Why do extreme speculative episodes repeat despite centuries of well-documented evidence of their devastating consequences?

Image courtesy of the Library of Congress.

This question has perplexed financial professionals for centuries. A few weeks ago, I published a paper called, “Speculative Supply Chains: How Rational Incentives Manufacture the Madness of Crowds.” The paper explains what I have come to believe constitutes part of the answer. It introduces the concept of a speculative supply chain, which is a network of financial intermediaries whose incentives gradually align toward the continuous deployment of capital.

This newsletter explains the mechanics of speculative supply chains, illustrating how they transform individually rational decisions into collectively irrational outcomes. The discussion is organized as a series of frequently asked questions addressing the framework, the evidence behind it, and its implications for today’s financial markets. The full paper is available here.

Summary

“Show me the incentive and I’ll show you the outcome.”1

—CHARLIE MUNGER, late vice chairman of Berkshire Hathaway

Speculative supply chains may be the least appreciated mechanism driving speculative episodes. As these structures mature, incentives favoring capital deployment grow stronger and become more closely aligned across various participant groups. At the same time, risk awareness becomes more segmented and corrective feedback is increasingly suppressed. This, in turn, prevents most market participants from recognizing the widening gap between prevailing market narratives and long-standing economic principles. This process helps explain how behavior that appears rational in isolation can aggregate into speculative excesses that are irrational at the system level.

In my paper, the framework is illustrated using two case studies. The first examines the Global Financial Crisis (GFC) as a completed speculative supply chain. Key participants included mortgage originators, investment banks, government-sponsored entities (GSEs), and money market funds. Pressure to deploy capital was then amplified by the trade media, specialized insurers, and ratings agencies. The second case study applies the framework to today’s private equity and private credit markets as a contemporary test of the thesis.

The following FAQs address questions readers may have and highlight several of the central ideas. The full paper is accessible here.

Speculative Supply Chain FAQs

Q1: What is a speculative supply chain?

Q2: What evidence led to this discovery?

Q3: How do speculative supply chains evolve?

Q4: How can finance professionals use this framework?

Q5: Why hasn’t anybody written about this before?

Q6: What evidence suggests that a speculative supply chain is driving allocations to private markets?

Q1: What is a speculative supply chain?

A speculative supply chain is a network of financial intermediaries whose incentives, over time, become increasingly aligned toward the continuous deployment of capital. Such supply chains are populated by a variety of actors responsible for capital allocation decisions, but those decisions are not based solely on the merits of the investments. Instead, they are influenced by self-interests, including job security, professional advancement, asset growth, fee generation, and the perceived safety of crowds. Figure 1 shows a high level illustration of a speculative supply chain driving capital deployment in private equity and private credit.

Because the incentives within speculative supply chains generally reward capital deployment, they tend to intensify as speculative episodes gain momentum and attract additional participants. As this occurs, incentives become increasingly aligned across participant groups. Consequently, capital allocation decisions become progressively less dependent on independent assessments of risk and return and more dependent on collective participant self-interest. Speculative episodes reach dangerous levels when incentives favoring capital deployment become substantially more influential than objective evaluations of the corresponding investment opportunities.

Figure 1. Institutional Speculative Supply Chain in Private Markets

Q2: What evidence led to this discovery?

I first introduced the speculative supply chain concept in two chapters of Investing in U.S. Financial History. I used it to explain the Dot-com bubble at the turn of the 21st century and the Global Financial Crisis of 2008–2009. At the time, however, I viewed it primarily as a useful way of understanding those two episodes rather than using it as a broader explanatory framework.

After the book was published, I recognized the same pattern emerging in private markets and alternative asset classes more broadly. The similarities were too striking to ignore. That realization led me to revisit other historical speculative episodes, where I found the same underlying structure repeatedly emerging despite differences in the assets, institutions, and time periods.

The recurring pattern suggested that the speculative supply chain was not unique to a handful of events, but may instead constitute a fundamental mechanism that helps explain why many speculative episodes repeatedly arise throughout financial history.

Q3: How do speculative supply chains evolve?

The formation and maturation of a speculative supply chain typically occurs gradually over many years—and in some cases decades. While the speculative episode that ensues may appear unique on the surface, a common progression is often observed as depicted in the following illustration.

A great paradox of speculative supply chains is that their most defining characteristics become progressively more difficult to recognize as speculative episodes advance. By the time risks appear elevated, many of the individuals best positioned to recognize them may be less inclined to challenge the incentives to ignore them. Their compensation, professional relationships, reputations, and future opportunities have become too dependent on continued capital deployment.

The irresistible pull of these incentives helps explain why speculative episodes often persist well beyond the point at which underlying risks seem obvious in retrospect. It also explains why outsiders, whose economic interests are less dependent on the perpetuation of the status quo, are more likely to recognize the warnings and voice their concerns.

Q4: How can finance professionals use this framework?

The framework is unusually valuable across a wide variety of stakeholders. A few of the more important beneficiaries include:

• Trustees of Institutional Plans — In many institutional investment programs, trustees are the final line of defense. The paper argues that private equity and private credit allocations are the output of a mature speculative supply chain. Despite more than two decades of massive investment in private markets, investment staff, consultants, private market managers, conference organizers, trade media, and even academic departments have strong incentives to continue deploying capital. Trustees should understand how these incentives may shape the recommendations that ultimately reach the boardroom and consider whether proposed allocations are being driven by investment merit or by the incentives embedded within the supply chain.

• Investment Consultants — Many investment consultants have a fiduciary duty to recommend asset allocations and investment managers that are in the best interests of plan beneficiaries. If the expected benefits of an investment become increasingly uncertain while the incentives to continue deploying capital remain strong, consultants must ask themselves whether their recommendations continue to satisfy their fiduciary obligations.2

• Wealth Managers — Many wealth managers also have a fiduciary duty to recommend investments that are in the best interests of their clients. Understanding how speculative supply chains evolve may help them recognize when an investment has reached the stage where distribution is being prioritized over investment quality, potentially leaving individual investors to absorb risks that earlier participants have already recognized.

• Policymakers and Regulators — One reason speculative episodes tend to recur is that policymakers often focus on preventing the last crisis rather than identifying the conditions that give rise to the next one. New regulations frequently address the most visible vulnerabilities of the previous episode, while a new speculative supply chain develops elsewhere. Private credit illustrates this dynamic. By focusing on the formation and maturation of speculative supply chains, rather than solely on the characteristics of the last crisis, policymakers may be better positioned to identify emerging systemic risks before they become widespread.

• Academia — Academic finance has devoted tremendous effort to developing increasingly sophisticated methods for evaluating investment performance, risk, and manager skill. Comparatively little attention is paid to whether the data feeding these models may itself be systematically influenced by incentives. The speculative supply chain framework shifts the focus from evaluating investment outcomes to understanding the incentives of the intermediaries responsible for creating, distributing, and valuing investment products. By examining how individually rational incentives shape the information that ultimately reaches investors, researchers may gain a deeper understanding of why speculative episodes continue to emerge despite increasingly sophisticated analytical tools.

Q5: Why hasn’t anybody written about this before?

In truth, several scholars have identified important components of the speculative supply chain framework. Hyman Minsky emphasized the tendency for financial stability to foster increasingly fragile financial structures, while Eugene Fama, agency theorists, and researchers in behavioral finance have each illuminated different aspects of market behavior, incentives, and decision-making. This paper builds on those insights while arguing that they have largely been developed in isolation. Its principal contribution is not the introduction of entirely new concepts, but rather their integration into a unified framework.

But the lack of synthesis is only part of the explanation. Speculative supply chains are inherently difficult to recognize because the forces that create them also tend to conceal them. Several characteristics make these systems unusually resistant to detection.

• Unspoken Decision Drivers — Individual incentives often exert a powerful influence on investment decisions, yet they are rarely discussed explicitly before, during, or after a speculative episode. Participants typically justify their decisions by pointing to investment characteristics, prevailing narratives, or accepted analytical frameworks, while the personal incentives shaping those decisions remain largely invisible.

• Biased Metrics — As speculative supply chains mature, the metrics used to evaluate investment quality increasingly become products of the capital flows they are intended to evaluate. Rising valuations, favorable historical returns, and strong performance statistics may therefore reflect the effects of sustained capital inflows rather than genuine improvements in underlying investment opportunities.

• Narrative Reinforcement — The narratives supporting continued capital deployment are frequently created, disseminated, and reinforced by participants whose economic interests depend upon the expansion of the supply chain. As those narratives gain widespread acceptance, they become increasingly difficult to distinguish from objective analysis.

• Suppression of Dissent — Mature speculative supply chains leave progressively fewer participants with both the incentives and credibility to challenge the prevailing consensus. Those who raise concerns tend to face increasingly severe professional, financial, or reputational costs as supply chains mature, while those who remain supportive are rewarded. As a result, corrective feedback becomes scarcer precisely when it is most needed.

Collectively, these characteristics make speculative supply chains naturally self-concealing. The same incentive structure that fuels their growth also obscures their existence, making them most difficult to recognize precisely when they pose the greatest systemic risk.

Q6: What evidence suggests that a speculative supply chain is driving allocations to private markets?

The second case study in the paper focuses on private equity and private credit in the present day. It is, however, a test case. We do not yet know how this will end. Nevertheless, private credit and private equity markets already show clear signs that align with five phases of the speculative supply chain framework.

1. Disruptive Economic Events — Private equity and private credit allocations both accelerated in the aftermath of disruptive economic events. Private equity allocations accelerated after institutional investors witnessed the extraordinary success of the Yale Endowment model in the early 2000s, while private credit emerged from the temporary lending vacuum created after the Global Financial Crisis. In both cases, early participants generated exceptional returns under conditions that were difficult to replicate at scale, attracting waves of imitators.3

2. Risk Segmentation — Capital deployment has become highly specialized. Fund managers, consultants, OCIOs, investment staff, trustees, wealth managers, and distribution platforms each evaluate only a portion of the investment process. Few participants assess how risks accumulate across the system as a whole.

3. Growth-Oriented Incentive Alignment — The economic interests of nearly every major participant increasingly benefit from continued capital deployment. Asset growth, fee revenue, compensation, professional advancement, market share, and product expansion all reinforce larger allocations rather than greater restraint.

4. Corrective Feedback Suppression — As allocations have expanded, skepticism has become increasingly costly. Trade media, conferences, professional organizations, academics, and many market participants have stronger incentives to reinforce prevailing narratives rather than to challenge them, reducing the influence of dissenting voices.

5. Narrative Detachment from Long-Standing Economic Principles — Despite record capital inflows, slowing exits, declining expected illiquidity premiums, and the rapid expansion of continuation vehicles and evergreen funds, narratives supporting continued allocations remain remarkably optimistic. These developments appear increasingly difficult to reconcile with long-standing principles of supply, demand, and expected returns.

Whether the current cycle ultimately produces a severe correction remains uncertain. The private markets case is, after all, a test. If a correction occurs, history suggests attention will again focus on the most visible participants rather than the underlying supply chain itself. Then, future reforms will likely target the institutions most closely associated with the downturn. Unless the underlying speculative supply chain is recognized, incentives will migrate, and a new speculative supply chain will begin forming elsewhere in the financial system.

Conclusion

A perennial debate in finance is whether speculative episodes can be identified and potentially mitigated before the most damaging consequences arrive. Thus far, neither academics nor practitioners have created a workable framework.

This paper offers a potential solution. It argues that extreme speculative episodes are often not the result of widespread irrationality. Rather, they emerge when speculative supply chains create aligned incentives toward continuous capital deployment, while operating with highly segmented risk awareness across groups of specialized participants.

The implications for investors, regulators, and policymakers are significant. Efforts to prevent future crises often focus on correcting the most visible vulnerabilities that contributed to the most recent speculative event. Yet financial history suggests that speculative supply chains tend to migrate to a new area of the market. Failure to identify and address the supply chain migration allows risk to reappear elsewhere, evolve through new intermediaries, and develop novel structures capable of attracting new sources of capital.

This framework suggests that the most effective means of identifying dangerous speculative conditions may be to focus less on the vulnerabilities of the previous crisis and more on the emergence and migration of speculative supply chains. Doing so may improve the ability of society to recognize dangerous speculative conditions and intervene before the most damaging consequences become unavoidable.

Disclaimer: This is a personal newsletter written by Mark J. Higgins, CFA, CFP, in his individual capacity. The views expressed herein are solely those of the author and do not necessarily reflect the views, opinions, or practices of IFA or any other organization or entity with which the author is affiliated. This content is intended for informational and educational purposes only; it does not constitute professional investment advice, an offer, solicitation, or endorsement of any specific financial strategy, product, or service. The discussion contains the author’s opinions based on publicly available information and should not be interpreted as factual or predictive of future events.

Nothing in this newsletter should be construed as a guarantee of investment results, nor should past performance discussed herein be taken as indicative of future outcomes. Investing involves risks, including the potential loss of principal, and investors should consult their financial adviser or other qualified professional before making investment decisions. Additionally, every effort has been made to ensure an accurate portrayal of market practices and conditions, but the author disclaims responsibility for errors, oversimplifications, or omissions. By publishing this newsletter, the author aims to foster dialogue and education and does not intend to disparage any individual, organization, or investment strategy. Readers are encouraged to consider differing viewpoints and conduct their own research before forming opinions or investment strategies.

Any references to future economic or monetary outcomes in this newsletter are speculative and based on historical analysis and public information. Comparisons to past events, like the Great Inflation or post–World War I inflation, are meant to provide context, not predict the future. Readers should view these discussions as hypothetical and not rely on them for financial decisions. Always consult a qualified professional for advice.

“The changes in the human conditions are uncertain and frequent. Many, on whom fortune has bestowed her favours, may trace their family to a more unprosperous station; and many who are now in obscurity, may look back upon the affluence and exalted rank of their ancestors.”

—ALEXANDER HAMILTON, June 28, 1788

Source: Image of Alexander Hamilton courtesy of the New York Public Library.

I distinctly remember sitting on the couch with my wife during the depths of the COVID-19 pandemic. I had recently devoted myself full time to writing a book on the financial history of the United States. I had virtually no income and her job at a company that was struggling financially seemed increasingly uncertain. The future looked bleak.

Yet I remember turning to her and saying, “You know, things really don’t seem that bad right now.” I wasn’t minimizing what we—or countless others throughout the world—were experiencing. The pandemic and its aftermath were real sources of suffering. Moreover, our personal anxieties were not imaginary. My point was simply that we tend to judge our circumstances against the best years of our own lives rather than against the full span of hardship endured by previous generations.

By that standard, the 2020s didn’t seem as bleak. I had spent the previous three years immersed in more than two centuries of American history. As much as I could, I tried to relive the experiences of the people who lived it. I envisioned what it was like to live through the financial devastation of the Panic of 1819, the Hard Times of the 1840s, the carnage of the Civil War, the corruption and lawlessness of the Gilded Age, the despair of the Great Depression, and the unimaginable sacrifice of two world wars.

By the time I arrived back in the present, suffering still existed everywhere. But on average, the death, destruction, poverty, and hardship seemed comparably less severe than what previous generations had endured. Despite all of our problems, both the nation and our family had inherited a world that was, in many important ways, better than the one our ancestors knew. And it was because of their sacrifices and resilience that we received this gift.

America’s Volatile But Reliable Path of Progress

Source: Image of the Battle of Iwo Jima courtesy of the Library of Congress.

In a few days, the United States will celebrate its 250th birthday. At the present, there seems to be two competing perspectives on the nation’s past, present, and future. Some see America primarily through the lens of its vices. They describe a nation defined by violence, exploitation, and corruption. Others see it primarily through the lens of its virtues, celebrating its history as though its progress were the product of pure altruism, flawless markets, and pristine politics.

Having slowly read myself to the present, I have concluded with high conviction that neither perspective is complete. The uncomfortable truth is that America is the product of both. But—and this is the important part—over the past 250 years, the nation’s virtues have repeatedly proven stronger than its vices. Progress has been uneven, often painfully so, but it has been remarkably reliable over the long run.

Each of us must decide how to live in a world of chronic imperfection. My study of history has taught me to appreciate humility and patience because I have concluded that human nature was never destined to be perfected within a single lifetime. Moreover civilizations are destined to evolve slowly, advancing through countless setbacks over many generations.

My faith in the American people does not rest on a belief that we are uniquely virtuous. It rests on a track record that is grounded in an insatiable desire to become more virtuous. Time and again, Americans have demonstrated an extraordinary capacity to confront failure, correct mistakes, and move closer to our ideals. That does not mean progress is inevitable, nor does it guarantee that future generations will continue this tradition. But after studying 250 years of American history, I find little reason to believe that America’s better instincts are nearing their end.

The United States of America is a microcosm of humanity itself—imperfect, often divided, and frequently disappointing. Yet with each generation, Americans have continued striving toward something better. The journey is uneven, and every generation has stumbled. But each generation has also moved the nation forward in their own unique way toward its founding ideals.

That history is worthy of celebration, and it warrants gratitude for the suffering and resilience of our ancestors. But, perhaps most importantly, it is reason to remain faithful in the nation’s future.

On that note, Happy 250th Birthday to the United States of America!

Source: Image of bald eagle and eaglets courtesy of StockCake.

Disclaimer: This is a personal newsletter written by Mark J. Higgins, CFA, CFP, in his individual capacity. The views expressed herein are solely those of the author and do not necessarily reflect the views, opinions, or practices of IFA or any other organization or entity with which the author is affiliated. This content is intended for informational and educational purposes only; it does not constitute professional investment advice, an offer, solicitation, or endorsement of any specific financial strategy, product, or service. The discussion contains the author’s opinions based on publicly available information and should not be interpreted as factual or predictive of future events.

Nothing in this newsletter should be construed as a guarantee of investment results, nor should past performance discussed herein be taken as indicative of future outcomes. Investing involves risks, including the potential loss of principal, and investors should consult their financial adviser or other qualified professional before making investment decisions. Additionally, every effort has been made to ensure an accurate portrayal of market practices and conditions, but the author disclaims responsibility for errors, oversimplifications, or omissions. By publishing this newsletter, the author aims to foster dialogue and education and does not intend to disparage any individual, organization, or investment strategy. Readers are encouraged to consider differing viewpoints and conduct their own research before forming opinions or investment strategies.

Any references to future economic or monetary outcomes in this newsletter are speculative and based on historical analysis and public information. Comparisons to past events, like the Great Inflation or post–World War I inflation, are meant to provide context, not predict the future. Readers should view these discussions as hypothetical and not rely on them for financial decisions. Always consult a qualified professional for advice.

“This will interest you…in this world where people have all these algorithms, and computer science, and fancy math, and so forth. Neither Warren nor I have ever used fancy math in business—and neither did Ben Graham, who taught Warren. Everything I’ve ever done in business could be done with the simplest algebra and geometry, and addition, and multiplication, and so forth. I never used calculus for any practical work in my whole damn life.”1

—CHARLIE MUNGER, late vice chairman of Berkshire Hathaway

On April 21, 2026, I published an article on SSRN, entitled “Applied Financial History: Expanding the Vision of Modern Finance.” The thesis is that the field of finance has come to rely too heavily on quantitative models, which restricts accepted truth to a narrow band of observations that can be proven at a high level of statistical significance. As a result, academics, policymakers, regulators, and many practitioners voluntarily blind themselves to simple, time-tested principles.

This entrenched bias toward quantification would be less concerning if conventional models were merely incomplete. The problem, however, is that their very design makes them likely to fail during the rarest and most impactful events that shape economic and market cycles. This is because the data on which they depend function primarily as lagging indicators. It is repetitive financial structures and hard-wired human behaviors that are visible in advance.

The paper concludes that financial history offers a practical remedy by surfacing long-forgotten patterns of behavior. It then demonstrates how policymakers and investors could have used financial history to make better decisions over the prior six years. Importantly, it is not merely an exercise in hindsight. It includes multiple time-stamped articles, newsletters, and conference presentations showing that costly errors in monetary policy, private markets, and institutional consulting practices were not only foreseeable, but in many cases avoidable. Several of the most significant examples are summarized in this newsletter, as they continue to present some of the more pressing financial risks today.

Inflation and Monetary Policy Errors

“A new era hardly renders the Great Inflation irrelevant. To the contrary, its history holds important lessons for the future. The simplest is this: Inflation, if it reemerges, ought to be nipped in the bud; the longer we wait, the harder it gets to rein it in.”2

—ROBERT J. SAMUELSON, author of The Great Inflation and Its Aftermath

In March 2023, I completed the manuscript of Investing in U.S. Financial History. At the time, the Federal Reserve was in the midst of an aggressive monetary tightening campaign to extinguish post-COVID inflation. I assumed that Chair Jerome Powell and the leadership of the FOMC would follow through on their commitment, even at the cost of weakening labor markets. That judgment was based on a belief that Powell had likely internalized a critical lesson from the Great Inflation of 1965-1982. The lesson was that inflation must be confronted quickly and decisively, because failure risks allowing it to reemerge and erode the Fed’s credibility.

Unfortunately, the subsequent three years proved my assumption was incorrect. Instead, the Fed clung to its familiar framework of “data dependency,” signaling greater confidence in complex models derived from the preceding four decades rather than the simple principle derived from a historical episode that was far more relevant. As inflation approached the long-term target of 2% in the summer of 2024, officials began signaling their intent to pivot toward easing. Chair Powell formalized that shift on August 23, 2024, announcing that the time had come for monetary policy accommodation.

On August 27, 2024, I published a newsletter, entitled “The Fed Leadership Believes This Time is Different,” which explained why the experience of the Great Inflation suggested the pivot was premature and constituted a policy error. My criticism sharpened as the Fed cut rates by a total of 100 basis points in late 2024 and an additional 50 basis points in late 2025.3

As Figure 1 indicates, history, rather than data dependency, proved the more reliable guide. As of April 2026, inflation has remained well above the Fed’s target for an additional 18 months. Moreover, the Fed’s credibility has weakened and political pressure from a new presidential administration has intensified.

Figure 1: Federal Funds Rate (Minimum) and Trailing 12-Month CPI-U
(April 1, 2021 - March 31, 2026)

Sources: Board of Governors of the Federal Reserve System. “The Fed Explained: Accessible Version.” Accessed April 13, 2026; U.S. Bureau of Labor Statistics. “Consumer Price Index Historical Tables for U.S. City Average.” Accessed April 13, 2026.

Some economists argue that it was unclear whether the Fed’s decision to ease monetary policy would reignite inflationary pressures. They also point to complicating factors such as tariffs and energy shocks stemming from the recent outbreak of war in the Middle East. That uncertainty was real. But the asymmetric risk of a premature pivot was also real. The potential costs of reigniting inflation in terms of the impact on household purchasing power and institutional credibility were both known and materially greater than the risk of maintaining restrictive policy for too long.

The failure to recognize this asymmetry was also a defining error of the Great Inflation. Under the leadership of William McChesney Martin, Jr. and Arthur Burns, the Fed learned that when inflation reemerges, their credibility eroded and political constraints intensified, making effective policy responses progressively more difficult. This principle was articulated clearly in Arthur Burns’s famous speech, entitled “The Anguish of Central Banking.”4

Outlook for 2026 and Beyond

The Federal Reserve has repeated the same error and now operates in a much more challenging policy environment. Their credibility is weakened; political pressure has intensified; inflationary pressures appear to be rising; and a spike in energy prices linked to the conflict in the Middle East adds further complication.

In May 2026, Kevin Warsh is set to assume the role of Federal Reserve Chair. Whether he can resist pressure to continue easing monetary policy before inflation is fully contained remains uncertain. It is also conceivable—although it seems far less likely—that inflation naturally subsides. But even in that scenario, meaningful damage has already been done. Household purchasing power has been further impaired, and institutional credibility has eroded. If policy easing continues prematurely, the risk of a relapse increases, raising the likelihood that future stabilization will require more aggressive intervention.

The FOMC under the leadership of Chair Powell discounted a simple lesson of the Great Inflation and placed its faith in models designed for a different era. In doing so, it failed to recognize that the credibility it inherited was not a permanent asset—it was earned through the resolve of prior leadership, most notably Paul Volcker. That credibility is now diminished and must be rebuilt under more difficult conditions.

A Speculative Episode in Private Markets

“Ben Graham used to say, ‘It’s not the bad investment ideas that fail; it’s the good ideas that get pushed to excess.”5

—CHARLIE MUNGER, late vice chairman of Berkshire Hathaway

One of the more striking patterns that emerges from studying repeated speculative episodes over several centuries is the conviction with which participants embrace narratives that appear sensible prior to a reckoning, but then are quickly relabeled absurdities soon after. Such warning signs are visible in language, unintended optics, and narratives that become increasingly detached from observable reality. A few memorable statements that preceded major speculative episodes in the U.S. are captured in Figure 2. The final quote by Marc Pinto, global managing director of private credit at Moody’s, is a leading candidate to capture the hubris that defines the speculative episode which currently appears to be entering the final stage.

Figure 2: The Familiar Language of Speculative Episodes

Sources: Alistair Roberts, America’s First Great Depression: Economic Crisis and Political Disorder after the Panic of 1837 (Ithaca, NY: Cornell University Press, 2012); “Fisher Says Prices of Stocks Are Low,” New York Times, October 16, 1929; Jim Cramer, “The Winners of the New World,” Speech at 6th Annual Internet and Electronic Commerce Conference and Exposition, TheStreet, February 29, 2000; Holden Lewis, “Experts: No Real-Estate Bubble Burst,” Chicago Sun-Times, September 10, 2004; “Moody’s Says the Banking System, Private Credit Markets Are Sound Despite Worries Over Bad Loans,” CNBC, October 17, 2025.

