# Hiding the Boat in the Ravine: Where the Risk Went After 2008
> Bloomberg Odd Lots hosts two researchers from UT Austin and Yale on their new paper, 'Private Credit's State Backstop.' After 2008 policymakers deliberately pushed risk out of the banking system — and it has come back around, through life insurers, into a public backstop structurally worse than the FDIC and never once tested.
Published: 2026-08-04
Locale: en
Tags: odd-lots, podcast-notes, private-credit, insurance, systemic-risk, english-finance-media
> *You hide a boat in a ravine, a mountain in a marsh, and call it secure.*
> *Yet at midnight a strong man carries it off on his back, and the sleeper never knows.*
> —— *Zhuangzi*, "The Great and Venerable Teacher" (4th c. BC)
## What this episode is about
The guests are **Andrew Granato** (assistant professor of law, UT Austin) and **Pranjal Drall** (JD-PhD candidate in financial economics, Yale). They've just published a paper whose title is the whole conclusion:
> **"Private Credit's State Backstop: How Private Equity Socializes Risk Through Insurers."**
Tracy opens with a clean premise: finance and investing work because of one rule — **you can invest in anything you like, the stupidest thing in the world; but if it blows up, you eat the loss.**
This episode is about where that rule broke.
**Original episode**: [Why Private Credit Got Entangled With Insurance](https://omny.fm/shows/odd-lots/why-private-credit-got-entangled-with-insurance)
## The notes I took
**Start with how the loop closed.** After 2008, policymakers made a deliberate choice: **move risk out of the regulated banking system** and into investment vehicles, so that when things went wrong the vehicles would eat the losses rather than socialising them through deposit insurance or a taxpayer bailout. That is a large part of how private credit grew into an enormous industry.
Sensible enough. The problem is that risk is now migrating **from private credit into insurers** — the other regulated industry where society is equally unwilling to let the customer hold the bag.
Joe's framing is sharp: **banks and insurers aren't that different; the difference is the redemption schedule.** A depositor can pull money on demand; a policyholder gets paid at a set time or on a triggering event.
**McKinsey calls the structure a flywheel.** Picture a PE firm with three arms: a traditional buyout arm using leverage, a private credit fund writing high-yield loans, and a **life insurance entity**. They feed each other: my credit arm can finance my buyout; the illiquid loans I originate can sit on the life insurer's balance sheet for years.
**The core attraction is permanent capital.** A private credit fund has LPs demanding returns; a life insurer's liabilities are very long dated and the capital is, as they're told, effectively permanent. The insight isn't new — one of Warren Buffett's central lifetime observations is that an insurance arm is an extraordinary source of patient capital.
**What's new is the aggression.** Over roughly fifteen years, private equity has bought life insurers in volume — recent estimates put something like **$750bn of life insurance assets** within PE's purview. And they're changing what those insurers hold. Life insurers were famous for stodgy portfolios of AAA-rated corporate bonds; **that is becoming less true across the industry, and private equity is leading the shift.**
**But the real subject of the paper is what happens when a life insurer fails.** Not the question everyone has chewed on for two years — whether private credit marks can be trusted — but the resolution regime.
On the banking side, **the FDIC is pre-funded and risk-based**. Every quarter a bank gets an assessment and pays a risk premium into the Deposit Insurance Fund. When a bank fails, that fund is spent down; if it were ever exhausted, the full faith and credit of the US government stands behind it.
Insurance is nothing like that. **There is no federal insurance regulator and no FDIC equivalent.** A failing life insurer doesn't go through corporate bankruptcy; its domiciliary state leads a resolution conducted **simultaneously in every state**, each with its own guaranty fund.
**And here is how a guaranty fund is funded:**
- It levies an assessment on **the other insurers still standing in that state**
- Only **after** the insolvency has happened — meaning **the firm that failed contributed exactly zero in advance**
- The assessment is weighted by each firm's **share of premiums sold** in that line of business — **by size, not by risk**
- And in roughly **34 states, that assessment carries a 100% tax credit** (20% a year over five years); about ten more states spread it over ten years; only about six offer none
Which means: **in a state with a full offsetting credit, this is economically equivalent to a taxpayer bailout of policyholders.** As they put it on the show — **nobody ever votes on this; it happens automatically by operation of law.** They call it a **stealth taxpayer bailout**.
