). Since this is largely independent of mainstream Wall Street, you can add it to the 2007-type debt default pile.
Wall Street itself has created far more dodgy assets than in any past bubble – even 2000 and 1929 pale by comparison. It has a mechanism to do so that was absent in 1929 and relatively small in 2000: the private equity fund and its brother the private debt fund. The managers of these organizations are generally paid a fee, typically 2% for private equity, on the assets they collect and may in addition earn a “carried interest” bonus of typically 20% of any profits, which are calculated with assets “marked to market” by “experts” in a way that may bear no relation to their true value. At the very least, this gives them a huge incentive to collect assets from the dozier pension funds and college endowments and a much smaller incentive to manage the assets properly, which requires knowing all the mundane and technical details of their investee company’s operations.
Boosting the fund’s net asset value by hugely leveraged “recapitalizations” of investee companies is a much easier way to declare returns, requires no understanding of the underlying businesses, and allows your auditor to sign off on profits, of which you receive 20%. Establishing a “private debt” fund to buy the debt created by such recapitalizations is another nice way to keep it all in house. If the company stubbornly refuses to increase in value, you can always sell it at an inflated price to a “continuation vehicle” new fund you have set up.
As you will have spotted, very little of all this requires the private equity investor to add value. The only problem with it is that, based on the law of supply and demand, which works as well in investing as in everything else, the gigantic flood of new money into this sector has depressed the returns to private equity investors well below those on the Standard & Poor’s 500 stock index, so private equity managers are being paid “2 and 20” to underperform a simple index fund.
Some investors have noticed this; the idiotic “Yale Model” of investment by which college endowments put all their assets into private equity, private debt and timberland, has now been thoroughly exploded by the grossly inferior returns achieved by the largest college endowments in recent years. You would think, with all that intelligence available, the Ivy League colleges could themselves invest better than Wall Street, but apparently not.
At some point, even the high pressure sales techniques of private equity managers will fail to attract new money into this sector, which needs a large flow of new money each year to maintain values. That is why, in the deregulatory Trump administration, ordinary retail investors have now been allowed into private equity — you can bet this would not have happened if the returns were still tolerable. You should avoid these investments like the plague; not only will they on average produce inferior returns, but as a supposedly “unsophisticated” retail investor with no important “contacts” you will be offered only the worst and most overpriced deals. As for private debt funds, they should be avoided even more firmly; they do not have even the theoretical upside potential of private equity investments. In the words of the famous question to J.P. Morgan, NONE of the customers-investors in private debt funds have yachts!
The public stock market is also overvalued, partly because of the appalling fashion for stock repurchases, which are simply a scam rewarding management with stock options at the expense of ordinary investors. However, the fashions for Artificial Intelligence and its associated “data centers” have created an additional bubble of their own, very similar to the “fiber-optic cable” overcapacity of 2000.
Not only are data centers fashionable, but the “Big Beautiful Bill” of last July allowed big companies to write off 100% of their capital investment in them. Since corporate behemoths are not allowed to pay negative tax, there has been a vigorous market in selling data center tax benefits to companies that still have tax capacity. That is why U.S. corporate tax receipts fell by 27% in the 6 months to March 2026 – with state and local tax incentives as well, a grotesque glut of data centers is being created. In theory excess data centers will come in useful in the long run, just as did fiber optic capacity, in huge glut in 2001 causing several bankruptcies, but filling up its capacity by 2010. However, there is one difference: ten-year old fiber optic capacity is almost as valuable as brand-new capacity, so a glut can be worked off over time. Conversely, ten-year old data centers are at least a couple of “Moore’s Law” generations out of date, so about as useful as a ten-year old laptop. Thus, the data center glut will have much less long-term value than did the 2000 fiber optic glut.
Ludwig von Mises explained in the 1920s what must happen when there is a glut of investment: it must be liquidated, sold for a tiny fraction of its cost or bulldozed, and huge amounts of money, both debt and equity, must be written off. That will almost certainly bring us a “triple-whammy” version of the 1930s. One can only hope that the global political reaction to the slump this time around will be less disastrous than that of the 1930s, which brought FDR but also Hitler. Even in the best case however Elon Musk can have little hope of being treated better than his 1920s/30s equivalent Andrew Mellon, who was hounded into his 1937 grave by the IRS.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)