Warning Signs in Private Markets

Over the past year, I have written multiple newsletters, articles, and LinkedIn posts warning about the many red flags in private markets. Much like the inflation dynamics in 2024, many are undetectable in conventional data favored by investors, regulators, journalists, and academics. Commonly cited metrics, such as IRRs, default rates, and reported volatility, are lagging indicators. The more compelling evidence derives from simple principles governing how speculative cycles form, advance, and eventually collapse. They typically proceed in the phases described below.

1. Disruptive Event — A genuine opportunity emerges, often in response to a prior crisis or introduction of a new technological innovation.

   Recommended Reading: The Panic of 1819, Silicon Valley Bank, and the Danger of Bank Runs

2. Early Success of Pioneering Financiers — Pioneering capital providers generate strong returns, attracting broader attention to the opportunity.

   Recommended Reading: A Whale of a Tale: The History of Venture Investing in the United States

3. Imitation-Driven Growth — Capital floods into the strategy as imitators seek to replicate the results of pioneers.
   Recommended Reading: A 45-Year Flood: The History of Alternative Asset Classes

4. Formation of a Speculative Supply Chain — Intermediaries, such as investment consultants, institutional allocators, fund managers, and wealth advisors, form a segmented supply chain around the opportunity.

   Recommended Reading: Incentives Are Dangerously Aligned in Private Markets
   

5. Convergence of Participant Incentives — Participants across the system become aligned toward asset growth, eroding investment discipline. Self-interest of supply chain participants gradually comes to dominate decision-making.

   Recommended Reading: Incentives Are Dangerously Aligned in Private Markets

6. Breakdown — The underlying economics inevitably deteriorate, and are revealed abruptly when inflows slow or reverse.

   Recommended Reading: The Music Has Stopped in Private Markets

The Language of Last Resort in Private Markets

“Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone.”6

—WALTER BAGEHOT, author of Lombard Street

The dynamics in private credit and private equity markets appear to be hovering between stages five and six of the cycle outlined above. A speculative supply chain has been operating at full capacity for many years, and capital deployment decisions are increasingly optimized around the self-interest of participants rather than underlying fundamentals.

An early signal that the system was approaching a breaking point appeared on February 18, 2026, when Blue Owl suspended quarterly redemptions in its OBDC II private credit fund. Wary of the risk of facing similar restrictions, investors submitted a wave of redemption requests across many semi-liquid private credit funds offered by Blackstone, BlackRock, Cliffwater, Morgan Stanley, Ares, and others.

In June 2025, I had a conversation with a tenured professor of finance at a top-ranked European business school. His research focuses on private debt and private equity. I outlined my concerns about the multi-decade influx of capital into private markets, combined with the inherently unstable structure of semi-liquid funds. I walked through the mechanics, including the widespread use of one-day gains, bank-like liquidity promises, and the historical tendency for such structures to fail under stress. The following exchange concluded our conversation:

This interaction captures a widening divide between the practice of finance and the academic quest to quantify it. Practitioners are often forced to act on incomplete information, responding to patterns before they are fully visible in the data. Academic frameworks, by contrast, frequently require empirical confirmation before being approved for use. In stable environments, academics are applauded for their rigor. In late-stage cycles, they are dismissed for their irrelevance.

In its most extreme form, this bias can lead academics to relinquish responsibility for warning investors about potentially dangerous market conditions. By the time the evidence becomes statistically undeniable, the damage has often already occurred. The subsequent collapse is then reframed as an unforeseeable event rather than the culmination of risks that were visible structurally and behaviorally long before they appeared cleanly in the data.

Investment Consultants: Shadow Architects of Speculation in Private Markets

“Can you imagine an investment consultant telling clients, year after year, to keep adding to an index fund replicating the S&P 500? That would be career suicide. Large fees flow to these hyper-helpers, however, if they recommend small managerial shifts every year or so.”7

—WARREN BUFFETT, former CEO of Berkshire Hathaway

Investment consulting firms play a central role in guiding the investment decisions of many of the world’s largest institutional investment plans, including public pensions, insurance companies, foundations, and endowments. They are typically regarded as independent and objective advisors—a reputation earned in the 1970s and 1980s when their primary function was independent performance reporting.

Over the subsequent four decades, competitive pressures transformed their role. Investment consultants expanded into asset allocation, manager selection, and private markets implementation. In doing so, their business models became increasingly tied to the construction and maintenance of complex portfolios. This evolution created a structural incentive that can encourage greater portfolio complexity, irrespective of whether it consistently improves outcomes.

Modern Portfolio Theory in Practice

In 1990, Harry Markowitz received a Nobel Prize in Economics for his pioneering work on portfolio construction. His framework, termed Modern Portfolio Theory (MPT), demonstrated how diversification across assets with imperfect correlations could improve risk-adjusted returns. This insight was operationalized through mean-variance optimization (MVO) models, which use assumptions about expected returns, volatility, and correlations to construct “optimal” portfolios.

The rise of MVO coincided with the transformation of investment consultants from performance reporters to portfolio architects. The model became the primary tool used to recommend allocations, but its effectiveness depends entirely on the quality of the inputs. Those inputs—expected returns, volatility, and correlations—are not objective truths. They are assumptions that, in practice, can be influenced by institutional incentives as well as underlying economics.

Pro-cyclical Assumptions in Private Credit

In May 2025, I delivered a presentation at the CFA Live conference in Chicago on whether private credit markets were experiencing an oversupply of capital. I argued that numerous warning signs suggested they were—and that if the market was not yet in a bubble, it was moving in that direction.

One of the more interesting discoveries was the peculiar behavior of investment consulting firm return assumptions. Despite massive inflows of capital into private credit in the 2020s, the median real return assumption had increased. Two of the largest allocators during the two quarters preceding the conference, RVK and Meketa, published assumptions that tracked this trend. The real return assumptions of Meketa seemed especially elevated relative to historical expectations.

Figure 3: Horizon Actuarial Survey Results of Private Credit Assumptions and Capital Flows

Figure 4: Meketa and RVK Private Credit Return Assumptions and Capital Flows

Source: CFA Institute Research Foundation, “Private Credit Panel: Is There an Oversupply of Capital?,” YouTube video, posted August 1, 2025.

Basic supply-and-demand principles, reinforced by centuries of history, suggest that expected returns should decline as capital floods a finite opportunity set. Instead, they moved in the opposite direction. This divergence is difficult to reconcile with traditional supply-and-demand expectations.

This trend was concerning in and of itself, but what followed over the subsequent nine months was even more revealing. As stress began to emerge in private credit markets, those same assumptions were subsequently revised downward by both firms. In early 2026, Meketa reduced its long-term return expectation by 90 basis points, while RVK lowered its assumption by 25 basis points.89

The Paradox of Academic Precision

The widespread use of MVO models among institutional investment consultants highlights a deeper blindspot that impairs the vision of academia. Modern Portfolio Theory assumes that MVO models are used to optimize portfolio outcomes, but it does not account for how the inputs are created.

In practice, return, volatility, and correlation assumptions are not immune to bias. They are susceptible to influence from the incentives of the consultants who produce them and allocators using them. Both groups operate within systems that reward portfolio complexity, increased allocations to private markets, and the appearance of academic-level rigor.

This speaks to a bigger problem. Many academics fail to anticipate how their work could be affected by the same market forces and incentives that shape the environments they are studying. In the case of Modern Portfolio Theory, the result is a costly paradox. A Nobel-prize-winning framework that academics laud for its citations can be used by practitioners to launder self interest using the language of scholarship.

Restoring the Vision of Modern Finance

“People calculate too much and think too little.”10

—CHARLIE MUNGER, late vice chairman of Berkshire Hathaway

The use of financial history offers a complementary analytical framework that addresses the voluntary blindness afflicting modern finance across multiple domains. By granting serious consideration to qualitative lessons from financial history, it provides a framework for identifying risks that are systematically underrepresented in conventional models. It prioritizes structural pattern recognition and directional insight in environments where statistical precision is inherently limited.

Had the Fed considered the lessons from the Great Inflation, post-COVID inflation may have already concluded. Had investors considered the fundamental dynamics of speculative episodes, the flood of excess capital into private markets may have subsided. Had academics considered the role of incentives in shaping the inputs into the models on which the allocation of trillions of dollars depend, the cost of malinvestment in private markets could have been mitigated.

But the deepest truth revealed by the study of financial history is that many financial crises repeat not because they’re undetectable, but rather because individuals who have strong incentives to preserve the status quo cannot tolerate the psychological discomfort that accompanies detection.

Disclaimer: This is a personal newsletter written by Mark J. Higgins, CFA, CFP, in his individual capacity. The views expressed herein are solely those of the author and do not necessarily reflect the views, opinions, or practices of IFA or any other organization or entity with which the author is affiliated. This content is intended for informational and educational purposes only; it does not constitute professional investment advice, an offer, solicitation, or endorsement of any specific financial strategy, product, or service. The discussion contains the author’s opinions based on publicly available information and should not be interpreted as factual or predictive of future events.

Nothing in this newsletter should be construed as a guarantee of investment results, nor should past performance discussed herein be taken as indicative of future outcomes. Investing involves risks, including the potential loss of principal, and investors should consult their financial adviser or other qualified professional before making investment decisions. Additionally, every effort has been made to ensure an accurate portrayal of market practices and conditions, but the author disclaims responsibility for errors, oversimplifications, or omissions. By publishing this newsletter, the author aims to foster dialogue and education and does not intend to disparage any individual, organization, or investment strategy. Readers are encouraged to consider differing viewpoints and conduct their own research before forming opinions or investment strategies.

Any references to future economic or monetary outcomes in this newsletter are speculative and based on historical analysis and public information. Comparisons to past events, like the Great Inflation or post–World War I inflation, are meant to provide context, not predict the future. Readers should view these discussions as hypothetical and not rely on them for financial decisions. Always consult a qualified professional for advice.

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.”1

—CHUCK PRINCE, former CEO of Citigroup (July 9, 2007)

My last newsletter, Born to Run: Evergreen Private Markets Funds, was published just hours before Blue Owl announced it had permanently eliminated the quarterly redemption window on its OBDC II private credit fund. The timing was somewhat coincidental, but the warning was just the most recent of many.

Over the prior nine months, I have written extensively about the structural fragility of semi-liquid private credit and private equity funds, specifically highlighting their vulnerability to bank-run-like panics.

Many fund managers, journalists, and investment advisors continue debating whether the run on private credit funds—which has prompted Cliffwater, Morgan Stanley, and BlackRock to gate redemptions—is merely a hiccup in a maturing industry or the beginning of a panic that is likely to accelerate rapidly. My assessment comes out on the latter side.

Why the Run is Likely Structural, Not Cyclical

My rationale begins with recognizing the true nature of semi-liquid private market funds. Fund managers portray them as innovative marvels of modern financial and liquidity engineering, but that characterization only holds when they are positioned as solutions to immediate challenges within a compressed time frame.

When evaluated against centuries of financial history, they appear neither novel nor durable. Instead, they are simply an ill-advised revival of a structure that has appeared many times before—and often fail.

Semi-liquid private market funds suffer many flaws, but the most egregious is that they violate one of finance’s oldest principles: never fund illiquid assets with redeemable claims unless a lender of last resort stands behind the structure. Private market managers have not only defied this principle, but they have also amplified the risk by selling these structures to individual investors, who historically are far more prone to run when conditions deteriorate.

But that’s not all. The danger becomes clearer when you consider the primary functions for which these vehicles were created in the first place. The first was to provide an outlet for aging private equity positions that cannot be exited at attractive prices. The second was to prolong the flow of capital into private credit markets that are already saturated with far too much of it.

Seen in this context, the recent gating of redemption requests at funds managed by BlackRock, Cliffwater, Morgan Stanley, and Blue Owl no longer seem like temporary disruptions. The far more likely explanation is that they are the first visible cracks in a structure that has been quietly absorbing pressure for many years. Private credit may be experiencing the first tremors, but private equity is likely even more problematic because it has absorbed excess capital for longer.

The reckoning appears to have begun in early 2026. If this is the beginning of a broader unwind, three questions help explain how it is unfolding:

1. Why have private equity and private credit funds become inundated with too much capital?

2. Why do allocations persist despite clear signs of excess?

3. Why are semi-liquid structures causing this multi-decade wave to break?

Question 1: Why have private equity and private credit become inundated with too much capital?

It seems nearly all investors assume that alternative asset classes are permanent, large-scale features of capital markets, but historically this has never been the case. Instead, they typically emerged to fill temporary voids in niche segments of the economy.

Venture capital formed to fund the commercialization of post–World War II innovations and expanded during the rise of the computing age in the 1970s and 1980s. Buyout funds flourished in the 1980s as firms benefited from a decades-long decline in interest rates combined with a massive expansion in equity multiples. Private credit attracted enormous capital after a cottage industry stepped in to fill a temporary funding gap following the Global Financial Crisis.

In each case, early investors generated unusually attractive returns because capital was scarce relative to the number of opportunities. As is usually the case, those returns attracted imitators. Over time, an entire industry formed around opportunities that were originally scarce. As more capital entered, the supply of capital soon dwarfed the demand for genuinely attractive investments.

How Institutional Imitation Fueled Capital Inflows

In 2000, David Swensen, CIO of the Yale University Endowment, published a book titled Pioneering Portfolio Management. The book outlined a framework Yale used to generate exceptional returns over a fifteen-year period. Unfortunately, many investors misinterpreted the lessons.

Rather than recognizing that Yale’s performance depended on strong governance, uniquely talented staff, and early access to a limited number of highly skilled managers, they concluded that simple exposure to alternative asset classes was sufficient to generate superior returns. In response, institutional portfolios rapidly increased their allocations to private equity, venture capital, and other illiquid strategies (Figure 1).

Figure 1: Allocation to Alternative Asset Classes for State and Local Pensions

Source: Public Plans Data. “National Data – Investments.” Center for Retirement Research at Boston College; MissionSquare Research Institute; National Association of State Retirement Administrators; Government Finance Officers Association. Accessed March 15, 2026. https://publicplansdata.org/quick-facts/national/#investments

Over time, the performance dynamics of private equity and private credit took a predictable turn. The success of early capital providers became the catalyst for its own undoing. As more funds entered the market, the supply of capital soon dwarfed the demand for genuinely attractive investments.

The consequence was unsurprising. Returns declined as entry valuations rose. Underwriting standards weakened as managers struggled to deploy ever-larger pools of capital. Financial and liquidity engineering become more integral to marketing pitches.

Recommended Reading: A 45-Year Flood: The History of Alternative Asset Classes

Question 2: Why do allocations persist despite clear signs of excess?

The obvious next question is why investors continue allocating to private markets if the prospects have deteriorated. The reason is because the presence of a speculative supply chain compels them to. In its simplest form, a speculative supply chain is a financial ecosystem in which the incentives of nearly every participant are aligned toward expanding the production and distribution of a particular investment product. Each participant may behave rationally according to their own incentives, yet collectively they amplify risk across the system.

This dynamic has appeared repeatedly throughout financial history. During the Global Financial Crisis, mortgage originators, investment banks, rating agencies, specialized insurers, and asset managers all benefited from increasing the volume of mortgage-backed securities. Each participant added incremental risk to the system, but the structure of incentives encouraged expansion rather than restraint. The result was a chain reaction of rational behavior that contributed to systemic instability2

Private markets today display many of the same features. The primary participants are shown in Figure 2.

Figure 2: The Private Markets Supply Chain

Speculative Supply Chain Amplifiers

What is interesting and often under-reported is that the supply chain does not operate in isolation. It is reinforced by a network of amplifiers that includes trade media, trade associations, and academia. These amplifiers often repeat the prevailing narrative that private markets provide superior returns and diversification benefits. When these messages are repeated across multiple trusted intermediaries, the overall system gains momentum and skepticism becomes increasingly rare.

The Danger of a Speculative Supply Chain

The danger of a speculative supply chain is that no single participant needs to behave irresponsibly for the system to become unstable. Each actor responds to incentives that appear reasonable in isolation. Institutional investors pursue diversification, consultants recommend strategies embraced by peers, managers raise funds to meet demand, and advisors seek differentiated products for clients.

But when these incentives become tightly aligned, the system functions like an assembly line with no stop switch and increasingly lax quality control. Capital flows steadily from institutional allocators to fund managers, from fund managers into increasingly marginal investments, and ultimately through distribution networks to retail investors. At that point, the supply chain is no longer responding to opportunity. It is merely sustaining its own existence.

By the 2020s, a speculative supply chain appeared to be running at full capacity in private markets. Excess capital, fragile liquidity structures, and a powerful distribution network combined to push illiquid investments toward the broadest investor base -- retail investors. Financial history suggests that when a system reaches this stage, it continues expanding until an external shock or a loss of confidence finally disrupts the process.

Question 3: Why are semi-liquid structures causing this multi-decade wave to break?

“The investing public is fascinated and captured by the great financial mind. That fascination derives, in turn, from the scale of the operations and the feeling that, with so much money involved, the mental resources behind them cannot be less…The rule will often be here reiterated: financial genius is before the fall.”3

—JOHN KENNETH GALBRAITH, A Short History of Financial Euphoria

Allocations by institutional investors, represented by public pensions, have plateaued in recent years. This is unsurprising given the sheer volume of capital already committed, combined with the fact that private equity, the larger of the two allocations, has failed to deliver returns comparable to public markets for many years.

The tapering of new institutional commitments, coupled with a clogged exit environment, created pressure across the private-markets ecosystem. Asset managers still had large portfolios to finance, consultants still had asset classes to recommend, and distributors still needed new products to sell. The solution was a structural innovation that allowed the industry to expand its investor base: semi-liquid vehicles designed specifically for individual investors and marketed as the “democratization” of private markets.

These structures typically offer periodic liquidity, often through quarterly redemption windows, while investing in assets that may take years to sell at reliable prices. The appeal is obvious. Investors are offered exposure to private markets together with the appearance of stability and the reassurance that they can redeem capital periodically.

The problem is that this model violates the previously explained principle of finance. Long-duration, difficult-to-price assets should never be financed with short-term liabilities unless a lender of last resort stands behind the structure. When that rule is ignored, the structure is unstable. As long as inflows continue and redemptions remain manageable, it seems advantageous to both investors and fund managers. But once investors begin to withdraw capital, the mismatch between liquidity promises and underlying assets becomes visible very quickly.

History provides many examples of this dynamic. Wildcat banks in the 1800s, trust companies in the early 1900s, and investment bank warehousing facilities in the early 2000s. In each case, when confidence weakened, investors rationally attempted to redeem before others did. It doesn’t take long before investors run, simply in anticipation of other people running – which is the hallmark of a bank or fund run. This risk is substantially amplified when individual investors provide a large percentage of the capital.

Taken together, semi-liquid private credit and private equity funds are unusually vulnerable to run mechanisms. Not only are Illiquid assets financed with redeemable capital, but the underlying investments were raised at the tail-end of two aged investment cycles. Financial history suggests that such combinations rarely remain stable for very long. They may function smoothly for several years. But when confidence weakens, the structural mismatch becomes impossible to ignore.

That day arrived on February 18, when Blue Owl announced that it had permanently eliminated quarterly liquidity in its OBDC II private credit fund.

The Bear Has Awoken in Private Markets

The history leading up to this moment explains why the recent gating of redemption requests at funds managed by BlackRock, Cliffwater, Morgan Stanley, and Blue Owl is unlikely to be a temporary “speed bump.” Instead, these events are better understood not as a temporary disruption, but as the break point in a long-building structure.

As the run on private market funds progresses, the architects are searching for narratives that might contain the damage. Some argue that the problems are isolated to a few poorly managed funds. Some attribute them to temporary market dislocations or idiosyncratic factors such as sector exposure. Some simply blame the media for socializing the issue -- conveniently, ignoring the fact that it was the same media that amplified the rush into private markets to begin with.

All these explanations miss the larger reality. As of early 2026, we are in the last phase of a multi-decade capital cycle. A narrative may eventually emerge that proves persuasive to some, but it is unlikely to be a sensible one.

The run on private markets will likely accelerate and spread. Many investors will be affected, and the process has only begun.

Disclaimer: This is a personal newsletter written by Mark J. Higgins, CFA, CFP, in his individual capacity. The views expressed herein are solely those of the author and do not necessarily reflect the views, opinions, or practices of IFA or any other organization or entity with which the author is affiliated. This content is intended for informational and educational purposes only; it does not constitute professional investment advice, an offer, solicitation, or endorsement of any specific financial strategy, product, or service. The discussion contains the author’s opinions based on publicly available information and should not be interpreted as factual or predictive of future events.

Nothing in this newsletter should be construed as a guarantee of investment results, nor should past performance discussed herein be taken as indicative of future outcomes. Investing involves risks, including the potential loss of principal, and investors should consult their financial adviser or other qualified professional before making investment decisions. Additionally, every effort has been made to ensure an accurate portrayal of market practices and conditions, but the author disclaims responsibility for errors, oversimplifications, or omissions. By publishing this newsletter, the author aims to foster dialogue and education and does not intend to disparage any individual, organization, or investment strategy. Readers are encouraged to consider differing viewpoints and conduct their own research before forming opinions or investment strategies.

Any references to future economic or monetary outcomes in this newsletter are speculative and based on historical analysis and public information. Comparisons to past events, like the Great Inflation or post–World War I inflation, are meant to provide context, not predict the future. Readers should view these discussions as hypothetical and not rely on them for financial decisions. Always consult a qualified professional for advice.

“On your left you can see a run on a bank. The people in line are men and women who have lost all their savings.”1

—UNNAMED TOUR OPERATOR (October 24, 1907)

In 2026, few Americans appreciate the terror of a systemic run on the banking system. Depositors at Silicon Valley Bank got a brief taste of it on March 10, 2023, but even that episode was quickly extinguished and failed to metastasize into a systemic crisis.2

Nearly all Americans today are fortunate to have been spared such experiences, because when bank runs are allowed to cascade without intervention—as they did in the 1810s, 1830s, and 1930s—economic depressions are almost inevitable. Yet this good fortune carries a quiet cost. Lacking first-hand experience with systemic runs, Americans no longer fear them. That amnesia breeds complacency, allowing similar vulnerabilities to accumulate in the shadows.

The Growing Danger in Private Markets

Over the past several years, the investment industry has embraced the “democratization” of private markets. As part of this effort, many firms have launched a new class of vehicles offering private-market exposure in a semi-liquid format. The stated value proposition is faster exposure to private assets than traditional drawdown funds, combined with the option for periodic redemption, typically on a quarterly basis.

But when one examines the mechanics of evergreen funds, an alarming conclusion emerges. These vehicles have never been tested under adverse conditions. Their track records were established almost entirely in calm markets, reinforced by steady asset growth. The absence of genuine stress obscures a fundamental vulnerability. Evergreen funds are not merely exposed to run dynamics—they are structurally more vulnerable to runs than traditional banks.

This does not imply that a run is imminent. Crises often take far longer to develop than observers expect. Structural fragility can be visible years in advance. The moment of collapse, by contrast, is typically triggered by something trivial and unpredictable. In 1905, Hetty Green warned of impending trouble more than two years before the onset of the Panic of 1907. Otto Heinze’s attempted corner of United Copper was merely the spark.

The remainder of this newsletter outlines three flaws that explain why a similar vulnerability is present today, why it is intensifying, and why it poses acute risks to investors.

Flaw #1: Fair-Weather Liquidity

“These customers can redeem [from evergreen funds]. I find it paradoxical that when customers can vote with their feet, I am seen to be doing something that is not market competitive. Whereas that’s not the discussion about locked-up structures where customers have a harder time leaving.”3

—JUAN DELGADO-MOREIRA, Co-CEO of Hamilton Lane

The signature attribute of an evergreen private markets fund is its liquidity feature. Unlike traditional drawdown funds, evergreen structures allow investors to enter the fund and establish immediate exposure to private markets. They also offer the option to redeem, although the conditions under which redemptions are permitted are far more limited than many investors assume.

Typical liquidity terms permit redemptions of up to 5% of a fund’s assets per quarter, subject to multiple constraints. In practice, honoring those requests depends on the fund’s cash on hand, access to credit lines, and the manager’s ability to sell portfolio assets at acceptable prices. Liquidity therefore depends on favorable conditions—steady inflows of new capital, calm markets, and functioning short-term credit. It may be ubiquitous in marketing materials, but it is largely a fair-weather feature in operation.

The distorted perception of liquidity is precisely what makes the architecture so dangerous. Investors are conditioned to treat liquidity as a structural feature rather than a highly contingent option exercised at the manager’s discretion. Once investors begin to doubt that liquidity will be available when needed, the incentive to redeem early rises sharply, creating the classic coordination problem that underpins bank runs. When a critical mass of investors fears that delay may mean forfeiting the ability to exit at current values, redemptions become self-reinforcing.

The opening quote is striking because it reinforces the illusion that liquidity is a durable feature of these products. Far less emphasis is placed on the legal reality. For example, despite the Co-CEO’s public remarks, the Hamilton Lane Private Assets Fund’s own prospectus states—in bold type—that investors have “No Right of Redemption” and that “The Fund is not a liquid investment.” The marketing narrative and the legal reality point in opposite directions, but when redemption pressure rises, investors should assume that the legal reality will prevail.

Figure 1: Excerpt from Hamilton Lane Private Assets Fund Prospectus

Source: Hamilton Lane Private Assets Fund, *Prospectus*, Form 424B-3, U.S. Securities and Exchange Commission, March 28, 2025, accessed [August 17, 2025], https://www.sec.gov/ix?doc=/Archives/edgar/data/1803491/000101376225004230/ea0236008-01_424b3.htm.