**Worse, the backstop isn't even good for policyholders.** The FDIC cap is $250k, generous for an ordinary checking account. Guaranty fund caps vary by state but run around $300k — which is roughly the **40th percentile** of life insurance policies. People who buy life insurance skew wealthier with larger policies, so **coverage here is far thinner than in a bank failure.**
Joe puts the two halves together: **we have the taxpayer-funded part, and we don't have the "at least policyholders can sleep easy" part.**
**And none of it has ever been tested.** Asked whether a large insurer has ever failed this way, the answer is no — AIG in 2008 was bailed out directly, not resolved through guaranty funds. **A national insurer with hundreds of billions in assets going through this machinery is entirely untested, and it would require Iowa, Oregon, New York and Tennessee to do it all at once.**
**The incentive distortions are what made me sit up.** Several stack on top of each other:
- Heading into distress, a rational (and amoral) insurer should **take more risk** and offer better terms to win premiums today — because it won't be paying at the end
- Banking has a guard against this: the FDIC **limits what rates a troubled bank can offer depositors**. Insurance has **no such mechanism**
- Because assessments scale with premium volume rather than risk, **conservative firms subsidise reckless ones**
- Opacity **punishes honest managers**: many private credit ratings are non-public "private letter ratings," so a manager buying genuinely investment-grade private credit may be graded much like one buying middle-market paper — **the advantage of good assets gets competed away**
**"Nobody yelling at you" is my favourite line in the episode.** If your money runs through a life insurer's balance sheet rather than a standard private credit fund, the scrutiny you get from creditors is far lower — the policyholders are a dispersed retail base, a large fraction of whom are **nominally fully covered** and therefore have no reason to care what you're doing. The exact phrasing: **"not having people yell at you is a very underrated incentive in the world."**
**The history of this state-level architecture is its own story.** In the 1800s the Supreme Court held that insurance wasn't interstate commerce, so it stayed with the states. In the 1940s the Court reversed itself — and Congress promptly passed McCarran-Ferguson, handing the authority straight back. Every so often a wave of insolvencies triggers a push for federal regulation, and each time the state regulators' association moves fast enough to pre-empt it with a state-level scheme. **The guaranty funds themselves came out of exactly that dynamic in the 1960s and 70s.**
Worth noting: that association (the NAIC) **is not a public body at all — it's a DC non-profit that makes money selling data to insurers.** And some states (Indiana was the example given) write their law so that **whatever the association adopts in future automatically becomes state law.**
**Finally, correlation.** Banks face it on two sides: assets (everyone writes mortgages) and liabilities (everyone withdraws at once). Insurers' liabilities are structurally more run-resistant — but **asset-side supervision is far weaker**. There are federal people standing inside a bank telling them what not to hold; insurance supervision is fragmented, with a fraction of the resources and power. The magnitude they give: **private credit is roughly 10–15% of insurer assets, and roughly a third of private credit is software.**
## What I took away
**1. Risk doesn't vanish when you move it. It relocates to somewhere you can see less well.**
This is the cleanest case of that I've come across: after 2008 we deliberately moved credit risk out of banks **specifically so losses would stop being socialised**. It went around the loop and came back — through life insurers — into a backstop that is **more socialised, less supervised, and never tested.**
It's the same shape as another episode from this batch. In [the piece on the Fed and the bond market](https://blog.getrealpha.com/en/blog/macrovoices-ep543-bond-vigilantes/) I wrote: **when a system's formal adjustment mechanism is suppressed, the adjustment relocates to somewhere you control far less.** This is its twin: **when a system's loss-bearing mechanism is relocated, the losses relocate to wherever nobody is watching.**
**2. A badly designed backstop can be more dangerous than no backstop.**
With no protection, creditors are careful, they screen counterparties, they demand compensation. With good protection (the FDIC), the distortions at least come with countermeasures — risk-based pricing, limits on what a troubled bank can offer.
**The worst case is the middle**: protection good enough that creditors stop monitoring, not good enough to actually catch anyone; costs borne invisibly by taxpayers with nobody voting on it; assessments scaled by size rather than risk, so the careful subsidise the reckless.
Generalised into a checklist: whenever you see a structure described as "backstopped," ask **who pays in advance, who pays afterward, and has it ever actually been run?**
**3. Opacity doesn't only hide risk — it punishes the honest.**
The most counterintuitive thing I learned today. When the rating system can't distinguish quality, the manager who buys genuinely good assets **gets no differentiation for it** while competing against inflated grades. **Bad money doesn't just drive out good — it makes good money look stupid.**
That generalises well beyond credit. Any domain where quality can't be externally verified drifts this way over time. It's a large part of why I'm increasingly obsessive about verification in my own work.
**4. "Nobody yelling at you" is an incentive I can see operating on myself.**
The line is about monitoring structure — run it through the insurer and no LP chases you every quarter. But reading it, I thought about my own decisions: **a lot of choices are made not because they're better, but because they're less likely to be questioned.**
My version: if a judgment doesn't require a record, a scoring date, or an explanation to anyone, my standards quietly slip. Much of what I've built over the past six months is a deliberate attempt to **get yelled at** — expiry dates, written criteria, and going back to mark my own answers.
**5. "Never been tested" is just another way of saying "unverified assumption."**
A national life insurer with hundreds of billions in assets, resolved simultaneously across fifty states — has never happened. Everyone who believes it will work smoothly believes **a design document**, not **a result**.
I got burned by exactly this recently: **a config saying something is covered is not the same as the artefact containing it.** The only ways to tell are to go look at the artefact, or to inject a controlled failure and see whether the alarm fires. Financial regulators can't run fault injection — that's a structural difficulty of their job. I can, in my own systems, and I should.
## Further reading
- The episode: [Odd Lots — Why Private Credit Got Entangled With Insurance](https://omny.fm/shows/odd-lots/why-private-credit-got-entangled-with-insurance)
- The paper: Andrew Granato & Pranjal Drall, *Private Credit's State Backstop: How Private Equity Socializes Risk Through Insurers*
- A companion piece on risk relocating from policy to the market: [Bond Traders Panic When the Fed Doesn't](https://blog.getrealpha.com/en/blog/macrovoices-ep543-bond-vigilantes/)
- The lines from the *Zhuangzi* are my own footnote to the episode, not part of it
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**Disclaimer**: This is a listener's reflection and general education, **not investment advice, an offer, or a solicitation**. Institutions, regulations and figures mentioned come from the public episode and published academic work; nothing here recommends any security or passes judgment on any individual insurer or financial institution. Investing carries risk, and insurance and annuity products are long-dated contracts — judge for yourself against your own circumstances and consult a qualified professional if needed. Copyright in the original episode belongs to its producers; please go listen and support them.