The fundamental architecture of evergreen private market funds renders them vulnerable to classic bank-run-like mechanics—except that, in this case, fund managers retain the discretion to lock the doors for as long as they see fit. This alone should alarm allocators. When combined with the next two flaws, however, the probability of a run becomes not merely plausible, but constitutes the base-case expectation over time.

Flaw #2: Inflated Asset Values

“Human nature being what it is, small loopholes are likely to be exploited until they become big ones, and big ones until they turn into financial disasters.”4

—SETH KLARMAN, owner of Baupost Group

Many evergreen private markets funds build their portfolios primarily through secondary purchases rather than direct origination. This provides immediate exposure to private assets and, more consequentially, enables managers to report strong early returns through valuation mechanics that are not available in traditional drawdown structures.

The apparent return advantage reflects a simple accounting choice. Evergreen fund managers often acquire secondary positions at discounts to GPs’ most recently reported NAVs. Under the practical expedient in ASC 820, funds may (though are not required to) mark these positions to GP-reported NAVs, producing an immediate increase in reported value—a “one-day gain.” This practice has been documented by independent analysts such as Tim McGlinn (Altview) and Leyla Kunimoto (Accredited Investor Insights), as well as journalists such as Jason Zweig and Jonathan Weil of The Wall Street Journal. The cases cited are not anomalies; this practice appears to be the norm. In an October 2025 report, EDHEC found that roughly 70% of reported gains for evergreen funds launched since 2021 came from unrealized gains, many likely recorded at or near inception. For the newest funds, the share exceeded 90%.5

There are three structural problems with this practice.

• Systemic Inflation of Returns — Reported fund returns are mechanically inflated by this accounting choice. What appears to be strong early performance is, in many cases, a function of accounting rather than economic value creation. This distorts the signal to prospective investors, who reasonably infer manager skill from reported performance.

• Amplified Downside Risk — Early gains on paper embed future downside risk. If GP-reported NAVs ultimately prove optimistic—or if realized exit prices converge toward secondary purchase prices rather than marked-up values—later investors bear the cost of that reversion. Early paper gains pull forward performance that may later be unwound, magnifying subsequent drawdowns.

• Distorted Perception of Stability — Smooth early returns train investors to expect stability, obscuring the buildup of liquidity and valuation risk. When marks eventually flatten or reverse, sentiment can shift abruptly from confidence to doubt. In structures offering periodic redemption windows, that psychological regime change turns valuation disappointment into redemption pressure.

Together, these mechanisms recreate several of the classic preconditions for a run: inflated apparent solvency, confidence shaped by calm conditions, and vulnerability to sudden loss of faith when valuations disappoint. These dynamics increase both the probability of a run and the damage it would inflict. But one additional flaw materially amplifies both the risk and the potential severity.

That distinction brings us to the final—and most structurally dangerous—flaw.

Flaw #3: Competitive Diseconomies of Scale

“An investment trust should be good and large because this tends to make the expenses of running it a negligible percentage of the whole. But when the trust is big in size, the investing problem becomes increasingly difficult.”6

—FRED SCHWED, JR., author of Where are the Customers’ Yachts?

The most troubling side effect of the one-day gain is that it creates two structural competitive disadvantages that intensify as evergreen funds scale.

Competitive Disadvantage #1: Diminishing Returns from NAV Mark-Ups

The first disadvantage is arithmetic. Early in a fund’s life, valuation adjustments on new investments can materially boost reported performance, which helps explain why strong early returns are common. As assets under management grow, the same adjustments contribute progressively less to total performance because they are diluted across a much larger capital base. The mechanical result is unavoidable: the larger the fund becomes, the harder it is to sustain competitive headline returns. This pattern is already visible in the relative performance of maturing evergreen funds versus newer vehicles. For example, Figure 2 illustrates this dynamic using the Ares Private Markets Fund.

Figure 2: Ares Private Markets Fund Performance and Assets (2023-2025)

Sources: Asset values are based on N-PORT filings with the SEC as of the periods ending September 30, 2023, September 2024, and September 2025 [accessed February 16, 2026]; Annual performance is based on the D-share as reported by Ares at https://www.areswms.com/solutions/apmf/performance [accessed February 16, 2026].

A 13.10% return in 2025 does not look alarming in isolation. But what matters is not the headline number—it is the source of the return. In this case, the most important two sentences in the entire filing appear in the footnote to the Form N-CSR.

Figure 3: Ares Private Markets Fund Performance Disclosure

Source: Ares Private Markets Fund. Form N-CSR: Certified Shareholder Report of Registered Management Investment Companies for the Period Ending September 30, 2025. Washington, DC: U.S. Securities and Exchange Commission, 2025.

This disclosure confirms that a material portion of reported performance is driven by the mechanics of secondary discount capture rather than by operating improvement or realized exits—precisely the dynamic that diminishes as funds scale and secondary discounts compress.

Competitive Disadvantage #2: Erosion of Underwriting Discipline

The second disadvantage is operational. As evergreen portfolios scale, managers have an incentive to favor volume over selectivity. Using the Hamilton Lane Private Assets Fund as an illustration, as of September 30, 2025, the portfolio held 273 positions across private equity and private credit, including 20 direct credit positions, 71 direct equity positions, and 182 secondary equity interests. Ninety-eight positions were added in the prior 18 months alone. Put differently, this implies that the Hamilton Lane Private Assets team is, on average, making a new private-markets investment every four business days. Complicating matters further, those investments were dispersed across six continents and more than twenty industry categories, ranging from software to veterinary services.

In private markets, information is sparse and rigorous underwriting quality is essential to gaining an edge. The pace and breadth of this fund’s underwriting is fundamentally incompatible with sustained selectivity. Continued asset growth only compounds the problem. As the number of positions rises, underwriting faces mounting pressures to become even less discriminating, reducing the ability to exercise meaningful underwriting discipline.7

Escalating Competitive Pressures

These two structural disadvantages would be destabilizing in any market. They become materially more dangerous in a market flooded with new entrants (Figure 2). Newly launched funds can deploy fresh capital into discounted assets and immediately benefit from the optics of one-day gains. Before scale dilutes that advantage, they can also afford to be more selective, placing additional pressure on larger, more mature vehicles that must deploy at volume.

Figure 4: Cumulative New Private Equity Evergreen Fund Launches (2009-2025)

Source: Cliffwater, “Evergreen Private Equity for the Long Run,” Cliffwater, September 24, 2025, https://www.cliffwater.com/ResourceArticle/evergreen-private-equity-for-the-long-run?docId=29441

In summary, as performance optics deteriorate with scale, large evergreen funds face two unfavorable paths: accept relative underperformance and risk outflows, or relax underwriting discipline to preserve performance optics. The first invites near-term redemption pressure. The second compounds structural instability, raising both the probability and potential severity of stress events over time.

Neither path is attractive for long-term investors.

Conclusion

Evergreen funds combine an implicit promise of liquidity with a structural dependence on continuous inflows. As assets scale, both sides of that equation become harder to sustain. Liquidity windows require ever larger inflows to remain credible, while performance optics deteriorate as the mechanical benefits of one-day gains fade and underwriting discipline erodes under volume pressure. The paradox is that scale weakens competitiveness. The largest vehicles become the most exposed.

The analogy to banking is instructive. A bank that must offer progressively worse terms as it grows eventually invites depositor flight. The difference, of course, is that banks operate with access to a lender of last resort. Evergreen private-market funds do not.

When inflows eventually slow or reverse across the evergreen category, the largest funds will be the most exposed and the latent failure modes embedded in these designs will activate. Managers then face an unavoidable tradeoff: gate withdrawals or permit exits at steep discounts through secondary or public-market channels. Several funds, including the Bluerock Private Real Estate Fund, have already encountered this dilemma. Similar open-ended vehicles in Canada have experienced investor gating at a systemic level. A January 12, 2026 Bloomberg report noted that redemption requests had been submitted on roughly 40% of the $80 billion of invested capital in these funds8

In more adverse scenarios, funds may be forced to liquidate assets into markets that lack natural buyers—an especially acute risk in private markets already saturated with capital. In such cases, recent reported prices can sit far above market-clearing levels—if a clearing price exists at all.

The financial historian Robert Sobel once observed that “generally speaking, inevitability appears only in retrospect.”9 This is true of many financial disasters, but evergreen private market funds present a rare case in which the failure modes are clearly visible in advance. It is not an exaggeration to say that these funds are structurally more vulnerable to runs than banks. They combine multiple mechanisms that do not merely permit runs—they make runs more likely as the product grows. The precise timing of the reckoning is unknowable, but the mechanics underpinning it are not.

A Solemn Warning from Wall Street’s Queen

“If you have any money in that place [the Knickerbocker Trust] get it out the first thing tomorrow…the men in that bank are too good-looking. You mark my words.”10

—HETTY GREEN, the Queen of Wall Street (March 1907)

In closing, as an observer of financial history, I confess to a kind of grim awe at the financial monstrosity the liquidity engineers of the 21st century have assembled. They appear to have revived abandoned machinery and added a feature that makes it even more vulnerable to a run than an unregulated bank. After more than 200 years spent trying to prevent such calamities, this is no small achievement in financial folly.

Observing bank runs is a deeply unpleasant experience, regardless of one’s vantage point. But history shows repeatedly that it is far less disturbing to witness such episodes of panic as an observer than as a participant. There is no reason to believe the same principle fails to apply to fund runs.

The Queen of Wall Street has long since passed, but her wisdom remains relevant. I cannot speak for her, but I can imagine what she would say to those who have money in evergreen private markets funds.

If I had my money in one of those places, I would be reassessing my exposure first thing tomorrow.

Disclaimer: This is a personal newsletter written by Mark J. Higgins, CFA, CFP, in his individual capacity. The views expressed herein are solely those of the author and do not necessarily reflect the views, opinions, or practices of IFA or any other organization or entity with which the author is affiliated. This content is intended for informational and educational purposes only; it does not constitute professional investment advice, an offer, solicitation, or endorsement of any specific financial strategy, product, or service. The discussion contains the author’s opinions based on publicly available information and should not be interpreted as factual or predictive of future events. Nothing herein should be construed as individualized advice, a prediction of future events, or a call to take immediate action of any kind.

Nothing in this newsletter should be construed as a guarantee of investment results, nor should past performance discussed herein be taken as indicative of future outcomes. Investing involves risks, including the potential loss of principal, and investors should consult their financial adviser or other qualified professional before making investment decisions. Additionally, every effort has been made to ensure an accurate portrayal of market practices and conditions, but the author disclaims responsibility for errors, oversimplifications, or omissions. By publishing this newsletter, the author aims to foster dialogue and education and does not intend to disparage any individual, organization, or investment strategy. Readers are encouraged to consider differing viewpoints and conduct their own research before forming opinions or investment strategies.

Any references to future economic or monetary outcomes in this newsletter are speculative and based on historical analysis and public information. Comparisons to past events, like the Great Inflation or post–World War I inflation, are meant to provide context, not predict the future. Readers should view these discussions as hypothetical and not rely on them for financial decisions. Always consult a qualified professional for advice.

Sources

“Nothing is easier than self-deceit. For what every man wishes—that he also believes to be true.”

—DEMOSTHENES (349 BCE)

Summary

It has been two months since my last newsletter, which is largely due to the amount of thought and effort required for this one. It argues that today’s private markets boom exhibits the same structural conditions that have preceded past financial crises. The three defining attributes are segmented risk creation, near-perfect alignment of incentives across an expansive supply chain, and a deeply rooted but flawed assumption about the nature and durability of private markets. Drawing on more than 200 years of financial history—and using the 2008–2009 Global Financial Crisis as a reference point—it shows how institutional allocators, investment consultants, fund managers, wealth advisors, trade associations, academics, and the trade media each act rationally according to their own incentives while collectively amplifying systemic risk.

By tracing the sources of these dynamics upstream, it becomes clear that the rapid growth of evergreen and semi-liquid private-market vehicles is not innovation, but rather a late-cycle mechanism for warehousing illiquid assets, delaying price discovery, and sustaining the appearance of stability. The warning here is not about bad actors; it is about a system whose incentives have become so tightly aligned that, if stress emerges, the resulting damage could be severe. Retail investors, positioned at the end of this speculative supply chain, must be especially vigilant.

The Speculative Supply Chain

After studying multiple financial crises over the past 235 years, I developed a deep respect for an uncomfortable reality: the most damaging crises are almost never caused by a small group of bad actors. This realization lays bare the flawed, but instinctual human, preference for simple and swift explanations. In the aftermath of a crisis, this is why we tend to gravitate toward narratives that bluntly assign blame to a handful of villains for having caused the entire event. This may feel emotionally satisfying, but it is rarely accurate.

To be clear, there will always be a subset of individuals who engage in especially egregious—and sometimes illegal—behavior, and they should be dealt with in proportion to the severity of their actions. But this alone is not nearly sufficient to explain systemic financial crises. Far more often, it is the product of millions of actors taking billions of small actions across an expansive and siloed supply chain. Each participant acts according to incentives that seem consistent with their immediate responsibilities and are defensible locally. Many may feel discomfort when bending rules, threading loopholes, or simply extracting more value than they contribute because they can, but few envision how doing this collectively, simultaneously, and without meaningful accountability mechanisms can produce outcomes wildly disconnected from any single person’s intent.

The tragic irony is that millions of individuals responding rationally to perfectly aligned incentives at the same time have historically proven far more dangerous than a small group of especially bad actors. Such conditions preceded crises in the 1810s, the 1830s, 1907, 1929, 1999, and 2008–2009.

Today, I strongly suspect we are observing the same conditions in private markets. This newsletter explains why.

Key Attributes of a Speculative Supply Chain

One way to understand speculative episodes is to think of them like manufacturing supply chains. Based on the experience of past financial crises, three core attributes consistently emerge. Each is outlined below using the 2008-2009 Global Financial Crisis (GFC) as a reference point.

1️⃣ Risk Segmentation

Segmentation of risk in an assembly line-like formation is a crucial component of a systemic financial crisis. Each segment adds risk to the production process, but it is extremely difficult for any participant to fully understand how the risk compounds as it moves through the system.

During the GFC, independent mortgage originators relaxed underwriting standards to increase loan volume. Those loans were then sold to investment banks, which repackaged them into mortgage-backed securities. These securities were then purchased by institutional investors, placed into funds, and ultimately sold to retail and institutional investors. Many participants at each station likely sensed that risk increased locally, but few considered whether it was being further amplified elsewhere in the chain and how those amplifications compounded. Figure 1 shows the key components in the GFC and the house of cards that emerged at the end.

Figure 1: The GFC Speculative Supply Chain1

Source: Investing in U.S. Financial History. (2024)

The relative isolation of different segments of a speculative supply chain is what makes systemic crises so difficult to see in real time. Almost no participant has sufficient visibility. In The Big Short, what distinguished figures like Michael Burry and Steve Eisman was not intelligence alone, but rather it was their unusual visibility into the entire supply chain. They were intelligent for sure, but many equally intelligent people failed to recognize the danger simply because they lacked the same visibility.

2️⃣ Incentive Alignment

The second attribute required for a systemic financial crisis is the near-perfect alignment of incentives among all participants. In many cases, alignment extends well beyond direct participants.

During the GFC, mortgage originators, investment banks, and fund managers all shared a common incentive to increase the volume of mortgage production and the issuance of mortgage-backed securities. But the alignment did not stop there. Additional risk amplifiers included ratings agencies (e.g., Moody’s), specialized insurers (e.g., AIG), and prominent voices in the financial media. Each benefited directly or indirectly from higher origination volumes, greater securitization activity, and expanding asset pools.

Critically, no major participant had a strong economic incentive to slow the assembly line. Fee structures, compensation models, market share dynamics, and political pressures all leaned heavily against restraint. Had even one systemically important segment been incentivized to reduce production volume or tighten underwriting standards, the crisis may have been averted—or at least rendered less catastrophic.

3️⃣ Deeply Rooted But Flawed Assumption

“There is no national price bubble [in real estate]. Never has been; never will be.”2

—DAVID LEREAH, chief economist, National Association of Realtors (2004)

At the core of every speculative episode lies a nearly universal assumption that later proves to be fundamentally wrong. In the 1810s, Americans purchased farmland aggressively thinking that wheat prices would remain elevated indefinitely. In the late 1920s, Americans believed it was safe to purchase stocks on margin because they assumed equity prices would never suffer sustained declines. During the GFC, people assumed that residential real estate prices would never decline on a national level.

The presence of a widely held—but fundamentally flawed—assumption allows participants in a speculative supply chain to systematically underestimate the incremental risks that they add to the system. Because the flawed assumption is rarely questioned and instead reinforced by recent experience, it provides the psychological comfort necessary to allow risks to remain unchecked.

The Private Markets Supply Chain

Historically, the aforementioned attributes were observable prior to the onset of a major financial crises. It is alarming, therefore, that all three are now visible in private markets. From end to end, each participant in the supply chain operates with incentives that are nearly perfectly aligned to increase production and overlook the erosion of underwriting standards. Moreover, indirect participants, such as the trade media, trade associations, and even academia, amplify production pressure and/or grant unearned legitimacy to the final product. The role of the major participants in the private market supply chain are as follows.

Direct Participants

1️⃣ Institutional Allocators

Over the past 25 years, staff at institutional investment plans (often referred to as allocators) have dramatically increased allocations to alternative asset classes (Figure 2). A large portion of inflows have gone to private equity and, more recently, private credit funds.

The herd behavior began in earnest soon after investors noticed the exceptional returns produced by the Yale University Endowment between 1985 and 2000. Many allocators assumed that blunt allocations to alternative asset classes were the key ingredient of Yale’s success. Moreover, they assumed that the Yale model was broadly replicable and scalable across institutions with vastly different governance practices, relative scale advantages, and access to professional talent. As allocations expanded, however, the underlying incentives subtly shifted from exploiting a perceived opportunity to preserving the professional roles that the opportunity created.

Over time, compensation, career progression, and job security became inexorably linked to the complexity of allocations rather than objective analyses of the results that they produced. Deviating from that framework by streamlining portfolios and reducing costs introduced substantial career risk. Once these incentives were firmly entrenched, allocations to private markets became self-reinforcing, while reductions became increasingly risky to allocators. These incentives remain extremely powerful today.

Figure 2: Growth of Alternative Asset Class Allocations in U.S. Public Pensions, 2001-2024

Source: Public Plans Database (PPD). Asset allocation data from “National Data – Asset Allocation for State and Local Pensions, 2001–2024.” Author’s calculations.

Note: “Alternative assets” defined as private equity, real estate, hedge funds, commodities, and miscellaneous alternatives as reported in the Public Plans Database. Categories combined by author.

2️⃣ Investment Consultants

“U.S. plan sponsors managing over $13 trillion rely on investment consultants for advice about which funds to invest in…We find that consultants’ recommendations of funds are driven largely by soft factors, rather than the funds’ past performance, and that their recommendations have a very significant effect on fund flows, but we find no evidence that these recommendations add value to plan sponsors.”3

—TIM JENKINSON, et. al. (September 2013)

Investment consultants first emerged in the late 1960s to perform independent performance reporting for institutional investment plans. In this role, consultants measured and compared the performance of portfolios which, at the time, were typically managed by bank asset-management departments.

Over the past five decades, however, consultants slowly but steadily expanded their roles. Performance reporting was supplemented with asset-allocation advice, portfolio construction, manager selection in public markets, and eventually facilitation of access to private markets. In other words, what began as an independent oversight function morphed into a portfolio design role.

A big problem is that, while consultants are now the architects of institutional portfolios, they never relinquished title to their roles as independent performance reporters. In effect, consultants reinstated the very conflict of interest that they originally sought to resolve.

More importantly, investment consulting firms are now deeply dependent on portfolio complexity. Introducing new asset classes, tinkering with existing strategies, and continuously replacing managers sustains perceived relevance and justifies fees. Yet, at the same time, consultants bear little accountability for long-term outcomes. When results disappoint, responsibility is attributed to some combination of markets, managers, and asset class cycles rather than calling into question the quality of the advice offered by the architects themselves.

The result is a powerful incentive to increase complexity without experiencing commensurate accountability for the results.

Recommended Reading

• The Unspoken Conflict of Interest at the Heart of Investment Consulting

3️⃣ Private Equity Fund Managers

“Investment discipline is the phrase that’s got to come back and be talked about. In the beginning, the innovators of this idea, of whom I was one, had a great deal of discipline . . . What has happened is imitators by the hundreds have gotten into this business and as imitators flocked in, discipline has eroded.”4

TED FORSTMANN, founder of Forstmann Little (1996)

Modern private equity funds trace their origins to the late 1970s and early 1980s. The United States was emerging from the Great Inflation, and several powerful tailwinds converged for the benefit of this nascent industry. U.S. corporations had diversified excessively, interest rates were falling, and equity valuations were rising. These conditions created fertile ground for leveraged buyouts and allowed private equity to generate extraordinary returns.5

By the 1990s, those tailwinds had faded. Corporate structures were leaner, interest rates settled, new fund managers proliferated, and returns moderated. By the end of the twentieth century, private equity returns had compressed closer to public market equivalents, especially after considering underlying fees and the administrative costs of maintaining exposure. The industry remained influential, but its prior record of generating excess returns proved difficult to sustain at scale.

Following the GFC, a related opportunity emerged. Banks tightened lending practices as they rebuilt their balance sheets and adapted to tighter regulation. This created a void in credit markets, as many strong companies struggled to obtain credit. Private credit fund managers rushed to fill the void. Early capital providers generated exceptional returns, which attracted followers. From 2005 to 2024, private credit AuM grew from less than $100 billion to $1.7 trillion in the United States alone (Figure 3).

Figure 3: Total U.S. Private Debt Assets Under Management ($ billions), 2000-2024

Sources: The Wall Street Journal, CION Investments, Prequin, KKR.

Today, private equity faces a fundamental challenge. Portfolio companies are increasingly difficult to sell at the values carried in fund portfolios. Public markets and strategic buyers are uninterested in supporting exits at current valuations. This has created a backlog of roughly 30,000 companies that remain stuck in aged portfolios.6

The private-equity model depends on realizations, as capital must be returned to investors to maintain revenue and make room for new fund launches. Continuation vehicles, interval funds, and evergreen structures have emerged as a solution to the backlog. These vehicles provide liquidity without reliance on traditional exits. Many also incorporate private credit exposure, further accelerating the growth of the newest and fastest-expanding segment of private markets.

More importantly, these structures weakened a critical constraint that once governed the industry. Historically, private-equity fundraising was restricted by realizations. Capital could not be raised indefinitely without exits. By recycling assets within a closed system and substituting liquidity mechanisms for true exits, that governor has been weakened. Fundraising is no longer tightly tied to realizations, allowing capital accumulation to continue even as exit conditions deteriorate.

Recommended Reading

• A 45-Year Flood: The History of Alternative Asset Classes

4️⃣ Evergreen Fund Managers

“I strongly believe that unless we avoid these and other errors and false principles we shall inevitably go through a similar period of disaster and disgrace [as Barings Bank in 1890]. If such a period should come, the well-run trusts will suffer with the bad as they did in England forty years ago.”7

PAUL C. CABOT, founder of the first U.S. Mutual Fund (March 1929)

The most dangerous investment vehicle in the private markets supply chain is the evergreen fund. These vehicles are the final destination for aged private equity positions and direct or secondary purchases of private credit positions. Evergreen funds provide investors with exposure to these illiquid assets through structures that promise periodic liquidity. Given their placement at the end of the supply chain, they are packed with risk, yet they continue to accumulate assets at a breathtakingly rapid clip (Figure 4).

Figure 4: Growth of Evergreen Funds ($ Billions) (2015-2025E)

Sources: Pitchbook, CapGemini World Report Series 2024 (January 2025), Hamilton Lane.

In many ways, evergreen funds are performing the function of a bad bank. In past financial crises, impaired or difficult-to-exit assets were carved out into separate vehicles so they could be worked out over time without forcing immediate loss recognition across the system. That is effectively what evergreen private market funds have become. They function like a mechanism for warehousing unresolved losses, delaying price discovery, and sustaining the appearance of attractive performance in a late-cycle environment.

Unlike traditional banks, however, evergreen funds perform these functions without being subjected to bank-level transparency, strict capital requirements, or liquidity regulation. Investors are often led to believe they are getting diversified portfolios of private equity and private credit positions; few fear that they are providing long-duration funding to absorb liquidity shortfalls generated elsewhere in the system. Instead, this reality is obscured by marketing language, structural complexity, and selective comparisons to traditional investment funds.

Few investors know that reported returns for these funds are often inflated by the recognition of large, one-day gains. Moreover, while liquidity is prominently advertised, it is highly conditional. Redemptions are limited to a small percentage of NAV (typically 5% per quarter) and subject to gates or suspension under even modest levels of stress. At the same time, investors bear an unusually heavy fee burden. Management fees at the fund level, incentive fees that are frequently assessed on unrealized gains, and layered fees from underlying managers can total in excess of 500 basis points. (Figure 5).

Figure 5: Estimated Layers of Fees for the Hamilton Lane Private Assets Fund

Source: Hamilton Lane Private Assets Fund. 2025. “HLP AF Fact Sheet, June 2025.” PDF, Hamilton Lane. Accessed August 15, 2025; Author’s estimates for underlying funds.

True believers who dismiss the possibility that the NAVs reported by these funds may not reflect the realizable value of the underlying assets may find little comfort in recent developments in public markets reported by people like Leyla Kunimoto and Jason Zweig. Faced with liquidity demands, a small number of funds have permitted investors to exit through public offerings. In each case, however, the public market proved unwilling to provide liquidity at valuations anywhere close to reported NAVs, revealing a meaningful gap between stated values and clearing price.8

Further Reading

• The Gilded Age Circus is Back in Town

5️⃣ Wealth Advisors

“These markets are the next frontier, full of boundless opportunities for Americans who want to save for a home, their children’s education, and their retirement. Our goal, is to help them seize those opportunities, so they can achieve their American Dream.”9

—ERIC J. PAN, President and CEO, Investment Company Institute (2025).

The final station in the private-markets supply chain is occupied by wealth advisors. It is also where the most aggressive sales activity can be observed.

Wealth advisors do not create private markets products, but they play a crucial role in distribution to retail investors. They deliver the message that lacking scale and access is no longer an impediment to investing in private markets. In this capacity, advisors serve as the last station before private markets truly exit the assembly line.

The incentives are straightforward. Private market products appear to offer higher expected returns, a differentiated narrative relative to competitors, and fee structures that can materially increase advisor revenue relative to traditional public market portfolios. Illiquidity can be reframed as protection against panicked selling; valuation opacity can be reframed as reduced volatility; and complexity can be reframed as a sign of sophistication. These features make private markets exceptionally attractive from a business development perspective, particularly in an environment where fee pressure on traditional advisory services is intensifying.

But unlike their clients, investment advisors are insulated from many of the risks. Performance is evaluated over long horizons; liquidity constraints can be attributed to product design rather than advice quality; and unfavorable performance can be explained way as a market feature rather than a lapse of judgement. On the other hand, asset growth is rewarded immediately. In combination, this creates a powerful incentive to allocate client capital in private market vehicles, often via evergreen funds.

The Amplifiers

It is difficult for a speculative supply chain to operate efficiently when skeptical opinions debunk marketing pitches. Voices of skepticism can extinguish exuberance and slow the speculative assembly line to a crawl. They are like rust on the gears of a conveyer belt.

This is why the most dangerous speculative supply chains are those in which all potential sources of skepticism are not merely muted, but are rather converted into vocal advocates. When a message laden with opportunity, inevitability, and safety is amplified simultaneously by multiple trusted intermediaries, the system acquires dangerous momentum. In the case of private markets, the key amplifiers are the trade media, trade associations, and even academia.

6️⃣ Trade Media

The trade media is among the most misunderstood participant in the private-markets ecosystem, largely because many readers fail to recognize that its role is structured for advocacy by design. Investors often operate under the naïve assumption that trade media exists primarily to report trends rather than to amplify them. In practice, however, members of the trade media are indirectly beholden to the industries they cover.

Trade publications, podcasts, and conference organizers typically depend on revenue generated from sponsorships, advertising, event attendance, and access journalism. These business models create powerful incentives to reinforce prevailing narratives rather than challenge them. Amplifying the status quo is commercially rewarded, while skepticism is not.

In 2025, private-market growth stories attract online attention, drive conference participation, and increase sponsorship demand. Skeptical coverage, by contrast, risks alienating advertisers and sources without offering comparable upside. It is therefore unsurprising that coverage emphasizes access, innovation, and growth while downplaying structural risks, conflicts of interest, and historical precedent.

Figure 7: Sample Private Markets Conference Agenda

Source: https://web.cvent.com/event/2672f251-eaba-4c86-b2a1-85237a639bd6/summary?RefId=2025PMPISite

The irony is that if the trade media openly acknowledged its structural bias, the resulting damage would likely be less severe. It is the misperception that no such bias exists that makes its influence especially pernicious.

7️⃣ Trade Associations

Trade associations exist to advocate for the commercial success of their members, but oftentimes they present themselves as if their mission lies elsewhere. Nevertheless, the greater the pressure that members apply to advocate for their interests, the more aggressive trade association messaging becomes.

Private market growth has clearly become a strategic priority for many companies operating throughout the investment supply chain, and relevant trade associations are responding accordingly. Policy statements, press releases, research reports, and public testimony increasingly frame expanded access as a clear benefit to investors rather than the companies selling the products.

One example that has risen in prominence recently is the Defined Contribution Alternatives Association (DCALTA). Their stated mission is to “help bridge the information gap on how to effectively incorporate non-traditional investments into defined contribution plans.” This may seem like an innocuous goal on the surface, but it should be viewed with caution. Listed below are the members and alliances of DCALTA.

Figure 8: DCALTA Members, Alliances, and Board Members

Source: https://www.dcalta.org/membership (accessed December 19, 2025)

According to a recent report by With Intelligence, six of the ten firms on the list (shaded in red) rank among the top ten evergreen fund providers—and many more names are unranked evergreen fund managers.10 The thread running through this newsletter is that understanding the incentives of supply chain participants and amplifiers provide critically important context clues. The names on this list are key funding providers to DCALTA, which gives them a powerful voice in the content of educational materials and events.

8️⃣ Academia

“Many an academic is like the truffle hound, an animal so trained and bred for one narrow purpose that it is no good at anything else…when something was obvious in life but not easily demonstrable in certain kinds of easy- to-do, repeatable academic experiments, the truffle hounds of psychology very often missed it.”11

—CHARLIE MUNGER, former vice-chair of Berkshire Hathaway

Academia is often presumed to function as an unbiased voice of reason—producing research that is methodical and independent of commercial influence. But accepting this assumption at face value would be a mistake. Academic finance is populated by human beings, and no human on the planet is fully inoculated from incentives. Research agendas are shaped by funding sources, data availability, and institutional partnerships. Entire research centers are often supported by industry sponsors. Moreover, as Charlie Munger observed, academic research shows a structural preference for identifying narrowly bounded nuance within existing frameworks rather than challenging the foundational assumptions on which those frameworks rest.

Over the past year, some research emerging from well-regarded universities has raised important questions. In April 2025, Tim McGlinn of the AltView examined a study produced by the Georgetown University Center for Retirement Initiatives in partnership with Willis Towers Watson (WTW). The report, “Making the Case: The Effect of Private Market Assets on Retirement Income,” advocated for greater inclusion of private markets in retirement portfolios, yet relied on unusually aggressive return assumptions that have received limited critical scrutiny—and no response to his repeated requests for clarification.

More broadly, many universities and business schools have built substantial portions of their curricula, research agendas, and career pipelines around private markets. These programs educate students, place graduates, attract donor funding, and reinforce institutional relevance in an area of growing demand. All else equal, this creates a structural bias toward viewing private markets as durable innovations rather than as late-cycle phenomena.

In such an environment, it becomes difficult for academic institutions to conclude that private markets may be experiencing a bubble—much less that one may already exist.

Conclusion

“We knew the long boom in general and mortgage credit in particular exhibited all the classic signs of a mania, including the widespread belief that housing prices would never fall to earth…But we didn’t appreciate the extent to which non-banks were funding themselves in runnable ways.”12

—TIMOTHY GEITHNER, former Secretary of the Treasury (2014)

In the early 2000s, real estate speculators, loan originators, investment bankers, credit-default-swap issuers, and complacent members of the financial media erected a financial house of cards. The collective danger was hidden in small, incremental contributions made by millions of individuals acting in unison under the shared illusion that real estate prices could never decline on a national level. Not only was this assumption false—real estate prices had declined nationally in the 1810s, the 1830s, and the 1930s—but the very act of believing a decline was impossible made it more likely to occur. And it did.

In 2025, nearly everybody believes that private markets offer diversification benefits and return enhancement that will never deteriorate. In fact, the number of actors with nearly perfectly aligned incentives raises the question of whether the term “supply chain” is too innocuous. A more accurate analogy may be a rail gun—a weapon that uses perfectly aligned magnets to accelerate a solid projectile to velocities exceeding seven times the speed of sound. Anything in its path suffers devastating consequences.

The financial system has quietly assembled the equivalent of a financial rail gun, and the projectile has exited the barrel. It is uncertain when it will hit or how extensive the damage will be. But if you are a retail investor, it would be prudent to steer clear of its path.

The relentless sales pitches promising privileged access to private markets may make you feel attractive.

But make no mistake.

You’re not a magnet.

You’re a target.

Disclaimer: This is a personal newsletter written by Mark J. Higgins, CFA, CFP, in his individual capacity. The views expressed herein are solely those of the author and do not necessarily reflect the views, opinions, or practices of IFA or any other organization or entity with which the author is affiliated. This content is intended for informational and educational purposes only; it does not constitute professional investment advice, an offer, solicitation, or endorsement of any specific financial strategy, product, or service. The discussion contains the author’s opinions based on publicly available information and should not be interpreted as factual or predictive of future events.

Nothing in this newsletter should be construed as a guarantee of investment results, nor should past performance discussed herein be taken as indicative of future outcomes. Investing involves risks, including the potential loss of principal, and investors should consult their financial adviser or other qualified professional before making investment decisions. Additionally, every effort has been made to ensure an accurate portrayal of market practices and conditions, but the author disclaims responsibility for errors, oversimplifications, or omissions. By publishing this newsletter, the author aims to foster dialogue and education and does not intend to disparage any individual, organization, or investment strategy. Readers are encouraged to consider differing viewpoints and conduct their own research before forming opinions or investment strategies.

Any references to future economic or monetary outcomes in this newsletter are speculative and based on historical analysis and public information. Comparisons to past events, like the Great Inflation or post–World War I inflation, are meant to provide context, not predict the future. Readers should view these discussions as hypothetical and not rely on them for financial decisions. Always consult a qualified professional for advice.

“Although the Fed’s anti-inflation credibility gives it greater leeway to ease policy in the short run, over the longer term that credibility is like a capital asset that will depreciate if it is not maintained. The Fed must still ensure that inflation does not stray from target by too much or for too long, and that it reliably returns to target over time after being displaced by some shock.”1

—BEN BERNANKE, former chair of the Federal Reserve Board

Over the past four and a half years, Americans have endured an extended bout of high inflation. It began soon after the COVID-19 pandemic receded in the spring of 2021. Since then, prices have risen by more than twenty percent in aggregate. The Federal Reserve’s aggressive tightening campaign eventually brought inflation down to roughly three percent—but they failed to finish the job. A premature pivot toward easier monetary policy allowed inflationary pressures to reignite in 2025. As a result, inflation remains stuck well above the Fed’s two-percent target.

The tragedy of post-COVID inflation is that it was largely foreseeable. Lessons from comparable historical episodes demonstrate that the Fed could have responded more effectively. Instead, under Chair Jerome Powell’s leadership, the Fed committed two unforced errors. The first was its failure to act swiftly and aggressively when price pressures first emerged in 2021. The second was its premature pivot toward monetary policy easing in September 2024 and again in September 2025.

These missteps unnecessarily intensified and prolonged post-COVID inflation—and, in the process, eroded the Fed’s credibility. That loss of credibility may prove to be the most damaging consequence, as it leaves the FOMC more vulnerable to political pressure to cut rates prematurely yet again in the future.

This newsletter explores why both errors were avoidable. It draws upon lessons from two historical events. The first one reveals why the Fed should have acted more forcefully when inflation first appeared in 2021. The second shows why the Fed should have maintained more restrictive policy through the fall of 2024. The hope is that this newsletter demonstrates how the Fed leadership can improve monetary policy decisions by considering the lessons of history alongside analysis of recent economic data.

A Note on Monetary Policy Criticism

Criticizing monetary policymakers makes for easy sport. Too often, such critiques are unfair—surfacing only after events support retroactive claims of having predicted them. This newsletter contends that the Federal Reserve made two significant unforced errors. What strengthens this criticism, however, is that these arguments were articulated and documented before the outcomes validated them. The time-stamped papers referenced at the end of this newsletter back this assertion. They show that the Fed’s missteps and their consequences were foreseeable in real time through the lens of financial history.

Unforced Errors of the Federal Reserve

Chair Jerome Powell often characterizes post-pandemic economic conditions as “unusual,” but he rarely acknowledges the existence of important historical precedents. These omissions matter. By placing emphasis on the rarity of current circumstances rather than precedents that explain them, Powell subtly reinforces the perception that the Fed bears little responsibility for its missteps over the past five years. But this perception is misleading. Financial history offers at least two comparable events that could have guided policy in real time.2

The first comparable event was the post–World War I/Great Influenza inflation of 1919–1920, which arose from remarkably similar underlying conditions. When those same forces reemerged after the COVID pandemic subsided, they signaled that inflation was unlikely to be transitory. The second was the Great Inflation of 1965–1982, which demonstrated that the Fed must extinguish inflationary pressures swiftly and decisively before easing policy. Failure to do so risks allowing inflationary embers to reignite and credibility to erode. Unfortunately, the Fed appears to have disregarded the key lessons from both episodes.

Event #1: The Post World War I/Great Influenza Inflation of 1919-1920

“According to the reports on business conditions in this district…apparently few years opened with brighter prospects than 1920. Labor was fully employed at the highest wages probably ever known, manufacturing plants were being operated at the greatest possible limit, supplies of goods were small, prices were continually advancing, the public was buying lavishly, and it was generally reported that goods were being consumed as fast as produced…These conditions, which had been developing for some months undoubtedly fostered buying and speculation in all kinds of commodities.”3

—RICHARD L. AUSTIN, chairman and agent of the Federal Reserve

On November 11, 1918, World War I ended with Germany’s surrender to the Allied Powers. Only a few months later, the deadly second wave of the Great Influenza pandemic subsided. Despite feeling relieved after emerging from both a devastating war and a global health crisis, Americans feared that a deep depression was imminent. Many believed the abrupt end of wartime spending and impending collapse in European demand for U.S. exports would trigger a severe contraction. Early in 1919, signs of economic weakness seemed to confirm those fears—but the downturn was short-lived. A surge in consumer spending soon followed, fueling an economic boom and sending inflation soaring.45

In retrospect, this outcome was unsurprising. After years of wartime rationing, followed by pandemic-related shutdowns, Americans were eager to spend on goods that were temporarily considered luxuries.6 They also possessed ample savings, accumulated during several years of war-driven trade surpluses. Consumer demand was further amplified by cheap credit, as the Federal Reserve maintained an overly accommodative stance for too long. At the same time, supply chain disruptions emerged as industries shifted from total war back to a peacetime economy. Together, these forces drove a surge in prices in 1919. Much like post-COVID inflation, it showed no sign of abating without an aggressive monetary response.789

Monetary Response in 1920

The Fed responded to post-WWI/Great Influenza inflation belatedly but aggressively. Alarmed when inflation peaked around 20% in 1919, the Federal Reserve Bank of New York sharply raised the rediscount rate from 4.75% to 6.00% in January 1920. It then increased rates again to 7.00% in June 1920.1011 The response was effective (see figure below). Wholesale prices declined sharply, and the U.S. suffered a severe but short recession in 1920-1921. When the economy recovered, price stability was reestablished.

Sources: Federal Reserve Bank of Minneapolis; U.S. Bureau of Labor Statistics.

Monetary Response in 2021

In April 2021, as the most acute phase of the COVID-19 pandemic waned, inflationary pressures ignited. Much like the 1919–1920 episode, the sudden release of pent-up demand, combined with massive fiscal and monetary stimulus, was the primary driver. Price pressures were further amplified by global supply chain disruptions, as the world economy transitioned from total war back toward normalcy.

Despite the clear precedent from a century earlier, Chair Jerome Powell attributed post-COVID inflation largely to supply chain disruptions. Believing these would be temporary, he concluded that high inflation would prove “transitory.” The 1919–1920 experience strongly suggested otherwise. It demonstrated that when inflation is fueled by excess demand and easy money, the central bank must respond quickly and decisively to reverse it. Yet Powell held to the “transitory” narrative until late 2021. By the time the Fed began raising rates aggressively in March 2022, inflation had persisted at elevated levels far longer than necessary.12

Event #2: The Great Inflation of 1965-1982

“The simplest [lesson from the Great Inflation] is this: Inflation if it reemerges, ought to be nipped in the bud; the longer we wait, the harder it gets to reign in.”⁷

ROBERT J. SAMUELSON, Author of the Great Inflation

The Great Inflation of 1965–1982 stands as one of the few truly unprecedented episodes in U.S. financial history.13 Neither before nor since has the nation endured such a prolonged and pervasive period of high inflation. Postmortem analyses have revealed a series of policy errors. The most consequential was the Federal Reserve’s persistent bias toward the employment side of its dual mandate at the expense of price stability. This imbalance compelled the Fed to abandon tight monetary policy on multiple occasions before inflation was fully extinguished. Each premature easing allowed inflation to reignite at progressively higher levels. In turn, every failure eroded the Fed’s credibility with both the public and elected officials. This rendered the institution increasingly vulnerable to political pressure, which Presidents Lyndon B. Johnson and Richard Nixon subsequently applied.

The Great Inflation of 1965–1982 was a miserable era. For seventeen years, rising prices made the American dream feel increasingly out of reach. Worse still, the expected trade-off between higher inflation and lower unemployment collapsed. Instead, Americans suffered both high inflation and high unemployment simultaneously. The figure below captures these dynamics: the blue line (left axis) shows the federal funds rate, the orange line (left axis) shows the 12-month trailing inflation rate, and the gray area (right axis) depicts the rise in unemployment.

Sources: Federal Reserve Bank of St. Louis; Bureau of Labor Statistics.

By the mid-1970s, inflation expectations had become deeply entrenched in the American psyche. Many feared it constituted a new normal. They resigned themselves to unaffordable mortgages, soaring commodity prices, and meager stock returns. It was not until Federal Reserve Chair Paul Volcker summoned the resolve to impose and sustain draconian monetary tightening from October 1979 through August 1982 that the Great Inflation finally ended. The remedy was painful. The U.S. suffered a deep recession from July 1981 to November 1982, and unemployment peaked at 10.8 percent in December 1982. But the pain proved worthwhile. The end of the Great Inflation ushered in a new era of economic stability and growth.

The central lesson of the Great Inflation is clear: the Federal Reserve cannot allow elevated levels of inflation to persist for too long. When it emerges, policymakers must act swiftly and decisively to extinguish it. Such action inevitably inflicts short-term economic pain, but hesitation or half-measures only delay the reckoning and increase the ultimate cost. Each failure also chips away at the Fed’s credibility, diminishing its ability to withstand political interference. Ironically, the longer inflation endures, the stronger the political pressure becomes. Elected officials are highly sensitive to voter frustration. All else being equal, they tend to favor overstimulating the economy—risking even higher inflation—rather than facing the immediate backlash of a recession.

Abandonment of Post-COVID Monetary Tightening

In 2024, the Federal Reserve’s leadership failed to heed the lessons of the Great Inflation. On August 23, 2024, Chair Powell announced the Fed’s intention to pivot toward a more accommodative monetary policy. Less than a month later, on September 18, 2024, the Fed cut the federal funds rate by 50 basis points, followed by two additional 25-basis-point cuts on November 7 and December 18. Policymakers defended this pivot by asserting that inflation was on track to return to the two-percent target and that labor market data showed signs of softening. In their public statements, Fed officials hinted that they understood the lessons of the Great Inflation, but their actions suggested otherwise. Despite their collective memory, they repeated the same error—loosening policy before inflation was decisively subdued.14

Compounding Cost of Unforced Errors

“Domestically, we should err on the side of a too liberal monetary policy, Arthur. Inflation was awful, but it was better for politics than unemployment. We should risk some inflation.”15

—PRESIDENT RICHARD NIXON

Inflationary pressures have persisted throughout 2025. Nevertheless, the current administration has steadily intensified pressure on the Fed to ease monetary policy before inflation is decisively subdued. This behavior is neither surprising nor unprecedented. Presidents Lyndon B. Johnson and Richard Nixon employed similar tactics during the Great Inflation. The political calculus was that the short-term pain of rising unemployment was far less tolerable to voters than the gradual burden of rising prices. The above quote from a recorded conversation between President Richard Nixon and Fed Chair Arthur Burns substantiates this logic. President Johnson’s actions were even more extreme. During a meeting at his Texas ranch, Johnson allegedly pinned Fed Chair William McChesney Martin Jr. against a wall and shouted, “Martin, my boys are dying in Vietnam, and you won’t print the money I need.”16

The Fed’s premature pivot in 2024 is difficult to excuse. Unlike the inflation of 1919–1920, the causes, consequences, and lessons of the Great Inflation are well documented. Yet the institution’s analytical culture seems so focused on interpreting the meaning of recent data that it has lost the capacity for historical intuition. The irony is that one doesn’t need complex, econometric models to grasp the big picture. History clearly demonstrates that easing policy before inflation is fully extinguished substantially raises the risk that it will reignite. Many current FOMC members lived through the Great Inflation and saw firsthand the suffering required to learn this lesson — yet they repeated the same mistake again.

The Rising Risk of a Great Inflation-Like Event

Soon after the Federal Reserve began raising interest rates in March 2022, I warned that the U.S. economy would likely enter a recession before price stability was restored. Afterall, recessions followed both the 1919–1920 inflation and the 1965–1982 Great Inflation. In each instance, an overcorrection was required to extinguish inflationary pressures decisively.

The similarities between post–World War I inflation and post-COVID inflation was not merely coincidental. The inflationary drivers in 1919–1920—pandemic, pent-up consumer demand, supply chain bottlenecks—were very similar to the drivers in 2021. Further, aggressive monetary tightening was required to end it. This precedent offered a clear roadmap for how the Fed would likely respond in 2022.

At the time, I also believed the Fed would avoid repeating the mistakes of the Great Inflation. The causes and consequences of that episode were thoroughly documented, and many current policymakers had personally experienced that era. For those reasons, it seemed the odds of another Great Inflation–like episode were low. In hindsight, that may have been too optimistic.

Another pattern I’ve described in a previous paper is the Fed’s recurring tendency to overcorrect for its last mistake. After the sharp recession of 1921-1922, policymakers were reluctant to tighten again too soon and thus delayed rate hikes in the late 1920s. This error contributed to the severity of the Great Crash of 1929. The same dynamic reappeared in the 1960s and 1970s, when the Fed prioritized employment over price stability because its leaders were still haunted by the mass unemployment during the Great Depression. By that logic, the Fed was predisposed to ease too early rather than too late in 2024 to compensate for its tardiness in raising rates in 2022. I considered this historical pattern, but I believed that the lessons of the Great Inflation would be more influential. It appears I was wrong.

Today, the Fed faces a serious credibility problem. The two errors described in this newsletter have weakened confidence in the institution at a moment when the public’s tolerance for the effects of inflation is wearing thin. Meanwhile, the current administration has shown a willingness to pressure the Fed to cut rates prematurely again, testing the boundaries of monetary independence—just as Presidents Johnson and Nixon once did. There is still a chance that inflation will subside on its own and/or the FOMC will summon the courage to retighten policy if necessary. But the more likely scenario is another premature easing cycle—followed by a renewed surge of inflation.

Unlike my earlier forecast, I hope this one proves wrong. Because if it doesn’t, a replay of the Great Inflation may already be unfolding.

Disclaimer: This is a personal newsletter written by Mark J. Higgins, CFA, CFP, in his individual capacity. The views expressed herein are solely those of the author and do not necessarily reflect the views, opinions, or practices of IFA or any other organization or entity with which the author is affiliated. This content is intended for informational and educational purposes only; it does not constitute professional investment advice, an offer, solicitation, or endorsement of any specific financial strategy, product, or service. The discussion contains the author’s opinions based on publicly available information and should not be interpreted as factual or predictive of future events.

Nothing in this newsletter should be construed as a guarantee of investment results, nor should past performance discussed herein be taken as indicative of future outcomes. Investing involves risks, including the potential loss of principal, and investors should consult their financial adviser or other qualified professional before making investment decisions. Additionally, every effort has been made to ensure an accurate portrayal of market practices and conditions, but the author disclaims responsibility for errors, oversimplifications, or omissions. By publishing this newsletter, the author aims to foster dialogue and education and does not intend to disparage any individual, organization, or investment strategy. Readers are encouraged to consider differing viewpoints and conduct their own research before forming opinions or investment strategies.

Any references to future economic or monetary outcomes in this newsletter are speculative and based on historical analysis and public information. Comparisons to past events, like the Great Inflation or post–World War I inflation, are meant to provide context, not predict the future. Readers should view these discussions as hypothetical and not rely on them for financial decisions. Always consult a qualified professional for advice.

Contemporaneous Documentation of Historical Precedents

The documentation provided below substantiates several of the forecasts described in this newsletter.

Lessons from the Inflation of 1919-1920

The lessons from the inflation that followed World War I and the Great Influenza were every bit as clear as those drawn from the Great Inflation, though the arguments I presented in earlier papers were somewhat less forceful. At the time, I was still developing confidence in the practical application of financial history. I was in the early stages of writing Investing in U.S. Financial History and had not yet fully grasped how compelling these historical parallels could be. Nevertheless, those early analyses anticipated that post-COVID inflation was unlikely to be transitory. They also warned that restoring price stability would require an aggressive monetary response—and that a recession would likely precede its return.

August 13, 2021 — A Post-COVID Recovery is Unlikely to Resemble the Roaring 20s; The Years 1919 and 1999 Provide More Insightful Comparisons

The title of this paper is one I will always regret, but the comparisons of the post-COVID years to the post World War I/Great Influenza years revealed that the economic dynamics were likely to be similar. It admittedly did not focus on inflation as a potential problem at the time, but when it materialized in force, it strongly backed the argument that it was unlikely to be transitory given the underlying causes.

May 19, 2022 — The Financial Effects of the COVID-19 Pandemic Are not Unprecedented: Multiple Historical Events Help Contextualize the Crisis

This article compares many COVID-related to comparable events throughout history. Not all forecasts were correct, but the comparison of COVID-19 inflation to the post-World War I/Great Influenza inflation was helpful in forecasting the aggressive Fed response in 2022 and 2023.

Lessons from the Great Inflation of 1965-1982

October 31, 2023 — The Siren Song of a Soft Landing

This newsletter noted that one of the Fed’s more dovish Presidents, Austan Goolsbee, seemed dangerously captivated by the prospect of a soft landing. It argues that that this would be a mistake.

August 27, 2024 — The Fed Leadership Thinks This Time is Different

This newsletter was written a few days after Chair Powell announced the impending pivot in monetary policy at the annual Jackson Hole Symposium. It argued that this was a mistake.

October 10, 2024 — The Fed’s Pivot Violated the Rule that Matters Most

This newsletter was written after the Fed’s pivot, and it once again reinforced the failure of the Fed to heed the most important lesson from the Great Inflation.

December 20, 2024 — Inflation Persisted Because the Fed Relented

This newsletter was written after inflationary pressures began reigniting, just as financial history predicted it would.

“For many denizens of Wall Street at the time, the measure of a man was not his honor or the value of his word, or even his net worth; it was the audacity of his scheming, regardless of whether the securities he was trading were legitimate, fabricated, or even his to sell.”1

—MICHAEL HILTZIK, author of Iron Empires

Several people have asked me what section of Investing in U.S. Financial History was the most fun to research. The answer is Part 2, which covers the post-Civil War period spanning from 1866 to 1895. Commonly referred to as the Gilded Age, it was an exciting and treacherous time for investors. On Wall Street, it was a period of peak clownery, as ethically challenged stock operators, such as Jay Gould, Daniel Drew, and “Jubilee” Jim Fisk, were not only rewarded financially for their capers, but they also enjoyed bonus points for the flair of their delivery.

More than any other Gilded Age scoundrel, “Jubilee” Jim embodied the absurdity of the era. Fisk was born on April Fool’s Day in 1835. At the age of 15, he ran away from home to join a traveling menagerie and circus. It was there that he honed his knack for theatrics and sleight-of-hand. During the Erie Railroad War in the late 1860s, Fisk applied his skills deftly, allegedly boasting that he was exercising his constitutional right to “freedom of the press” while printing millions of dollars of illegal shares in the Erie Railroad. Then, in a farcical reenactment of George Washington’s crossing of the Delaware River, Fisk and Jay Gould fled New York City police by navigating a rowboat across the Hudson River with a pile of pilfered cash in stow. Ultimately, neither Fisk nor Gould was held accountable.2

Reading about Gilded Age schemes was entertaining because the behavior was so outlandish it was impossible not to laugh. But it was important to remember that victims were not amused. It takes many years before financial horror shows can be recast as comedies.

A Circus Act That Would Put the “Jubilee” in Jim Fisk

Well, ladies and gentlemen, that distinct Gilded Age scent is in the air again. The circus is back in town. The resurgence of meme stocks is reminiscent of 19th century market corners. Crypto assets and decentralized banking are yielding countless frauds, scams, and even violent kidnappings. But the most dangerous act is playing out in private markets. The peril derives from its scale, rapid growth, deceptive returns, and appalling fees.

Before detailing the main event unfolding in the center ring, it is important to first note that private markets, which include buyout, venture, and private credit funds, have experienced massive over-allocations of capital over the last several decades. The driver was an effort by institutional plans to replicate the performance of the Yale University Endowment by crudely mimicking their asset allocation. The multi-decade flood of capital all but assures that most investors will suffer disappointing returns for many years to come.3

Perhaps realizing the folly of their ways, a growing number of institutions—including the Yale University Endowment—are now selling positions in the secondary market. A frequent buyer is a new type of fund, often referred to as an “evergreen fund.” These funds offer retail investors (and even some institutional investors) with access to private markets. These Frankenstein-like creations claim to offer opportunities to enhance returns by providing access to previously inaccessible private markets in a vehicle that offers liquidity comparable to public markets. Only the passage of time will reveal the final verdict, but it seems the most likely outcome is that they will provide neither.

Nevertheless, over the past several years, evergreen funds have attracted massive inflows of capital (see Figure 1). A key driver is the breathtaking returns they tend to generate during their first few years of operation. But what is the source of these exceptional returns? Is it sustainable? Is it even real?

Figure 1: Growth of Evergreen Funds ($ Billions) (2015-2025E)

Sources: Pitchbook, CapGemini World Report Series 2024 (January 2025), Hamilton Lane.

Over the past several months, reporters at the Wall Street Journal, such as Jason Zweig and Jonathan Weil, combined with laudable efforts by freelancers, such as Tim McGlinn and Leyla Kunimoto, have unearthed many disturbing facts. Their revelations strongly suggest that evergreen fund prospects are dim at best, and catastrophic at worst. The fatal flaw is simple: their liberal use of one-day gains.

One-Day Gains: The Heart of Evergreen Fund Financial Engineering

Yes, you read that previous sentence correctly. Many evergreen fund managers are literally reporting enormous gains within a single day of purchasing assets—and they are doing it as a matter of routine. If you’re like most people who hear this for the first time, your next question will probably be: “is that even legal?” It’s hard to believe, but indeed it is. It is permitted because of a relatively obscure accounting rule established in 2009. At the time, the primary investors in private markets were institutional plans, such as pension plans and endowments. These investors rarely sold their positions before the funds were fully liquidated. As a result, the secondary market was relatively small in the early 2000s (see Figure 2).

The few secondary transactions that occurred at the time were usually purchased at a discount to the general partner’s (GP’s) last-reported net asset value (NAV). This created a reporting problem. Buyers of secondaries questioned whether the purchase price or the NAV should be used to value the investment on their books. The accounting principle of conservatism, not to mention common sense, dictates that what you just paid for an asset provides a more accurate reflection of its value. But reporting entities voiced concerns to the Financial Accounting Standards Board (FASB) because of the added work required to reconcile future NAV updates with their cost basis.

In September 2009, the FASB addressed these concerns by issuing Accounting Standards Update No. 2009-12, subtitled “Fair Value Measurements and Disclosures (Topic 820): Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent).” A component of the update was the allowance of a “practical expedient,” which permitted (but did not require) reporting entities to immediately use the GP’s reported NAV rather than the purchase price to value secondaries. Reporting entities opting to use the practical expedient recorded one-day gains when they immediately marked the secondary position up from the purchase price to the NAV.

Fundamental to FASB’s decision was the fact that secondaries were relatively uncommon and were being sold at temporarily distressed prices due to the pressures of the 2007-2009 Global Financial Crisis. The Update explained this rationale stating, “Some constituents also asserted that principal-to-principal or brokered transactions are uncommon for the types of investments within the scope of the amendments in this Update and often involved a distressed seller.”4

Given the low volume of secondary transactions and abnormality of market conditions in 2009, the FASB appears to have assumed that the purchase price and NAV of secondaries would eventually converge. They acknowledged that one-day gains would inflate the perceived performance of secondary positions for some time, but they concluded that the cost of performance distortions was less important than the benefits of reducing the administrative burden for reporting entities.

A Secular Change in Secondaries

One could argue that allowing one-day gains was never advisable, but in fairness to the FASB, the impact was relatively immaterial in 2009. Secondary transactions were uncommon and legitimately occurring in broadly distressed markets. But this is hardly the case in 2025. Over the past 16 years, secondary transactions have grown more than sixteen-fold, rising from a mere $10 billion in 2009 to $162 billion in 2024 (see Figure 2). In the first half of 2025, transactions hit $110 billion, putting them on a pace to far exceed 2024 levels.5 Further, securities markets are healthy, which discredits the common claim that steep discounts applied to secondaries are a function of temporary market dislocations.

Instead, it seems far more likely that discounts accurately reflect the true value of portfolios. After all, many indicators suggest that private equity firms have taken on far too much capital over the past several decades and that reported NAVs are likely inflated. Evidence includes an enormous backlog of investments awaiting exit, sharp rise in the use of continuation vehicles, tepid activity in IPO markets, and a general lack of interest from strategic buyers in purchasing portfolio companies at current prices. It is quite logical, therefore, to assume that the price paid in secondary transactions is closer to the real value of the portfolio than the GP’s reported NAV. In fact, the sharp rise in competitive bids for secondaries suggests that buyers may be overpaying. Finally, it is also possible, if not probable, that the NAV and price paid for secondaries will never converge.6

Figure 2: Secondary Transactions 2002-2024 ($ Billions)

Source: “Lodge, Cari, et. al. “Blossoming New Era of Secondaries.” Commonfund. (March 6, 2025).

Evergreen Funds Use a Practical Expedient as a Sales Accelerant

“Human nature being what it is, small loopholes are likely to be exploited until they become big ones, and big ones until they turn into financial disasters.”7

—SETH KLARMAN, owner of Baupost Group

Now that you understand the history of one-day gains and the secular changes in secondaries markets, it is easy to understand the danger of investing in evergreen funds that depend on them. The following six problems explain why these types of funds are unattractive investments.

Problem #1: Past Returns are Heavily Driven by One-Day Gains

Many evergreen funds allocating heavily to secondaries report lofty returns during their first several years, and these returns are often disproportionately driven by one-day gains. Take Hamilton Lane’s Private Assets Fund as an example. Citing an inception date of January 1, 2021, the fund reported the cost basis and fair value of its holdings to the SEC for the period ending March 31, 2022. The table below shows several metrics based on this report.

Figure 3: Hamilton Lane Private Assets Fund Holdings (March 31, 2022)

Source: Hamilton Lane Certified Shareholder Report N-CSR for Period Ending March 31, 2022.

The SEC filing does not provide enough data to fully dissect Hamilton Lane’s returns, but it provides plenty of insight into the return dynamics. Most importantly, it shows that soon after the fund’s inception, gains from secondary transactions dwarfed gains on direct investments. This makes it unsurprising that the fund recorded a 22.11% return in 2021. Moreover, this practice appears to have continued, as revealed in Jason Zweig’s article published on June 6, 2025 in the Wall Street Journal.8 Finally, given that Hamilton Lane has publicly defended the use of one-day gains—euphemistically referring to them as “NAV uplifts”—investors would be wise to assume that most of the gains in this fund will continue to be derived from these mark-ups.

This newsletter does not include an investigation of every evergreen fund in detail, but similar practices at other funds have been reported by journalists.

Problem #2: Future Returns Depend Heavily on Continuous Inflows of Capital

Evergreen funds that depend on one-day gains have a strong incentive to attract inflows of new capital to continue generating competitive returns. Even if the existing portfolio produces positive returns, it simply cannot match the power of adding fresh batches of one-day gains. The math here is illustrated with a simplified one-year return scenario for two hypothetical funds.

Figure 5: Hypothetical Return Scenario for Evergreen Funds

Key Assumptions:
1. Purely for the sake of simplicity, it is assumed that all secondaries are purchased on Day 1.
2. Fund A and Fund B both generate a one-day gain of 20% on new secondary purchases and a 3% gain on the remaining portfolio.

In this scenario, Fund A produces a total annual return of 11.5%, while Fund B produces a total annual return of only 4.5%. Unless the remaining portfolio generates a gargantuan return, the only way Fund B can remain competitive with Fund A is to buy massive amounts of secondaries and record more one-day gains. In this case, Fund B, would need to purchase $2 billion in secondaries to match Fund A’s return.

Problem #3: The Impact of One-Day Gains Deteriorates as Funds Grow

The third problem with evergreen funds is a byproduct of the second problem. Because evergreen funds must continuously purchase incrementally larger amounts of secondaries to remain competitive, it won’t take long before demand for secondaries outstrips supply. This will reduce the negotiating power of evergreen funds, as secondary transactions begin receiving multiple bids. In fact, there is abundant evidence that this has already happened. For example, the New York City pension system’s recent $5.0 billion sale of private equity holdings attracted 80 bidders!9

Another problem is that the sheer volume of transactions required to satisfy evergreen funds’ appetite for one-day gains will likely force fund managers to be less discerning with their purchases. All else being equal, it is much easier to be selective when you only need to buy $100 million of secondaries versus several billion dollars worth.

The combination of increased demand from buyers and reduced ability to discriminate on purchases seems highly likely to impair future returns. The performance of the Hamilton Lane Private Assets Fund appears to validate this thesis (Figure 4).

Figure 4: Annual Net Returns and Total Assets of the Hamilton Lane Private Assets Fund - R Shares (XHLRX) (January 1, 2021 - December 31, 2024)

Sources: Hamilton Lane Fund Fact Sheet as reported for period ending April 30, 2024. SEC Forms N-PORT for periods ending 12/31/2021, 12/31/2022, 12/31/2023, 12/31/2024.

Of course, Hamilton Lane could claim that a decline from a 22.11% return to a 9.17% return is hardly catastrophic. That may be true, but only if we conveniently forget that these returns were driven heavily by one-day gains, which may not be real.

Problem #4: Liquidity Can Evaporate Quickly

Evergreen funds claim to offer investors liquidity despite the fact that their portfolios consist primarily of illiquid assets. Once again, using Hamilton Lane as an example, the co-CEO, Juan Delgado-Moreira publicly stated:

“These customers can redeem [from evergreen funds]. I find it paradoxical that when customers can vote with their feet, I am seen to be doing something that is not market competitive. Whereas that’s not the discussion about locked-up structures where customers have a harder time leaving.”10

Well, that’s a relief. That is, of course, until you read the prospectus for the Hamilton Lane Private Assets Fund. It’s difficult to imagine a public statement that contrasts more sharply with a fund’s actual rules. A screenshot of the introduction to the section on share repurchases is below.

Source: Hamilton Lane Private Assets Fund, *Prospectus*, Form 424B-3, U.S. Securities and Exchange Commission, March 28, 2025, accessed [August 17, 2025], https://www.sec.gov/ix?doc=/Archives/edgar/data/1803491/000101376225004230/ea0236008-01_424b3.htm.

Can the language be any clearer? The prospectus states (in bold font no less) that there is “No Right of Redemption” and “The Fund is not a liquid investment.” With this inconvenient fact out of the way, the prospectus further explains the repurchase policies. Yellow highlights were added by the author to focus your attention:

Source: Hamilton Lane Private Assets Fund, *Prospectus*, Form 424B-3, U.S. Securities and Exchange Commission, March 28, 2025, accessed [August 17, 2025], https://www.sec.gov/ix?doc=/Archives/edgar/data/1803491/000101376225004230/ea0236008-01_424b3.htm.

In effect, this statement reveals that the fund anticipates redeeming no more than 5% of the Fund’s net assets during a repurchase event (generally quarterly), and it is subject to the Board’s sole discretion as to whether to honor redemption requests. This is an extremely light commitment to liquidity. Sure, investors can vote to redeem their shares, but if the Board is not in a redeeming mood and/or investors holding more than 5% of assets simultaneously cast their votes, there is a good chance their money is going nowhere. Anybody who believes that this will never happen is frighteningly naïve to the nature of securities markets.

Problem #5: Nauseatingly High Fees

In light of the questionable past returns, poor return prospects, and highly conditional liquidity, one would think that these funds are incapable of demanding high fees. Well, think again. Figure 6 provides a breakdown of actual fees charged by the Hamilton Lane Private Assets Fund, as well as estimated fees charged by the GPs of the underlying funds in the portfolio.

Figure 6: Estimated Layers of Fees for the Hamilton Lane Private Assets Fund

Source: Hamilton Lane Private Assets Fund. 2025. “HLP AF Fact Sheet, June 2025.” PDF, Hamilton Lane. Accessed August 15, 2025; Author’s estimates for underlying funds.

It is important to note that these figures may underestimate the fees. First, it assumes a management fee of only 1.5% (rather than 2%) for the underlying private fund interests, as it is plausible that most secondaries are in the later stage of their fund lives. Second, it assumes no incentive fees will be paid on funds that Hamilton Lane purchases in the secondary market because this is simply too difficult to estimate. Third, it does not account for other fees, such as fees charged by custodians to hold these funds.

Problem #6: Untrustworthiness

“The first thing is character…a man I do not trust could not get money from me on all the bonds in Christendom.”11

—J. PIERPONT MORGAN (December 19, 1912)

The final problem may be the easiest to observe but most frequently overlooked. This may sound harsh, but executives at many firms promoting these products have proven, through their actions and public statements, that they cannot be trusted. The statement regarding liquidity from Hamilton Lane’s co-CEO is one example. Another is the convoluted reporting practices embraced by many evergreen funds, including Hamilton Lane, the Partners Group, and several others. On August 13, 2025, Jonathan Weil published an article in the Wall Street Journal revealing how many evergreen funds provide the cost basis of hundreds of investments in an absurdly confusing footnote style. This seems like an intentional obfuscation tactic designed to hide the role of one-day gains (see image below).

Let’s put this in a slightly more relatable context. Suppose you asked a general contractor to itemize every cost on a home renovation, and they sent you a list of 200 items with a single footnote listing 200 cost figures separated by commas. Would you trust them? I doubt it. So, why is it okay if a fund manager does it?

If a fund manager resorts to juvenile behavior like this, one must ask what else they are hiding. Then again, do you really need to know? They’ve already given you a taste of their character. It would be imprudent to trust them managing the inventory at a bake sale, much less a multi-billion dollar fund.

Steer Clear of the Secondaries Circus

“When people are cautious, questioning, misanthropic, suspicious, or mean, they are immune to speculative enthusiasms.”12

—JOHN KENNETH GALBRAITH, author of The Great Crash: 1929

Over the past 230 years, financial engineers have assembled many circus-like events. While private markets evergreen funds may not qualify as the zaniest, they certainly deserve a spot under the tent. Funds that depend on one-day gains are reporting returns that are likely to be grossly exaggerated—assuming they’re real at all. But even if they are real, simple arithmetic and early evidence reveals they cannot be sustained for long. Meanwhile, many investors who place their well-earned money into these funds are rewarded with highly conditional liquidity and exorbitant fees. If there is a way for these funds to defy the steep odds stacked against them, I don’t see it.

It is difficult to predict the timing and severity of financial disasters, but I strongly suspect that most evergreen funds will end in one. There will come a time when inflows reverse into outflows, redemptions are denied, portfolios are revalued to reflect reality, and investors find themselves stuck in overpriced, poor-performing funds for a very long time. When that moment will arrive is anybody’s guess, but my personal belief is that the day of reckoning will be measured in a few years, at most.

The structures of these funds are unstable; promises of enhanced returns are hollow; and pledges to redeem shares are unreliable. Fund managers know or should know that they are undeserving of the enormous fees they charge to simply feast on secondaries. Prospective investors should not only beware; they should be scared. The laws of math don’t respect hubris, nor do they suffer fools who deny their existence.

The secondaries circus will surely draw a crowd, but it’s a risky, high-priced ticket. If this suits your fancy…well, open your wallet, glue yourself to a seat, and enjoy the show!

Disclaimer: This is a personal newsletter written by Mark J. Higgins, CFA, CFP, in his individual capacity. The views expressed herein are solely those of the author and do not necessarily reflect the views, opinions, or practices of IFA or any other organization or entity with which the author is affiliated. This content is intended for informational and educational purposes only; it does not constitute professional investment advice, an offer, solicitation, or endorsement of any specific financial strategy, product, or service. The discussion contains the author’s opinions based on publicly available information and should not be interpreted as factual or predictive of future events.

Nothing in this newsletter should be construed as a guarantee of investment results, nor should past performance discussed herein be taken as indicative of future outcomes. Investing involves risks, including the potential loss of principal, and investors should consult their financial adviser or other qualified professional before making investment decisions. Additionally, every effort has been made to ensure an accurate portrayal of market practices and conditions, but the author disclaims responsibility for errors, oversimplifications, or omissions. By publishing this newsletter, the author aims to foster dialogue and education and does not intend to disparage any individual, organization, or investment strategy. Readers are encouraged to consider differing viewpoints and conduct their own research before forming opinions or investment strategies.

“Exigencies are to be expected to occur, in the affairs of nations, in which there will be a necessity for borrowing. That loans in times of public danger, especially from foreign war, are found an indispensable resource, even to the wealthiest of them…On the one hand, the necessity for borrowing in particular emergencies cannot be doubted, so on the other, it is equally evident, that to be able to borrow upon good terms, it is essential that the credit of a nation should be well established.”1

—ALEXANDER HAMILTON, first secretary of the U.S. Treasury

Alexander Hamilton is buried at Trinity Churchyard, which is only two blocks from the New York Stock Exchange.

July 12th marks the tragic passing of Alexander Hamilton. On this day in 1804, Hamilton died from a gunshot wound suffered in a duel with Aaron Burr. His gravestone honors his many contributions to the United States, the most notable of which were his brilliant financial reforms. In 1790, Hamilton nearly single-handedly resurrected the nation’s severely damaged credit by persuading a divided Congress to repay the nation’s war debts; enact modest tariff increases to fund repayment; and provide a firm footing for the U.S. financial system by establishing the nation’s first central bank.

Alexander Hamilton’s financial talents and virtues derived from his ability to gaze far into the future and anticipate challenges that the newly formed nation would likely encounter. Most importantly, he saw that preserving the nation’s ability to borrow on attractive terms would prove essential to its survival. Having barely defeated Great Britain in the Revolutionary War, Hamilton experienced first-hand how nations entering wars with limited credit face long odds of victory. The timing of future threats was unknowable, but Hamilton knew that they lurked on the horizon. Therefore, maintaining abundant debt capacity was essential, which is the principle that he articulated in the opening quote of this newsletter.2

The Secret to Rendering Public Credit Immortal

“Persuaded as the Secretary is, that the proper funding of the present debt, will render it a national blessing: Yet he is so far from acceding to the position, in the latitude in which it is sometimes laid down, that “public debts are public benefits,” a position inviting to prodigality, and liable to dangerous abuse,—that he ardently wishes to see it incorporated, as a fundamental maxim, in the system of public credit of the United States, that the creation of debt should always be accompanied with the means of extinguishment. This he regards as the true secret for rendering public credit immortal.”3

—ALEXANDER HAMILTON, first secretary of the U.S. Treasury

Hamilton’s foresight secured the nation’s survival on multiple occasions over the past 237 years. As he predicted, the U.S. encountered several public dangers, forcing Americans to draw upon their abundant debt capacity to fund effective responses. Notable examples included heavy borrowing during the War of 1812, Civil War, Great Depression, and two World Wars (Figure 1).

Figure 1: Total Gross U.S. Public Debt as a Percentage of GDP (1792-2032E)

Source: Mark J. Higgins, Investing in U.S. Financial History: Understanding the Past to Forecast the Future, (Austin: Greenleaf Book Group, 2024).

For most of its history, the U.S. also adhered to a second Hamiltonian financial principle. After each crisis subsided, the country gradually repaid its debts by running fiscal budget surpluses (Figure 2). This ensured that future generations could confront existential threats with adequate debt capacity. Hamilton considered this principle to be the key to “rendering public credit immortal.”

Figure 2: U.S. Fiscal Deficits and Surpluses (1792-2024)

Sources: Bureau of the Census, Historical Statistics of the United States, 1789-1945 (Washington, DC: U.S. Bureau of the Census, 1949).

Public Credit Reverts to Mere Mortality

“The position of the United States after World War II was entirely abnormal and unsustainable. We came through unscathed. Our industrial power actually strengthened, while our potential competitors were substantially destroyed and needed our help to rebuild themselves…It has been both natural and desirable for others to catch up to us from a very depressed state.”4

—PAUL A. VOLCKER, former chairman of the Federal Reserve Board

The U.S. emerged from World War II as the world’s wealthiest nation. Moreover, while the industrial infrastructures of European and Asian countries lay in ruins, the U.S. “Arsenal of Democracy” had fueled massive expansion of its industrial capacity and sharpened its technological edge. Americans enjoyed an extraordinary period of economic prosperity in the 1950s. Jobs were plentiful, poverty rates fell dramatically, inflation was low, and the middle class thrived. The combination of exceptional wealth and a vastly superior means to produce it explains why many Americans are nostalgic about life in the 1950s.³

The prosperity of the 1950s, however, gave way to chronic fiscal deficits in the 1960s. Politicians tolerated deficit spending, in part, because debt-to-GDP levels had substantially declined as a result of exceptional economic growth and reasonably balanced budgets in the immediate post-World War II years. Reverting back to Figure 1, you can see the dip in debt-to-GDP levels in the 1960s and 1970s.

The problem was that it was never realistic to expect such extreme economic dominance to last indefinitely. European and Asian countries steadily rebuilt their economies, and the wealth and competitive advantages of the U.S. narrowed relative to the rest of the world. Americans’ perceptions of their relative position, however, failed to keep pace. Decade after decade, this emboldened politicians to expand federal spending programs at an unaffordable rate. The most significant expansions involved entitlements, such as Social Security, Medicare, and Medicaid.5

To this day, few Americans have come to terms with the nation’s distorted perceptions of its own wealth. But the ruthless laws of math don’t lie. The data clearly reveal that the U.S. has spent far more than it can afford for more than half a century and has no plan to stop. Figure 3 presents Congressional Budget Office (CBO) data that shows past, current, and projected debt held by the public as a percent of GDP. This is precisely the situation that Alexander Hamilton feared when he advised Congress to establish a formal mechanism for extinguishing the debt after public dangers subside.

Figure 3: Past, Current, and Projected Total Debt Held by the Public to GDP (1962 - 2054)6

Making Unsustainable Deficits Even More Unsustainable

“If now the most classical, hardline president in fifty years [Ronald Reagan] accepts indefinite deferral of a balanced budget who will any longer be inhibited by fear of deficits?”7

—HERB STEIN, economist

After taking office in 1980, President Ronald Reagan announced a bold economic plan. The fiscal component included a combination of tax and spending cuts. The original plan was conceptually sound, but the final legislation deviated from the core principles. Proposed spending cuts were watered down to gain support from various constituencies in Congress, but tax cuts were left relatively intact. This allowed deficit spending to persist. The above quote expresses the frustration of a fiscal conservative regarding the inability of Reagan to end chronic deficit spending. In a rare example of unrelenting bipartisanship, the United States failed to shake this habit over the subsequent 45 years.

On July 4, 2025, President Donald Trump signed the One Big Beautiful Bill Act into law. According to the CBO, the bill is expected to increase the federal debt by another $3.2 trillion over the next 10 years, making an unsustainable situation even more unsustainable.8

The passage of the One Big Beautiful Bill Act is disappointing, but it is hardly an anomaly. For more than 200 years, politicians have rewarded key voting blocs with tax relief, while neglecting the unpleasant task of making painful spending cuts. Congress repeated this mistake in 2025, and it will likely keep repeating it unless a critical mass of Americans demands a return of fiscal responsibility.

Rendering Public Credit Immortal Again

In the 2020s, it appears most Americans remain mired in a deep state of denial. Those who downplay the impending consequences of nearly one hundred years of unsustainable spending can only resort to magical thinking to justify their positions. Some fantasize that perhaps the U.S. can outgrow its debt problems, much like it did in the late 1940s and 1950s. But those times were legitimately different. The industrial infrastructures of many global competitors were wastelands, and several tailwinds (e.g., exceptionally high productivity growth and steady labor force expansion) are now headwinds.9

Others venture deeper down the rabbit hole. The darkest recesses of Wonderland are occupied by proponents of Modern Monetary Theory (MMT), who make the ludicrous and frankly childish claim that the U.S. can run fiscal deficits indefinitely because the nation possesses the world’s dominant reserve currency. This argument may work for a few more years, but nations eventually lose their reserve currency privileges once the world stops viewing them as a risk worth taking. The Dutch suffered this fate in the late 1700s, and the British suffered it in the mid-1900s. The U.S. has no special immunity to this outcome.

The only realistic option for Americans is to re-embrace Hamiltonian financial principles and make painful sacrifices to rescue the public credit from its descent into mortality. This requires Americans to collectively relinquish claims that satisfy their present wants (as well as many needs) so that the nation’s children can afford the bare essentials. The consequences of voluntary action would be very painful but ultimately survivable. Inaction, on the other hand, may offer short-term relief, but when the day of reckoning arrives, the consequences would be far more severe. If current generations of Americans live to see such a day, they will discover that fate cares nothing for the magical thinking that currently shields them from feeling the shame of irresponsibility.

Hopefully, Americans find the will to resurrect Alexander Hamilton’s spirit, sacrifice in ways that many believe are beneath them, and restore the immortality of the public credit. Only then will current generations gain the right to claim they rose to the occasion and returned the financial resources that were unjustly pilfered from their progeny. Such an achievement would be worthy of praise from Alexander Hamilton. He dedicated and ultimately sacrificed his life to create a rock-solid financial foundation upon which the United States of America now rests. By restoring the immortality of public credit, perhaps we will allow his spirit to rest in peace once again.

Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are not guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.

“In the history of every great catastrophe, you will find some masterly bit of stupidity set fire to the oil-soaked rags.”

—EDWIN LEFEVRE, author of Reminiscences of a Stock Operator

This morning, the acclaimed journalist, Jason Zweig, published an article in the Wall Street Journal revealing disturbing behavior on the part of Hamilton Lane management. Astute analysis by Tim McGlinn, owner of The AltView, was critical to the story. I encourage everybody to read the article and follow Tim on LinkedIn.

The first revelation in Zweig’s article was Hamilton Lane’s use of a valuation methodology that enabled the Hamilton Lane Private Assets Fund to record generous mark ups on secondary investments—often within days of purchasing them.1 This practice is roughly equivalent to paying $1 million for a house, immediately marking it up to $1.25 million based on the last Zillow estimate, and then bragging to your friends that you just made a 25% profit overnight. These markups help explain the lofty and surprisingly stable returns of the Hamilton Lane Private Assets Fund since its inception in September 2020. The technique is especially concerning because there is compelling evidence that private equity fund NAVs have been overstated by GPs over the past several years.2

Needless to say, the Hamilton Lane Private Assets Fund’s hard-to-believe track record has attracted several billion dollars of fresh capital from investors over the past several years. But apparently management was unsatisfied with a 1.40% annual management fee on the fund’s $3.9 billion of AuM.3 In March 2025, Hamilton Lane sweetened their deal by somehow persuading shareholders to waive the 8% preferred return hurdle and then fork over a massive $58 million payment by permitting the distribution of incentive fees on unrealized gains.45 A substantial portion of the unrealized gains was based on the previously described mark ups. It is hard to imagine why a shareholder would vote for this change. Whatever the reason, the decision to treat investors in this manner constitutes the “masterly bit of stupidity,” (not to mention greed), that attracted Tim McGlinn’s and Jason Zweig’s attention.

Private Markets and Late-Stage Speculative Episodes

Zweig’s article was unnerving but hardly surprising. This kind of behavior is typical in the late stage of a speculative cycle, and the U.S. has experienced many over the past 235 years. The first one occurred in 1791 when frenzied traders speculated in “scrip” granting them options to purchase shares in the initial public offering of stock in the First Bank of the United States. Fortunately, Alexander Hamilton’s brilliant financial instincts prevented a catastrophe. Americans have since experienced many more manias and crashes. Each one seemed unique in the moment, but when evaluated over the span of several centuries, a familiar pattern emerges. In 2025, there are clear signs that the pattern has repeated in private markets, and it has now entered the dangerous late stage.

So, how did this happen? Private markets, which include investments such as venture capital, buyouts, real estate, hedge funds, and private credit, were all the rage among institutional investment plans over the past two decades.6 Mesmerized by the exceptional returns of the Yale University Endowment at the turn of the twenty-first century, trustees began shoveling substantial amounts of capital into these markets. Multiple red flags steadily emerged, but they were largely hidden by the slow passage of time. Now, it appears the check for collective complacency is coming due. It is a tragic irony that a company unworthy of bearing Alexander Hamilton’s name may be the proverbial canary in the coal mine alerting investors to the danger.

The remainder of this newsletter reveals seven red flags which strongly suggest that private markets are in the late stage of a classic speculative cycle. At best, this means they are severely overvalued; at worst, it means that at least some segments may qualify as a bubble.

Private Markets Red Flags

🚩 Widespread Acceptance of a Flawed Narrative

🚩 Presence of a Complacent and Siloed Supply Chain

🚩 Large and Increasingly Indiscriminate Capital Inflows

🚩 Unbalanced Media Coverage

🚩 Stealthy Exit of Smart Money

🚩 Aggressive Sales to Retail Investors

🚩 Sudden Loss of Confidence in the Narrative

This newsletter is mainly written for the benefit of retail investors. I fear it will be of limited use to institutional investment plans, as most have already thoroughly polluted their portfolios with private investments. Retail investors, however, are just now being lured into the quagmire. They would be wise to resist temptation. Even if private markets are not outright bubbles, the sheer volume of excess capital all but assures that the vast majority of investors will be unrewarded for the exorbitant fees and hidden risks.

🚩 Red Flag #1: Widespread Acceptance of a Flawed Narrative

“There is no national price bubble [in real estate]. Never has been; never will be.”

—DAVID LEREAH, chief economist of the National Association of Realtors

Beneath the foundations of history’s worst bubbles were widely accepted narratives that ultimately proved to be dead wrong. In the 1810s, American farmers believed that wheat and cotton prices would remain at astronomical levels for many years. In the late 1920s, Wall Street speculators believed that using short-term debt to purchase stocks was safe because the markets would never experience a sustained decline. In the late 1990s, Americans believed that any company with a “.com” placed after its name offered a sure path to riches. In the early 2000s, Americans believed that real estate prices would never decline on a national level.

In the 2020s, it seems almost every institutional and individual investor believes that private markets offer a foolproof way to enhance returns and/or reduce portfolio risk. Few question the validity of this narrative despite mounting evidence that not only is it unlikely to be true in the future, but there is also strong evidence that it failed to materialize in the past.7 Even more frighteningly, to this day, it is nearly impossible to find anybody who contemplates the possibility that private markets are susceptible to bubbles.

A paradox of investing is that speculative excesses happen only when the vast majority of investors believe they can’t happen. It is reminiscent of a famous scene in the movie The Usual Suspects, when a shadowy villain Keyser Söze explained how the myth of his existence enabled him to achieve maximum surprise. After completing his crime spree, Söze ended the movie by declaring, “the greatest trick the devil ever pulled was convincing the world he didn’t exist.” Speculative episodes thrive under similar conditions.

🚩 Red Flag #2: Presence of a Complacent and Siloed Supply Chain

“What are the odds that people will make smart decisions about money if they don’t need to make smart decisions—if they can get rich making dumb decisions?”8

—MICHAEL LEWIS, author of The Big Short

A few years before the Global Financial Crisis (GFC) of 2007-2009, a handful of investors, such as Mike Burry and Steve Eisman, placed large bets on the potential collapse of securities tied to the real estate market. In the book, The Big Short, they were portrayed as geniuses—and, to be clear, they deserve a lot of credit for their investment acumen—but the most important factor driving their success was not sufficiently explained. The real estate bubble in the early 2000s was extremely difficult to detect because it was visible only to a small handful of people who understood each segment of the real estate and mortgage-backed security supply chain. Even the most vocal real estate skeptics usually failed to appreciate the full scale of the problem because they only understood a few segments.

People like Mike Burry and Steve Eisman were exceptions. They saw how individuals with no real estate experience were using massive amounts of debt to indiscriminately buy properties with the sole intention of flipping them for a quick profit. They saw how mortgage lenders were motivated only by sales volume, which led them to issue loans with little regard for the borrower’s ability to pay. They saw how investment banks purchased and repackaged these loans into risky products that were nevertheless rated triple-A. Finally, they saw how lax ratings agencies, specialized insurers, GSEs, and the financial media reinforced the faulty narrative, giving speculators a false sense of security. The figure below from Investing in U.S. Financial History shows how this supply chain worked.

Source: Investing in U.S. Financial History: Understanding the Past to Forecast the Future (February 2024).

On the surface, the supply chain in private markets looks quite different, but it is similar in the sense that each segment adds incremental risk, and few investors appreciate how these risks compound as products move along the assembly line. Moreover, participants in the supply chain are so hyper-focused on extracting value from their particular segment that they have little care for the risks embedded in the products that pop out at the end.

Several private markets skeptics with whom I have spoken place inordinate blame on the proverbial wolves of Wall Street, which largely consist of private fund managers. I respectfully disagree, but only because, while I acknowledge that the wolves of Wall Street tend to behave like insatiable gluttons, this makes them highly predictable. Like a pet dog, if you keep feeding them, they will keep eating until they vomit all over the house. The trick is to stop feeding them before they overeat.

This is why I believe the more insidious link in the private markets supply chain consists of investment consulting firms and investment plan staff members. For more than twenty years, they have encouraged trustees to continuously increase allocations well beyond a point that made sense. Their recommendations were often driven by dubious return assumptions, embarrassingly light due diligence, and the presence of an unstated conflict of interest that biases their recommendations toward serving their business interests and career aspirations. Moreover, neither consulting firms nor plan staff receive much attention from regulatory authorities.9 These were important points in a recent presentation I delivered at the CFA Institute’s CFA Institute Live 2025 conference in Chicago. It can be downloaded for free in this LinkedIn post, and the dynamic was discussed further in my interview with Lotta Moberg, PhD, CFA on the CFA Institute’s Enterprising Investor podcast on May 5, 2025. The graphic below shows the institutional investment plan supply chain, highlighting the particularly damaging role of investment consultants and investment plan staff.

🚩 Red Flag #3: Large and Increasingly Indiscriminate Capital Inflows

“‘An Aristocracy of Successful Investors’ advertised a new guide to investment. The headline read: “He made $70,000 after reading, “Beating the Stock Market.” No doubt whoever it was did. He might have made it without reading the volume or without being able to read.”

—JOHN KENNETH GALBRAITH, author of The Great Crash 1929

Fundamentally, an asset bubble is nothing more than a colossal imbalance of supply and demand. The resulting scarcity of attractive investment opportunities causes prices of sound investments to rise to unattractive levels and compels fund managers to allocate the excess to unworthy investments and/or outright frauds. Eventually, a critical mass of investors awakes to this reality, capital flows reverse, and the speculative cycle ends with a crash.

The flood of capital into private markets has now persisted for more than two decades. It began soon after the late CIO of the Yale Investments Office, David Swensen, published Pioneering Portfolio Management in 2000. Followers assumed they could improve their performance by bluntly allocating to alternative asset classes. Few paused to consider the fact that Swensen was both uniquely talented and early to enter these markets. Replicating his performance was never likely for the masses. Nevertheless, by 2010, AuM in key private markets was increasing at more than 10% per year. Figure 1 shows total AuM of three major private markets (private equity, hedge funds, and private credit). Figure 2 shows the rapid growth of public pension plan allocations, which was a significant driver of AuM growth.

Figure 1: Private Equity, Hedge Fund, and Private Credit AuM ($Billions)
(2010-2024)

Source: Prequin.

Figure 2: Average Public Pension Plan Allocation to Alternative Investments (%) (2001-2023)

Sources: Equable (2024).

🚩 Red Flag #4: Unbalanced Media Coverage

“You have to throw out all of the matrices and formulas and texts that existed before the Web. You have to throw them away because they can’t make money for you anymore, and that is all that matters. We don’t use price-to-earnings multiples anymore…If we talk about price-to-book, we have already gone astray. If we use any of what Graham and Dodd teach us, we wouldn’t have a dime under management.”

—JIM CRAMER, host of Mad Money (February 29, 2000)10

The worst speculative episodes in U.S. history were amplified by the media. In 1928 and 1929, it was rare to see journalists challenge the legitimacy of the Great Bull Market. In fact, when the businessman and economist, Roger Babson, presciently predicted the Great Crash of 1929 less than two months before it arrived, he was almost universally dismissed by journalists. A similar phenomenon occurred in the late 1990s. It was rare to find journalists willing to challenge the use of senseless metrics, such as user growth, to rationalize ridiculous dot-com stock valuations. It also happened during the real estate bubble in the early 2000s, as few journalists challenged the easily disprovable narrative that U.S. real estate prices have never declined on a national level.11

In 2025, it is rare to find anybody in the financial media who questions the merits of investing in private markets or is even willing to entertain the possibility of a bubble. This is precisely the type of groupthink that adds momentum to speculative cycles.

Source: “Financial Markets.” The New York Times. (September 9, 1929), 34.

Red Flag #5: Stealthy Flight of Smart Money

“Once a majority of players adopts a heretofore contrarian position, the minority view becomes the widely held perspective. Only an unusual few consistently take positions truly at odds with conventional wisdom.”

—DAVID SWENSEN, late CIO of the Yale Investments Office

In 1928 and 1929, a handful of astute investors, such as Bernard Baruch, Joseph Kennedy, and Charles Merrill, sensed the market had become completely detached from reality, and they sold the majority of their holdings in U.S. stocks. But if they dared to share their opinions, they were subjected to ruthless ridicule. In fact, Charles Merrill was so disturbed by the criticism that he feared he had lost his mind. In 1928, it took multiple visits to a psychiatrist before he regained confidence in his sanity. Of course, when the October 1929 crash arrived, Merrill, Baruch, and Kennedy were vindicated, but it was tough going in the meanwhile.12

On April 17, 2025, Secondaries Investor reported that the Yale Investments Office was exploring the sale of up to $6 billion in private equity investments, which would constitute roughly 30% of Yale’s total holdings in private markets. Secondaries Investor also stated that this transaction would constitute the endowment’s first known secondary sale. Yale confirmed the potential sale, but refused to specify the target amount. But, sure enough, on June 5, 2025, Bloomberg reported that Yale was nearing a deal to close a sale of $2.5 billion of its venture capital portfolio.13

Some people argue that Yale’s potential sale of private equity holdings is merely a response to the Trump Administration’s aggressive funding cuts for Ivy League institutions. This may be true, but my suspicion is that it is only a minor part of the story. Yale pioneered investments in private markets in the 1980s, but capital was in short supply and attractive opportunities were more plentiful at the time. The opposite is true in 2025. The Yale Investments Office is widely regarded as one of the more astute investors, which makes it plausible that their proposed sale of private equity is a dash for the exit.

Red Flag #6: Aggressive Sales to Retail Investors

“The most notable piece of speculative architecture of the late 20s, and the one by which, more than any other device, the public demand for common stocks were satisfied, was the investment trust or company.”

—JOHN KENNETH GALBRAITH, author of the Great Crash 1929

For most of the 1800s, the U.S. relied on foreign capital to fund the building of critical infrastructure and commercialization of innovation. Americans certainly benefitted, but foreign investors often suffered from a pernicious and repetitive cycle. It would begin with the introduction of an innovation, such as canals, steamships, and railroads. Foreign investors would enthusiastically flood the market with capital, which eventually resulted in massive overbuilding. The market would eventually crash, and foreigners would then indiscriminately sell their securities for a fraction of their cost. At that point, astute American investors would repurchase shares in the few sound companies that remained, which enabled them to own the infrastructure that was built on somebody else’s dime.

This phenomenon ended in the early 1900s when the U.S. began running large budget surpluses. Foreigners lacked sufficient capital to meet America’s needs, which compelled the wolves of Wall Street to begin targeting their own. From that moment forward, it became common for speculative cycles to end after Wall Street firms exhausted the funds of the last and most vulnerable cohort of capital providers: retail investors. Starting in the 1920s, the most common vehicle used to extract capital from retail investors was the investment company, which is now more commonly referred to as a mutual fund or 40-Act fund.

Over the past twenty five years, private markets were largely reserved for institutional investment plans and ultra high net worth investors. But as is always the case in speculative cycles, overly enthusiastic investors eventually flooded the market with excess capital. The classic cycle of overbuilding and malinvestment ensued. According to a June 2, 2025 article published in the Wall Street Journal, a backlog of approximately 30,000 companies now sits on the balance sheets of private equity firms. The prospect of exiting these investments at acceptable prices is daunting.14

Over-allocated institutional investment plans and private fund managers are now desperately seeking exits, which helps explain their sudden interest in bringing private markets to retail investors. Once again, a vehicle of choice is the 40-Act fund. Heavy marketing to retail investors has led to massive inflows into evergreen funds with fancy names, such as interval funds and continuation funds (see Figure 3).

Rather than explaining the mechanics of each type of evergreen fund, it is easier to describe what most of them likely contain: the funds that private fund managers either can’t sell and/or institutional investors can no longer bear to look at. But, if this is the case, how is it that many newly minted 40-Act funds are advertising lofty returns that are eerily stable? Well, if the performance seems too good to be true, perhaps it is too good to be true. This brings us to the final and most disturbing red flag.

Figure 3: Growth of Evergreen Funds ($ Billions) (2015-2025est)

Sources: Pitchbook, CapGemini World Report Series 2024 (January 2025), Hamilton Lane.

Red Flag #7: Sudden Loss of Confidence in the Narrative

“Human nature being what it is, small loopholes are likely to be exploited until they become big ones, and big ones until they turn into financial disasters.”

—SETH KLARMAN, owner of Baupost Group

Speculative cycles end when a critical mass of investors suddenly loses faith in the flawed narrative on which it was based. This was a factor in the late 1920s when speculators failed to realize that corporate earnings were being padded by interest earnings on call loans that the companies issued to speculators, who then turned around and used the loans to purchase stock in the very same companies that issued them. When the Great Depression began, demand for call loans dried up, and companies suffered from lower demand for their products and the evaporation of interest income on call loans.

This dynamic is what makes the valuation and compensation practices at Hamilton Lane especially unnerving. Many investors were likely drawn to the fund because of its impressive track record, but Zweig’s article raises serious questions as to whether Hamilton Lane grossly overestimated the value of the underlying investments and the corresponding returns. Even more concerning is the fact that Hamilton Lane is not the only fund manager to make liberal use of this alleged loophole. In a previous Wall Street Journal article, Jonathan Weil revealed that StepStone used the same tactic.15 It would be unsurprising if journalists discover that many more funds are employing similar practices. Moreover, it is quite conceivable that pension funds, foundations, endowments, and family offices are employing it as well. This may call into question the quality of their reported returns and the real value of their portfolios. In other words, it is quite possible that Zweig’s article is the proverbial canary in the coal mine that signals the presence of a much graver hazard.

Concluding Thoughts: This is the Place to Stop the Trouble

“It is easy enough to burst a bubble. To incise it with a needle so that it subsides gradually is an operation of undoubted delicacy.”

—JOHN KENNETH GALBRAITH, author of the Great Crash 1929

On October 22, 1907, the Panic of 1907 was in full force. A bank run had taken down the Knickerbocker Trust; depositors were lining up at banks and trusts throughout the city; and it appeared the Trust Company of America would be the next institution to fall. J. Pierpont Morgan hastily assembled his top lieutenants, and they concluded that, if not for the bank runs, the Trust Company of America was solvent. Morgan immediately convened the CEOs of the leading trusts, and by the next morning they had orchestrated a rescue. It was later revealed that after concluding the analysis of the Trust Company’s balance sheet, Morgan stated “This is the place to stop the trouble, then.”

Source: “Aid Trust Co. of America.” The New York Times. (October 23, 1907), 1.

Researching the 235-year financial history of the U.S. taught me to never ignore the red flags that typically signal the approaching end of a speculative cycle. Over the past few years, I have often pondered whether a loud enough voice of reason in 1927, 1997, or 2003 could have prevented the subsequent bubbles and corresponding crashes.

In 2025, it is uncertain whether the flood of capital in private markets qualifies as a bubble, but after considering all the red flags, it would be wise to assume that it does. At a minimum, the excess supply of capital—not to mention the obscenely high fees—will prevent the vast majority of investors from generating attractive returns. This makes the cost of avoiding this purported “opportunity” negligible compared to the danger of participating in it. People need to understand the true purpose of the toll-laden bridges leading to private markets. They are escape routes for overindulgent investors who are desperately seeking a way out. Retail investors would be wise to learn from the mistakes of their predecessors and run from these bridges. If they do, they can record a true rarity in the annals of financial history by forcing complacent investment consultants, investment advisors, investment plan staff, and fund managers to suffer the full consequences of the mess they created.

I hope this newsletter helps counteract what, by all measures, seems like yet another episode of irrational exuberance. But even if it fails to persuade most investors to avoid private markets, perhaps it will spare a few. On this point, I turn to Charles Merrill for inspiration. He couldn’t stop the Great Crash of 1929, but he spared at least one person’s fortune. After his final office visit, Merrill’s psychiatrist proudly revealed multiple brokerage statements proving that he had sold all of his stock. He then explained, “Mr. Merrill, you are so crazy that I want to show you I have not a single share of stock in my accounts.” By following Merrill’s advice, his psychiatrist entered the Great Depression with abundant reserves. Perhaps this newsletter will offer similar protection to somebody today.16

Purchase Investing in U.S. Financial History

Investing in U.S. Financial History is available in hardcover, audiobook, and eBook formats. Please note, however, that the eBook version was published in fixed format layout to ensure that graphics are more easily viewed. The eBook is ONLY intended to be read on large screens, such as tablets, laptops, or desktop computers.

Disclaimer: This is a personal newsletter written by Mark Higgins, CFA, CFP, in his individual capacity. The views expressed herein are solely those of the author and do not necessarily reflect the views, opinions, or practices of IFA or any other organization or entity with which the author is affiliated. This content is intended for informational and educational purposes only; it does not constitute professional investment advice, an offer, solicitation, or endorsement of any specific financial strategy, product, or service. The discussion contains the author’s opinions based on publicly available information and should not be interpreted as factual or predictive of future events.

Nothing in this newsletter should be construed as a guarantee of investment results, nor should past performance discussed herein be taken as indicative of future outcomes. Investing involves risks, including the potential loss of principal, and investors should consult their financial adviser or other qualified professional before making investment decisions. Additionally, every effort has been made to ensure an accurate portrayal of market practices and conditions, but the author disclaims responsibility for errors, oversimplifications, or omissions. By publishing this newsletter, the author aims to foster dialogue and education and does not intend to disparage any individual, organization, or investment strategy. Readers are encouraged to consider differing viewpoints and conduct their own research before forming opinions or investment strategies.

“For practical purposes, the financial memory should be assumed to last, at a maximum, no more than twenty years. This is normally the time it takes for the recollection of one disaster to be erased and for some variant on previous dementia to come forward to capture the financial mind.1

—JOHN KENNETH GALBRAITH

Over the past year, I had the privilege of making many guest appearances on podcasts to discuss how to use the lessons of financial history to explain current economic events. Among my favorites was a podcast with Russell Napier, who is the keeper of the Library of Mistakes in Edinburgh, UK. The Library offers several educational programs and maintains a vast collection of financial and economic history books. Its core mission is to continuously refresh the public’s collective memory of lessons learned from past financial traumas, and thereby reduce the probability of repeating them. Tragically, instinct still compels many people to ignore these lessons and, instead, learn by suffering the painful consequences of repeating them. Several financial mistakes affecting the world today fit squarely in this category.

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This newsletter focuses on three big mistakes in the United States. All three were preventable if policymakers had heeded the lessons of history. Interestingly, unlike most financial mistakes, these three originated in Washington, DC rather than Wall Street. The first mistake was the Federal Reserve’s premature pivot to more accommodative monetary policy in September 2024. The second was the Trump Administration’s needless initiation of a global trade war on April 2, 2025. The third is the continued failure of the U.S. Congress to deal with chronic, unsustainable spending—especially on entitlement programs. In combination, these mistakes have caused unnecessary price instability, dangerous turmoil in financial markets, costly damage to international relations, and intensifying political polarization within the nation’s borders.

The good news is that the United States is no stranger to dark comedies, and it has an impressive track record of moving past them. The bad news is that the path is always painful and messy. Many people suffer during such periods, and the dark comedy of the 2020s is unlikely to be an exception.

Mistake #1: Failure to Learn from the Great Inflation

“American policymakers tend to see merit in a gradualist approach because it promises a return of general price stability—perhaps with a delay of five or more years but without requiring significant sacrifice on the part of workers or their employers. But the very caution that leads politically to a policy of gradualism may lead also to premature suspension or abandonment in actual practice.”2

—ARTHUR BURNS, former chairman of the Federal Reserve Board

In August 2021, I published a paper on SSRN, entitled “Investors Can Temper Their Inflation Fears: Post-COVID Inflation is Unlikely to Resemble the Great Inflation of 1968 to 1982.” I argued that Post-COVID-19 inflation was unlikely to rise as high or last as long as it did during the Great Inflation of 1965 to 1982.3 Instead, I argued that it was more likely to resemble the Post World War I/Great Influenza inflation of 1919-1920, which lasted approximately two years. My thesis was contingent upon the belief that the Federal Reserve Board would avoid repeating the monetary policy errors that their predecessors made in the late 1960s and 1970s.

Unfortunately, the Fed’s actions over the past nine months revealed that this assumption was wrong. Despite a relatively strong economy and resilient labor market, on September 18, 2024, the FOMC pivoted to a more accommodative monetary policy by announcing a 50-basis point cut to the federal funds rate. Then, the FOMC followed with two additional 25 basis point cuts in November and December, respectively. With unemployment hovering around 4%, the Fed had clearly prioritized the employment side of their mandate at the expense of price stability. Concerned that the Fed was moving too soon and too fast, I published several newsletters warning that their actions would likely cause inflation to reignite.4

What was most disappointing about the Fed’s shift in policy was that the decision was not merely a function of unconscious bias. Discussions at a recent meeting of the Fed’s Shadow Open Market Committee (SOMC) revealed that the FOMC had intentionally prioritized the employment mandate. Former President of the Federal Reserve Bank of Richmond and member of the SOMC, Jeffrey Lacker, revealed this in an April 8, 2025 interview with Kathleen Hays on Central Bank Central. Specifically, Lacker recounted how the Federal Reserve symbolically expressed a bias toward full employment by intentionally moving the paragraph describing the Fed’s employment mandate ahead of the paragraph describing the inflation mandate in the 2020 revision of its policy framework statement (see the excerpt below). This almost certainly reinforced the Fed’s bias toward prioritizing full employment over price stability for the past five years. It also makes it less surprising—but no less disappointing—that the FOMC pivoted toward more accommodative monetary policy in September 2024 despite the fact that the labor market remained strong and inflation remained well above the 2% target.

Federal Reserve’s 2020 Revision to its Statement on Longer-Run and Monetary Policy Strategy

Source: Board of Governors of the Federal Reserve System. (August 27, 2020).

Inflationary Pressures Reappear in 2025

In early 2025, the fear that inflation could reignite—or at least remain sticky—was validated. Trailing 12-month CPI metrics for January and February 2025 were stronger than anticipated and remained well above the Fed’s target of 2%. Meanwhile, labor markets remained tight, with unemployment still hovering around 4%.

As if the CPI reports were not worrisome enough, the newly elected President Donald J. Trump soon fanned the inflationary flames by announcing aggressive tariff policies. This began almost immediately after the inauguration when President Trump announced plans to enact tariffs on Canada and Mexico. Over the next two and half months, President Trump expanded the list of affected countries and substantially increased tariff rates. The rapid escalation culminated in an announcement of sweeping tariffs affecting the entire world on April 2, 2025. The shocking announcement prompted major disruptions in global securities markets, while the expectation of higher prices caused consumer confidence to plummet and inflation expectations to rise. Figure 1 shows the rise of inflation expectations according to a survey administered by the University of Michigan (right axis), as well as the federal funds rate over the past 12 months (left axis) . While it is too early to predict how Trump’s policies will evolve and impact price stability over the next several months, the sharp increase in inflation expectations over the past two months is a bad omen.5

Figure 1: University of Michigan 5-Year Inflation Expectations (May 2024 - April 2025)

Source: University of Michigan

In summary, Trump’s tariff policies and the resultant trade war have compounded the Federal Reserve’s previous errors. That said, the effects of Trump’s tariffs on the global economy and international relations are far more concerning. These risks lie at the heart of the second mistake.

Mistake #2: Failure to Learn from the Great Depression

“For Japan, the year begins with the Manchurian occupation a complete success as a military measure, but with new problems at home...A combination of circumstances which included an adverse trade balance, the precipitous fall in the price of silver, and the withdrawal of foreign trade credits forced Japan to abandon the gold standard in December…Events of the next few months will presumably show whether 1932 is to be a year of reconciliation between these neighbors in the East or a year of economic warfare.”6

—THE NEW YORK TIMES (January 2, 1932)

Part 4 of Investing in U.S. Financial History is entitled “The Great Depression and Global Destabilization.” It begins with the deepening of the economic depression after the Great Crash of 1929 and ends with the surrender of Japan to Allied forces on September 2, 1945. The most important insight from Part 4 is that World War II likely would not have occurred if not for the Great Depression. Moreover, the Great Depression likely would not have occurred if not for short-sighted monetary, fiscal, and trade policies implemented by government policymakers throughout the world.

Source: The New York Times (January 2, 1932).

In the United States, the most significant error was the Federal Reserve’s failure to stop the spread of bank runs and subsequent collapse of the banking system in the early 1930s. A close second, however, was the ill-advised passage of the Smoot-Hawley Tariff Act, which President Herbert Hoover signed into law on June 17, 1930.7 The Act substantially raised tariffs on a variety of imports in an attempt to increase domestic production and reduce unemployment. History proved that the Smoot-Hawley Act failed to achieve these objectives. Instead, it triggered a series of retaliatory tariffs from trading partners and also inspired trading partners to erect new trade barriers with each other. These policies became known as “beggar-thy-neighbor” trade policies. Over the course of several years, they caused a dramatic reduction of global trade, thereby intensifying the effects of the Great Depression on all nations—including the United States.

The combined impact of the Great Depression and beggar-thy-neighbor trade policies were especially devastating in Germany and Japan. In the late 1920s, the Nazi party was relegated to the fringe of German politics, and it appeared it would soon fade into oblivion. But, Hitler effectively channeled the misery of the Great Depression and lingering bitterness over Germany’s treatment by the Allied Powers after World War I to revitalize the Nazi movement and establish himself as the dictator of the Third Reich. In Japan, the effects were even more pronounced. Starved of natural resources by the Depression and collapse of global trade, the Empire of Japan began a brutal campaign of colonization in Manchuria, China, and Southeast Asia. Fearful of Japan’s colonial expansion and brutal treatment of native populations, on August 1, 1941, the United States enacted an oil embargo, thereby depriving Japan of 80% of its oil imports. Left with a three-year supply of oil and having failed to negotiate a settlement with the United States, the Empire of Japan attacked Pearl Harbor on December 7, 1941, thus drawing the United States into World War II.

The Danger of Trump’s Trade War

On April 2, 2025, the Trump Administration announced a sweeping array of tariffs affecting more than 180 countries. The tariffs were far higher than what nearly every economist anticipated, in part, because they were based on an inane formula allegedly concocted by the Trump Administration’s trade advisor, Peter Navarro. The formula was based only on the level of trade deficits rather than the presence of actual trade barriers. In effect, the actions by the Trump Administration constituted an opening salvo in an economic war on the world. Several nations responded with reciprocal tariffs, and the 1930s-like, tit-for-tat escalation intensified.

Investors predictably responded negatively to the escalating rhetoric. Global equity markets suffered double-digit declines within a matter of days. But, the far graver concern was a simultaneous sell-off of Treasury securities, which normally experience elevated demand when equity markets decline sharply. Faced with a growing panic among equity investors and potential deterioration of confidence in U.S. Treasuries, the Trump Administration announced a 90-day pause on most tariffs on April 9, 2025.

As of April 15, it remains unclear how the trade war will proceed. Will the Trump Administration settle for modest tariffs, which are unlikely to trigger a full blown trade war? Or will they challenge the world to a trade war by erecting far higher trade barriers? If the answer is the former, there is ample time for the United States to turn away from the abyss. If the answer is the latter, the world may be forced to learn a lesson by experiencing pain and suffering that few alive today have witnessed.

The good news is that the potential consequences of a global trade war are well-known and well-documented. The bad news is that government policymakers are prone to choose a path of needless repetition rather than prudent avoidance. Only time will tell which path the Trump Administration will choose.

Mistake #3: Failure to Immortalize the Wisdom of Alexander Hamilton

“He [Alexander Hamilton] ardently wishes to see it incorporated, as a fundamental maxim, in the system of public credit of the United States, that the creation of debt should always be accompanied with the means of extinguishment. This he regards as the true secret for rendering public credit immortal.”8

—ALEXANDER HAMILTON (January 9, 1790)

In the Spring 2025 issue of the Museum of American Finance’s Financial History magazine, I am publishing an article entitled “Short-Term Gains and Long-Term Pain: The History of U.S. Entitlements.” It explains how entitlement programs have gradually evolved and massively expanded over the past 235 years. The most rapid period of expansion occurred during the decades immediately following World War II. This was largely because Americans enjoyed an anomalous period of extraordinary wealth, which emboldened them to demand more from the government with each passing year. Even to this day, few Americans understand that the relative abundance of the 1950s was never destined to last. For more detail on this misperception, I encourage you to read a previous post, entitled “The Phantom Menace: Inflated Expectations.”

The Abandoned Principles of Alexander Hamilton

In 1790, the United States was effectively bankrupt. Many states had defaulted on bonds issued to fund the Revolutionary War, and in extreme cases, some states even failed to fully compensate veterans for their service in the war. President George Washington appointed Alexander Hamilton to serve as the nation’s first secretary of the Treasury and restore the nation’s impaired credit. Hamilton proceeded to consolidate the war debt of the states under the federal government and selectively raise tariffs to ensure adequate coverage of interest and principal payments.9 He also articulated two fundamental principles regarding the use of public debt in his First Report on the Public Credit. The first was that it should be used primarily to address public dangers, especially foreign wars. The second—which is expressed in the above quote—was that the debt should be extinguished when the danger subsided. In combination, the application of Hamilton’s programs and principles repaired the nation’s credit in 1790 and established a solid foundation for future economic growth.

The United States largely abided by Hamiltonian principles for roughly 150 years, But by the end of the 1950s, these principles seemed all but forgotten. The federal government began running fiscal deficits regardless of whether public dangers existed, and it has continued running deficits in almost every year since (Figure 2). Now, mounting debt levels, combined with substantially larger deficits in the aftermath of the COVID-19 pandemic, have prompted a debt reckoning in the United States. Yet, even to this day, few politicians dare acknowledge that the primary driver of the nation’s fiscal imbalance is unsustainable spending on entitlement programs. The inconvenient truth, however, is that it is mathematically impossible for the United States to restore its fiscal health without making material changes to these programs. Doing so will require broad sacrifice from U.S. citizens. This will feel unfair to most, if not all, Americans called upon to sacrifice. Nevertheless, failure to act will prevent future generations from enjoying the same benefits and protections that current generations take for granted.

Figure 2: U.S. Federal Budget Deficits as Percent of GDP (1792-2023)

Source: Bureau of the Census, Historical Statistics of the United States, 1789-1945 (Washington, DC: U.S. Bureau of the Census, 1949).

Final Thoughts

The United States faces serious challenges in 2025. Persistent inflation, a damaging trade war, and chronic overspending are not easy problems to solve. Moreover, these challenges interact in ways that make each one even more difficult to surmount. For example, the Trump tariffs are designed to correct the perceived unfairness of the nation’s trade deficits. One of the major contributors to the nation’s trade deficits is the low rate of savings among Americans. At least in part, the incentive for Americans to save is weakened by the massive expansion of entitlement programs over the past 75 years.

Fortunately, there is good news as well. The truth is that Americans have confronted and overcome many challenges that seemed insurmountable in the past. This is because the United States is populated by enough people who possess the courage to confront intractable problems and creativity to design innovative solutions that stretch the limits of human imagination. The United States almost certainly faces many difficult years ahead, but history strongly suggests that the nation’s knack for solving the most vexing problems is also likely to repeat.

Purchase Investing in U.S. Financial History

Investing in U.S. Financial History is available in hardcover, audiobook, and eBook formats. Please note, however, that the eBook version was published in fixed format layout to ensure that graphics are more easily viewed. The eBook is ONLY intended to be read on large screens, such as tablets, laptops, or desktop computers.

Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.

“Credit, public and private, is of the greatest consequence to every country. Of this it might be emphatically called the invigorating principle. No well informed man can cast a retrospective eye over the progress of the United States, from their infancy to the present period, without being convinced they owe, in a great degree, to the fostering influence of credit, their present mature growth.”1

—ALEXANDER HAMILTON, U.S. Secretary of the Treasury

Investing in U.S. Financial History: Understanding the Past to Forecast the Future was published exactly one year ago today. The objective was to provide a reference to educate investors, government policy makers, journalists, members of academia, students, and curious individuals on the key financial, economic, and investment principles that have shaped the more than 230-year history of the United States of America. Although the book focuses primarily on the United States, many lessons are equally useful to citizens of foreign nations. In fact, many of the most thrilling experiences I have had over the past year involved discussions with people who reside beyond this nation’s borders.

Investing in U.S. Financial History is also a living reference. I intend to update it every three or four years, and when the story outlives me, I will pass the baton to a successor. Finally, I will continue expanding on many of the concepts in the book by publishing articles in this newsletter, as well as various media outlets, such as the Museum of American Finance’s Financial History magazine and the CFA Institute’s Enterprising Investor. To that point, the remainder of this newsletter highlights three chapters that are especially relevant today.

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Placing the Present into Context

Over the past two years, I spoke with many podcasters, academics, and journalists about the important lessons from financial history. Quite a few commented that the publication of the book was perfectly timed because the lessons were never more important than they are in the 2020s. The truth, however, is that there are always historical precedents that can help demystify current events. The question, therefore, is usually which chapter of Investing in U.S. Financial History to reference rather than whether a relevant chapter exists. Today, three chapters stand out as especially relevant. Two are included as attachments to this newsletter, but one requires you to purchase the book. The password to view the attachments is Fiduciary_duty1

Chapter 1: Overdue Credit to America’s Financial Founding Father

“Persuaded as the Secretary is, that the proper funding of the present debt, will render it a national blessing: Yet he is so far from acceding to the position, in the latitude in which it is sometimes laid down, that “public debts are public benefits,” a position inviting to prodigality, and liable to dangerous abuse,—that he ardently wishes to see it incorporated, as a fundamental maxim, in the system of public credit of the United States, that the creation of debt should always be accompanied with the means of extinguishment. This he regards as the true secret for rendering public credit immortal.”

—ALEXANDER HAMILTON, First Report on the Public Credit (January 9, 1790)2

The first chapter of Investing in U.S. Financial History begins two years after the ratification of the U.S. Constitution in 1788. The former British colonists had triumphed over the British Empire, but they were left with a financial system in complete disarray. President George Washington directed the nation’s first secretary of the Treasury, Alexander Hamilton, to restore the nation’s credit and create a durable foundation for a new financial system.

Hamilton’s most pressing problem was restoring confidence in the public credit. Many colonial governments had defaulted on bonds issued to fund the Revolution, and some even failed to fully compensate Revolutionary War veterans. Hamilton assigned the greatest urgency to this task because unlike many of his peers, he understood that responding to future “public dangers” would inevitably require borrowing on attractive terms. But such terms would only be available if the credit of the nation was sound.

Very early in my research process, I suspected that this chapter would be critically important, but it was only recently that I fully appreciated the brilliance of two principles articulated by Hamilton. The first was that the public credit was primarily intended to be used to borrow during periods of public danger; the second was that the debt should be repaid once the danger subsided. The United States largely abided by these principles for roughly 150 years, but then abandoned them in the aftermath of World War II. A critical inflection point occurred in the mid-1960s, which is the second chapter of importance.

Chapter 1 Overdue Credit

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Chapter 23: Inflated Expectations

“Let this session of Congress be known as the session which did more for civil rights than the last hundred sessions combined; as the session which enacted the most far-reaching tax cut of our time; as the session which declared all-out war on human poverty and unemployment in these United States; as the session which finally recognized the health needs of all our older citizens; as the session which reformed our tangled transportation and transit policies; as the session which achieved the most effective, efficient foreign aid program ever; and as the session which helped to build more homes, more schools, more libraries, and more hospitals than any single session of Congress in the history of our Republic . . . All this and more can and must be done. It can be done by this summer, and it can be done without any increase in spending.”3

—PRESIDENT LYNDON B. JOHNSON, (January 8, 1964)

The first half of the 2020s were a tumultuous time, and it seems quite likely that the latter half will be even more challenging. Most journalists describe the past few years as unprecedented, but two phenomena that occurred in the 1960s and 1970s suggest otherwise. The first event was the Great Inflation of 1965-1982, and the second was the quiet abandonment of Hamilton’s principles regarding the use of the public credit. Both are covered in Chapter 23: Inflated Expectations, which is only available in the book.

Post-Pandemic Inflation and the Great Inflation

In the spring of 2021, the worst of the COVID-19 pandemic subsided, and people throughout the world emerged from isolation. Americans were especially flush with cash and eager to spend it. The sudden release of this enormous pent-up demand, combined with pandemic-related supply chain disruptions and massive monetary stimulus, fueled high rates of inflation. The Federal Reserve leadership responded belatedly, in part, because they failed to realize that inflation was driven by far more than “transitory” supply chain shocks. Eventually, however, the Fed responded correctly by aggressively raising the federal funds rate by a total of 525 basis from March 2022 to July 2023—and then holding rates at that level for approximately 14 months.

In the summer of 2024, it appeared that the Fed was on its way to returning inflation to its long-term target of two percent, but then the FOMC made a fateful error. Similar to William McChesney Martin, Jr. and Arthur Burns, who presided over the Great Inflation of 1965-1982, Chair Jerome Powell permitted the FOMC to abandon restrictive monetary policy, thereby allowing inflation to reignite. The final pages in chapter 23 help explain why Chair Powell’s actions were in error by recounting how Martin and Burns made similar errors during the Great Inflation.

Abandonment of Hamiltonian Principles

The second challenge for the United States in 2025 is far more severe than persistent inflation. The issue is dealing with the nation’s unsustainable fiscal deficits and an unprecedented level of debt that has accumulated as a result. The source of this problem can be traced to the decades following World War II. It was during these years that the United States definitively abandoned the Hamilton principles regarding the use of debt. The shift in mentality occurred somewhat gradually, but the most striking moment occurred when President Lyndon B. Johnson initiated his ill-fated Great Society programs in the mid-1960s. Since that time, running chronic fiscal deficits has become a deeply entrenched and bipartisan practice.

The nation’s current fiscal predicament is made all the more severe by the fact that entitlement spending (e.g., Social Security, Medicare, and Medicaid) is by far the biggest source of the problem, yet it remains politically untouchable. This brings us to the third chapter, which, in retrospect, I unwisely cut from the final manuscript.

Chapter X: America’s First Funded Pension Plan

“It is not improper to observe, that pensions in all countries begin on a small scale, and are first generally granted on proper consideration, and then they increase till at last they are granted often on whim or caprice as for proper considerations.”4

—NATHANIEL MACON, former Speaker of the House (January 1818)

Caption: U.S. and British ships engaged in the Battle of Lake Erie during the War of 1812; photo provided courtesy of the Library of Congress.

In 1799, the U.S. Navy established America’s first funded pension plan. The plan’s funding source was rather peculiar. At the time, the U.S. Navy was struggling with enlistment because joining the crew of a privateer was much more lucrative. For those who are unfamiliar with privateering, it was effectively a legal form of piracy. Congress authorized private vessels to capture enemy ships and share in whatever treasures they confiscated. To compete with privateers, Congress authorized a similar prize system for the U.S. Navy.

The fact that the first funded pension plan in the U.S. was financed by state-sponsored piracy is interesting in its own right, but it was not enough to warrant inclusion in the book. However, what I failed to appreciate when I completed the manuscript in March 2023 was how the rise and fall of the U.S. Navy pension served as a useful case study to evaluate the history and potential fate of entitlement programs today. In a few months, the history of the U.S. Navy pension plan will appear again in an article in the spring issue of the Museum of American Finance’s Financial History magazine. The article will recount the history of entitlement spending in the United States. In the meantime, the unpublished chapter (accessible in the link below) provides an interesting preview of this long-lost tale of piracy and pension funding on the high seas.

Chapter X America's First Funded Pension Plan

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Concluding Thoughts

I hope the chapters shared in this newsletter help people view current events in a different light. Not every event happening today has a relevant, past precedent, but most do. Understanding the Great Inflation will help explain why inflationary pressures are reigniting in 2025 and why the Federal Reserve leadership should have anticipated this outcome. Understanding why Alexander Hamilton established two key principles for the use of the public debt will explain why the United States now finds itself in a dangerous position if it fails to re-embrace these principles soon. Finally, bearing witness to the rise and fall of the U.S. Navy pension plan will provide a proverbial shot over the bow which warns Americans of the potential fate of current entitlements.

First-Year Achievements for Investing in U.S. Financial History

The most nerve-wracking part of publishing this book was releasing it to the public and opening it up to criticism. A few months before publication, a friend and fellow author advised me to steel my nerves by reading one-star reviews of my favorite books. Her point was that no matter how good a book is, it will surely attract a few one star reviews. She was right, I received a couple one-star reviews over the past year, but am relieved that they were the exception rather than the rule.

In closing, I wrote this book to reveal lessons that I believe are critically important to many different stakeholders in this nation. The fact that it is achieving this objective is what gives me the most satisfaction. Nevertheless, I am also thrilled to have received a few book awards and positive, professional reviews. I have listed a few highlights below. Thank you to those who took the time to review and judge this book. And thank you to all of the readers who have invested their time to absorb and apply the lessons.

Awards

• 2024 New York City Best Book Awards — Winner in “Finance”

• 2024 American Book Fest Book Awards — Winner in “Personal Finance”

• 2024 Money Awareness and Inclusion Awards — Finalist for Best Book

• 2024 Axiom Book Awards — Bronze Medal in Personal Finance/Retirement Planning/Investing

Reviews

• Advisor Perspectives — Reviewed by William J. Bernstein

• CFA Institute’s Enterprising Investor — Reviewed by Martin Fridson, CFA

• Publisher’s Weekly — Editorial Staff

• Financial Planning — Reviewed by Tobias Salinger

Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.

“Persuaded as the Secretary is, that the proper funding of the present debt, will render it a national blessing…he is so far from acceding to the position, in the latitude in which it is sometimes laid down, that “public debts are public benefits,” a position inviting to prodigality, and liable to dangerous abuse—that he ardently wishes to see it incorporated, as a fundamental maxim, in the system of public credit of the United States, that the creation of debt should always be accompanied with the means of extinguishment. This he regards as the true secret for rendering public credit immortal.”1

—ALEXANDER HAMILTON, First Report on the Public Credit (January 9, 1790)

A New Era of Financial History

My recently published book, Investing in U.S. Financial History: Understanding the Past to Forecast the Future, separates the roughly 230-year financial history of the United States into six eras. The longest lasted roughly 75 years; the shortest lasted 15 years; and the average was 39 years. The reason for the variance is because historical inflection points are driven by fundamental shifts in the economy and financial system, rather than the passage of a specific number of years.

Table of Contents of Investing in U.S. Financial History: Understanding the Past to Forecast the Future.

The final era of the book began in 1982 with the end of the Great Inflation and rise of Silicon Valley, and it ended in March 2023 amid the depths of post-COVID-19 inflation. Now, it appears the U.S. is entering a seventh era. The title remains hidden by the inherent uncertainty of future events, but I suspect the most powerful theme will be the nation’s reckoning with chronic, unsustainable spending habits that began soon after World War II ended in the summer of 1945. To be clear, the consequences of decades of unsustainable spending were hardly a secret in the 2010s, but the tremendous costs of the COVID-19 pandemic pulled the day of reckoning forward by several years.

The bad news is that rebuilding the wealth of the American Empire will take a long time and will be painful. There will be extreme winners, extreme losers, and everything in between. The good news is that the 234-year financial track record of the United States strongly suggests that the American people will solve these problems just like their ancestors solved seemingly insurmountable problems in their time. The coming waves of struggle, suffering, healing, and growth will form another set of lesions on the battle-scarred body of this nation. But if history offers a vision of the future—and it usually does—the American people will endure and emerge stronger for having passed yet another grueling test of their resilience.

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The Character of the Next Era

The seventh era of U.S. financial history begins with the second term of President Donald J. Trump. Like many presidents who come to power during transitions from one era to the next, President Trump is revered by supporters and despised by detractors. This newsletter does not address the substance of these diametrically opposed views, nor does it take a position on the many contentious social issues. Having taken an oath of political neutrality (see the note below), I only comment on the underlying economic currents that help explain the current state of affairs.

The newsletter opens by identifying several parallels between the Great Inflation of 1965-1982 and the first half of the 2020s. Specifically, it explains how massive, pandemic-related fiscal stimulus, combined with a Federal Reserve that was unwilling to abandon a long-standing dovish bias, allowed high levels of inflation to persist for nearly four years. It then addresses the issue of chronic, unsustainable fiscal deficits and the unwieldy debt burden that they have created. It concludes by explaining important consequences for the rest of the world now that the U.S. is turning inward in a way that world leaders have not witnessed for nearly a century. Rebuilding the wealth of the nation has clearly taken center stage. This does not mean that the U.S. will completely abandon its engagement abroad, but it does mean that allies, trading partners, and enemies would be wise to assume that they are dealing with an empire that will place its own interests above all others for quite some time. The Trump Administration’s use of tariffs, freezing of foreign aid, and plans to withdraw military support are manifestations of this philosophical shift.

Some readers may feel this newsletter is too conservative, while others may believe it is too liberal. I assure you my aspiration is only to be factual. This is because relatively early in the process of writing Investing in U.S. Financial History, I concluded that political neutrality is essential to maintaining credibility. I reached this conclusion after watching many historians and economists dilute the impact of their work by allowing personal political beliefs to alter the presentation of what should be sterile facts.

Maintaining political neutrality is difficult, and it does not mean I will refuse to comment on the potential impact of financially relevant political decisions. It just means that when I do offer commentary, I will do my best to take the perspective of an observer rather than supporter or dissenter. Regardless of what happens in this world—no matter how extreme—I will strive to maintain this standard. In short, my goal is to live in the past, observe the present, and combine insights from both to help shed light on the future.

Echoes of the Great Inflation

“People have come to feel in increasing numbers that much of the government spending sanctioned by their compassion and altruism was falling short of its objectives: that the quality of public schools was deteriorating, that crime and violence were increasing, that welfare cheating was still widespread, that collecting unemployment insurance was becoming a way of life for far too many—in short, that the relentless increases of government spending were not producing the social benefits expected from them and yet were adding to the taxes of hard-working people and to the already high prices they had to pay at the grocery store and everywhere else. In my judgement, such feelings of resentment and frustration are largely responsible for the conservative political trend that has developed of late in the United States.”2

—ARTHUR BURNS, chairman of the Federal Reserve Board (September 30, 1979)

When comparing past eras to the present, it is impossible to find a perfect match. This is because, as Mark Twain reportedly said, history tends to rhyme rather than repeat. But if a comparable must be chosen, the Great Inflation of 1965-1982 seems like the best choice. The opening quote from Arthur Burns, who chaired the Federal Reserve from 1970 to 1978, describes several underlying frustrations that probably feel familiar today—and much like today, these frustrations were amplified by persistently high levels of inflation.

Thus far, the post-COVID-19 inflation is less severe than the Great Inflation, but the two events have much in common. Most importantly, at the heart of both were excessive federal government spending and overly dovish monetary policies. Another similarity is the tendency of today’s politicians to place far too much blame on pandemic-related, supply chain shocks.3 This is reminiscent of the excuses used by politicians in the 1970s when they placed inordinate blame on oil embargoes. It is true that both inflationary episodes were amplified by supply shocks, but they were not the most important factors. Another similarity is the clash between conservative and liberal values on a variety of social issues. Although the various issues subject to debate are different today, the intensity of the conflict is reminiscent of the 1960s culture clashes. The final parallel is the profligate spending of the United States. On this matter, however, the potential consequences are far more severe in the 2020s. Whereas the 1960s marked the beginning of unsustainable spending, the 2020s will likely mark the curtailment of it.

Three Financial Currents Likely to Shape the Next Era

The Great Inflation offers a useful framework for evaluating the next several decades, but it is incomplete. Ultimately, it is impossible to identify all of the financial drivers of an emerging era in advance. Nevertheless, it seems highly likely that the three issues that follow will play an important role. The first and most immediate issue is dealing with post-COVID-19 inflation. The second, and by far the most important, is dealing with the unsustainable spending of the federal government. The third, which is largely a product of the second, is the shifting philosophy in the U.S. regarding its relationship with the rest of the world.

Issue #1: Post-Pandemic Inflation

“There can be no danger of galloping or runaway inflation in the reckonable future unless our monetary and fiscal policies become utterly reckless.”4

—ARTHUR BURNS, former chairman of the Federal Reserve Board (1957)

In 2021, post-COVID-19 inflationary pressures ignited in the United States. The causes were similar to the ones that fueled the post-World War I/Great Influenza inflation in 1919-1920. Nevertheless, Fed Chair Jerome Powell initially attributed post-COVID-19 inflation to “transitory” supply chain shocks and assured the American people that inflationary pressures would naturally dissipate. The dynamics of the 1919-1920 inflation suggested a different scenario was more likely. Throughout 1919, the Fed made the same miscalculation and waited a full year for inflationary pressures to subside. When it became apparent that tighter monetary policy was needed, the Fed abruptly raised rates by 125 basis points in January 1920, and another 100 basis points in June 1920. Inflationary pressures finally yielded, and the U.S. entered a sharp but brief recession in 1921.5

In 2021 and most of 2022, the Federal Reserve seemed largely, if not completely, oblivious to this precedent, which explains, in part, why they committed the very same error. The Fed claimed that post-COVID-19 inflation was a “transitory” event that was largely attributable to supply chain shocks. It was only after high inflation persisted for roughly 18 months that the Fed began raising rates aggressively, much like they did in 1920. Despite nearly everybody’s expectations (including my own), the aggressive monetary policy tightening failed to return inflation to the long-term target of two percent, nor did it trigger a recession in 2023 or even 2024. This is because nearly everybody underestimated the staying power of the massive fiscal stimulus enacted during the pandemic. This included a particularly ill-advised third round of fiscal stimulus, which was absurdly dubbed the “Inflation Reduction Act.”

Despite the Fed leadership’s awareness of lingering inflationary pressures, they remained enamored by the prospect of orchestrating an unprecedented soft landing. By the summer of 2024, the Fed was anxious to return to a “neutral rate” of interest, and on August 22, 2024, Chair Jerome Powell announced an impending pivot toward more accommodative monetary policies. The subsequent reduction of interest rates by a total of 100 basis points during the last four months of 2024 defied one of the more important principles discovered during the Great Inflation, which is that ending extended periods of elevated inflation requires central bankers to decisively extinguish every last ember. Failure to do so allows inflationary pressures to reignite, which is precisely what appears to be happening now. Over the past five months, bond vigilantes have pushed up long-term rates; surveys of long-term inflation expectations have risen; and current inflation remains stuck around 3%.6

It is uncertain how the post-COVID-19 inflation will end—but it is clear that it is not over. Some planned policies of the Trump administration may be inflationary, while others may be disinflationary. The President has also voiced a dangerous and ill-advised intention to influence monetary policy by “lowering interest rates immediately.”7 If the inflationary pressures turn out to be stronger than deflationary pressures, at a minimum, the Fed will need to leave rates higher for longer. It is also conceivable that they will need to raise them. This would test the commitment of the Fed to uphold their independence from political influence. It would also test the Trump administration’s willingness to honor it. This could result in an epic battle between the Federal Reserve and the executive branch, which is a conflict that is not in the interest of the American people.

Issue #2: Unsustainable Fiscal Deficits

“The position of the United States after World War II was entirely abnormal and unsustainable. We came through unscathed. Our industrial power actually strengthened, while our potential competitors were substantially destroyed and needed our help to rebuild themselves…It has been both natural and desirable for others to catch up to us from a very depressed state.”

—PAUL A. VOLCKER, former chairman of the Federal Reserve Board

The nation’s unsustainable fiscal deficits and unwieldy debt burden are likely to be the most powerful forces shaping U.S. economic and political events over the next several decades. This moment of reckoning was a long time coming. The spending binge began soon after World War II ended in 1945. As former Fed Chair Paul Volcker concisely explained in the above quote, the U.S. emerged as the world’s wealthiest nation. Moreover, while the industrial infrastructures of nations across Europe and Asia lay in ruins, the U.S. “Arsenal of Democracy” fueled massive expansion of its industrial capacity and sharpened its technological edge. In the 1950s, the U.S. enjoyed an extraordinary period of economic prosperity. Jobs were plentiful, poverty rates fell dramatically, and the middle class thrived. The combination of exceptional wealth and a vastly superior means to produce it explains why many Americans are nostalgic about life in the 1950s.³

The image shows a tank assembly line at a retooled Chrysler facility that was part of the Arsenal of Democracy. (Image provided courtesy of the Library of Congress)

Unfortunately, the exceptional prosperity of the 1950s set the stage for the onset of chronic fiscal deficits in the 1960s. Politicians tolerated the deficits, in part, because debt-to-GDP levels had substantially declined as a result of exceptional economic growth and reasonably balanced budgets in the immediate post-World War II years. In Figure 2, the dip in debt-to-GDP levels in the 1960s and 1970s is clearly visible.

Figure 1: Total U.S. Public Debt as a Percentage of GDP (1792-2032E)

Source: Mark J. Higgins, Investing in U.S. Financial History: Understanding the Past to Forecast the Future, (Austin: Greenleaf Book Group, 2024).

The problem was that it was never realistic to expect the economic dominance of the 1950s to last forever. European and Asian countries steadily rebuilt their economies and the wealth and competitive positioning of the U.S. relative to the rest of the world weakened. Americans’ perceptions of their relative position, however, failed to adjust at the same pace. Decade after decade, this emboldened politicians to continue expanding federal spending programs at an unaffordable rate.

Few Americans have come to terms with the nation’s distorted perceptions of its own wealth, but the ruthless laws of math do not lie. The data clearly reveals that the U.S. has spent far more than it can afford for more than half a century. As a result, the national debt has increased to dangerous levels, and is projected to increase much further at the present pace. This is precisely the situation that Alexander Hamilton sought to avoid when he advised Congress to establish a means for extinguishing the public debt during prosperous times. Figure 2 presents Congressional Budget Office data that shows past, current, and projected debt held by the public as a percent of GDP.

Figure 2: Past, Current, and Projected Total Debt Held by the Public to GDP (1962 - 2054)8

Many Americans cling to the fantasy that federal spending can continue at the present pace, but when pressed, they can rely only on magical thinking to justify their arguments. Some hope that the U.S. can outgrow its debt problems, much like it did in the late 1940s and 1950s. But those times were different. The industrial infrastructures of global competitors were in ruins, and several tailwinds (e.g., exceptionally high productivity growth and steady labor force expansion) are now headwinds. Others, such as proponents of Modern Monetary Theory, make the ludicrous claim that the U.S. can accrue debt forever because the nation possesses the world’s dominant reserve currency. This argument may provide false comfort for a few years years (maybe even a decade or two), but empires eventually lose reserve currency privileges once the world no longer views their credit to be a risk worth taking. The Dutch suffered this fate in the late 1700s, and the British suffered it in the mid-1900s. The U.S. does not possess special immunity to this outcome.

It seems like the only realistic option is for the U.S. citizenry to acknowledge, confront, and overcome misperceptions about its own wealth. Accomplishing this feat may rank among the most difficult financial tests since the nation’s founding. After all, the last time the solvency of the United States was called into serious question was in 1790. The next era of U.S. financial history will test the credit of the U.S., and it will be a completely unfamiliar experience for every American.

Issue #3: Trade and International Relations

“You should fully understand the special position that the United States now occupies in the world, geographically, financially, militarily, and scientifically, and the implications involved. The development of a sense of responsibility for world order and security, the development of a sense of overwhelming importance of the country’s acts, and failures to act, in relation to world order and security—these, in my opinion, are great musts for your generation.”9

—GENERAL GEORGE C. MARSHALL (February 22, 1947)

Blessed by enormous wealth after World War II, Americans abandoned their isolationist leanings for the first time in history. Few Americans realize that prior to that point, the default position of the United States was to remain largely detached from global affairs. After World War II, however, Americans willingly gazed far across the Atlantic and Pacific oceans searching for opportunities to rebuild a better world. This sentiment was expressed by General George C. Marshall in a speech he delivered at Princeton University.

On February 3, 1948, President Harry S. Truman signed the Economic Recovery Act of 1948, which allocated roughly $13 billion to European reconstruction. It is now known as the Marshall Plan in honor of its architect. In addition to providing desperately needed aid to Europe, the Marshall Plan created a strong bias toward engagement in U.S. foreign policy. This became an enduring precedent that persisted for nearly a century. It was an admirable precedent to be sure, but it was also one that was largely made possible by the extraordinary and historically anomalous wealth of the United States. All else being equal, it is much easier to be altruistic when you believe you possess a bottomless reservoir of financial assets to fund it.

President Harry S. Truman signing the Economic Recovery Act of 1948. (Image courtesy of the Library of Congress)

The United States Turns Toward Its Isolationist Roots

The world slowly but steadily changed over the last 80 years, and it has now reached an inflection point. In 2025, the wealth and competitive advantages of the U.S. remain strong in an absolute sense, but they have diminished in a relative sense. The U.S. is still the largest economy, but its share of global economic output has shrunk substantially since the 1950s. At the same time, chronic fiscal deficits have taken a toll on the nation’s borrowing capacity.

The harsh reality for the rest of the world is that the U.S. is less willing to play the role it has played abroad since the end of World War II—and at a minimum, it is far less willing to fund it. U.S. debt capacity may not be exhausted from a technical perspective, but the coffers are nearly empty from a psychological perspective. As a result, the U.S. is now squarely focused on rebuilding its own wealth.

At the root of President Trump’s tariff plans is pressure from the American electorate to rebuild the nation’s wealth. To be clear, tariffs are not risk-less maneuvers. In a worst case scenario, they can trigger tit-for-tat retaliation, which causes all nations to suffer. Nevertheless, a large percentage of Americans appear willing to take that risk.

The most important point to absorb is that the U.S. is turning back toward its isolationist leanings, and it is unclear how long this shift will last and how far it will go. In the meantime, allies and trading partners would be wise to assume they are largely on their own until Americans once again feel comfortable with the adequacy of their financial reserves. Protective tariffs, freezing of foreign aid and withdrawal of military support are likely to be far more common in the foreseeable future.

Final Thoughts

“You will perceive Sir, I have neither flattered the state nor encouraged high expectations. I thought it my duty to exhibit things as they are not as they ought to be.”10

—ALEXANDER HAMILTON, letter to Robert Morris (August 13, 1782)

In the summer of 1782, the American Revolution had taken a devastating toll on the colonists. The superintendent of finance, Robert Morris, dispatched many of his most trusted leaders to get a more detailed assessment of the economic conditions in the thirteen colonies. Alexander Hamilton was sent to the colony of New York where he observed catastrophic economic damage and widespread human suffering. He suspected that reports on other colonies were sugarcoated by his compatriots because they feared revealing just how bad the conditions were. Nevertheless, Hamilton refused to alter his report because he believed the leaders of the Revolution needed reliable information to make the best decisions possible.

This newsletter may seem heavy on despair and light on hope. My aim, however, is to channel the spirit of Alexander Hamilton and simply “exhibit things as they are” so that people can prepare and respond more effectively. None of the problems that this country faces are easily solved, but neither are they insurmountable. Admittedly, many of America’s ancestors have experienced better times, but many have also experienced far worse. Fortunately, recognizing problems for what they are and designing innovative solutions is an enduring American tradition. It explains why the track record of this nation strongly suggests that Americans will overcome their present challenges, and the United States will continue the slow but steady mission of making this country and the world a better place.

Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.

“Common sense I believe is the most valuable possession anyone can have. Such success as I have had in life has been due to it, and to the fact that I was not afraid to use such common sense as God gave me.”1

—HETTY GREEN, the Queen of Wall Street (July 18, 1897)

The Museum of American Finance’s Winter 2025 issue of Financial History will feature an article detailing the unappreciated values of Hetty Green. If you never heard her name, it is unsurprising. Hetty Green was modest by nature and, therefore, left no monuments to glorify her conquests on Wall Street.

Among Hetty Green’s many impressive skills was her ability to sense the ebbs and flows of the monetary tides. This enabled her to amass massive cash reserves well in advance of market panics, which frequently tormented denizens of Wall Street around the turn of the twentieth century. In a rare interview conducted on July 18, 1897 with a journalist from The Saint Paul Globe, Hetty Green listed common sense as her greatest virtue. Sadly, it appears that common sense is in short supply at the Federal Reserve in 2024.

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An Ill-Advised “Recalibration” of Monetary Policy

Note: The Whip Inflation Now (WIN) program which was launched in 1974 was an attempt by President Gerald Ford to tame inflation by encouraging consumers to alter their spending and savings habits. It is now counted among one of the federal government’s worst public relations blunders.

On August 23, 2024, Chair Jerome Powell used his annual speech at Jackson Hole to send a clear message that the Federal Reserve intended to pivot toward less restrictive monetary policy. In the newsletter published on August 27th, I explained why financial history strongly suggested that this decision was premature. Then, on September 18, 2024, the FOMC cut the federal funds rate by 50 basis points, projecting a high-level of confidence that post-COVID-19 inflation would continue on a path to the Fed’s long-term target of two percent. In the newsletter published on October 10th, I explained why financial history strongly suggested that such confidence was unwarranted, and that this decision constituted a big policy error.

Sure enough, over the subsequent months, inflation data remained stubbornly high, while labor markets and economic growth remained strong. This put the FOMC in an unenviable position. They had painted themselves into a corner by expressing confidence in a plan to enact further rate cuts through the remainder of 2024 and throughout 2025. Backtracking after only a few months risked spooking the markets. Therefore, rather than admitting an error, the FOMC sprinted down the inflationary gauntlet hoping to somehow emerge unscathed.

On November 7th, the FOMC enacted a 25-basis-point cut to the federal funds rate. Then, on December 18th, the FOMC announced another 25-basis-point rate cut. In the post-meeting press conference, Chair Powell suggested that the “recalibration” was completed—or at least nearly completed. But just like labeling inflation “transitory” in 2021 proved to be short-sighted, financial history, most current data, and a healthy dose of common sense strongly suggests that the Fed’s recalibration will not go according to plan.

A Press Conference Full of Mixed and Misleading Messages

“If you can’t understand what the professor is saying, don’t dismiss the possibility that he might be wrong.”2

—PAUL A. VOLCKER, former chairman of the Federal Reserve

Chair Powell’s press conference was a masterpiece of mixed and misleading messages. I was physically uncomfortable watching him grasp at straws to defend a policy that is indefensible. He attempted to rationalize the continued easing of monetary policy despite a preponderance of data—not to mention powerful historical precedents—that indicate it was a mistake. Not only did Chair Powell fail to present a convincing case, but he also cited data that contradicted his own argument. Below, I highlighted three examples that seemed especially misleading and/or illogical.

Monetary Policy is “Meaningfully Restrictive”

On several occasions, Chair Powell described the current federal funds rate as “meaningfully restrictive.” The problem is that even back-of-the-envelope math suggests that it is roughly neutral—and perhaps even slightly accommodative. Thomas Hoenig, former president of the Federal Reserve Bank of Kansas City made this point in a post-meeting interview with Kathleen Hays of Central Bank Central. Moreover, regardless of whether the Fed believes current policy is restrictive, the actual data on labor markets, prices, valuations of risk assets, and long-term bond yields clearly indicate that monetary policy is not restrictive enough.3

Long-Term Inflation Expectations Are Well-Anchored

Some journalists at the press conference expressed concern about rising inflationary pressures. Chair Powell attempted to ease their concerns by claiming that long-term inflation expectations are well-anchored. It is unclear whether this is true, but even it is true, expectations are anchored in a bad place. For example, the University of Michigan survey has consistently revealed that median five-year inflation expectations remain slightly above 3% (see figure below). Moreover, inflation expectations have increased slightly since the Fed announced its pivot in August 2024. In other words, five-year inflation expectations are well-above the Fed’s two percent target, and it seems quite plausible that they are headed in the wrong direction. Even if one gives Chair Powell the benefit of the doubt and concedes that inflation expectations are “well-anchored,” they are moored in dangerous waters.

Current Monetary Policy Balances the Risks of Price Stability and Maximum Employment

Chair Powell stated that current monetary policy balances the risks to price stability and potential weakening of labor markets. Nothing could be further from the truth. Using the Fed’s own data and projections from the SEP, inflationary pressures have risen meaningfully since the August 2024 pivot. Moreover, labor markets strengthened, and unemployment remains steady at slightly above four percent. Many economists would argue that this unemployment rate is consistent with full employment. Given the imprecision of estimating the natural rate of unemployment, it is also quite conceivable that the U.S. is operating below the rate of full employment. Cutting rates multiple times in the face of a strong labor market, strong economy, and rising inflationary pressures is precisely the opposite of what the Fed should be doing. In other words, the FOMC’s concerns are squarely biased toward supporting labor markets despite the fact that current data and compelling lessons from history overwhelmingly support adopting a strong bias toward price stability.

The Fed Needs to Stop Torturing the Data and Open Their Eyes

“Faced with the choice between changing one’s mind and proving that there is no need to do so, almost everybody gets busy on the proof.”

—JOHN KENNETH GALBRAITH

In August 2024, Chair Powell and the FOMC made a clear commitment to easing monetary policy despite compelling historical evidence that it was premature. As a result, inflationary pressures have strengthened while pressure on labor markets has weakened. This outcome was both foreseeable and preventable.

In the late 1960s and early 1970s, the Fed abandoned monetary policy tightening prematurely on several occasions, which allowed inflationary pressures to reignite at incrementally higher levels. Americans suffered seventeen years of stagflation as a result. The Great Inflation of 1965-1982 ended only after Chairman Paul A. Volcker courageously instituted draconian monetary policies, forcing a painful recession. The key lesson was that central bankers must extinguish inflation promptly and decisively if a similar situation were to arise in the future.

Chair Powell and the FOMC ignored this lesson and then dismissed a barrage of data warning them that they were repeating the mistakes of their predecessors. The FOMC leadership knew or should have known that abandoning tight monetary policy prematurely was likely to produce a similarly undesirable outcome. It is patently unsurprising that it did.

Chair Powell has damaged the Fed’s credibility by allowing the FOMC to intentionally dump gasoline on the inflationary embers. Any future claims that the Fed is a victim of unpredictable circumstances will ring hollow in the halls of financial history. The Federal Reserve is not dealing with an unprecedented event—they have simply ignored past precedents and will now pay the price.

Learn More about Financial History

The insights in this newsletter draw from my recently published book, Investing in U.S. Financial History: Understanding the Past to Forecast the Future. The book can be purchased by clicking on the cover below.

Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.

This newsletter is more narrowly focused than most, but several insights may still prove useful to both individual and institutional investors. The newsletter questions the merits of the philosophical foundation upon which nearly every institutional investment plan strategy now rests. It argues that investment strategies that were once considered unconventional (i.e., complex asset allocation, active management, and alternative asset classes), are now conventional. Moreover, it explains how existential financial incentives of investment consultants, OCIOs, and investment staff prevent trustees from discovering this reality. My hope is that this newsletter, and the recommended reading at the end, provides trustees with a much-needed, fresh perspective.

Entering and Exiting the Investment Consulting Profession

“Proper education is one long exercise in augmentation of high cognition so that our wisdom becomes strong enough to destroy wrong thinking maintained by resistance to change.”

—CHARLIE MUNGER, former vice chairman of Berkshire Hathaway

In 2009, I began my career as an investment consultant. Prior to entering the field, I read David Swensen’s book, Pioneering Portfolio Management. But like most readers, I overlooked the most important points. I arrogantly assumed that achieving Yale-like returns by skillfully selecting active managers and allocating to expensive alternative asset classes was possible for most institutional investment plans—or at least a meaningful portion of them. I believed all that was required was advice from a reasonably qualified investment staff, investment consulting firm, or OCIO. It was this belief that attracted me to investment consulting.

After several years, it become clear to me that reality was quite different than theory. Each quarterly meeting gave me a deeper appreciation for the fact that successful use of a “Yale strategy” was a rarity. For nearly all other investors incremental increases in portfolio complexity, active management, and alternative asset classes merely increased fees and were more likely to detract value rather than add it.

I expressed these concerns with increasing intensity, but colleagues almost universally dismissed them. They clung to unsubstantiated beliefs that, in aggregate, their recommendations added value to clients. At the same time, they proclaimed (and still proclaim) that their recommendations are immune to self-interest because of “no-conflicts-of-interest” policies. In reality, however, their advice suffers from a deep-seated conflict-of-interest rooted in the fact that the viability of their current business model depends on the implicit claim that proprietary asset allocation, active manager selection, and alternative asset class exposure add value. The mere contemplation that this assumption is false constitutes an existential threat that is easier to deny than to resolve.

Conventional Practices Impair Investment Plan Performance

“Once a majority of investors adopts a heretofore contrarian position, the minority view becomes the widely held perspective.”

—DAVID SWENSEN, late CIO of the Yale Investments Office

After leaving the investment consulting profession in March 2022, I spent two years completing my book, Investing in U.S. Financial History: Understanding the Past to Forecast the Future. The book recounts the major events that shaped the evolution of the U.S. financial system, economy, and securities markets from 1790 until 2023. The last fifty years of U.S. financial history were especially critical in the evolution of my personal, investment philosophy.

In 2024, nearly all trustees believe that that they can produce better results than a relatively simple portfolio consisting only of low-cost index funds. They believe they can do this by relying on complex asset allocation modeling, skillful active manager selection, and heavy alternative asset class exposure. In other words, they assume the same thing that I assumed fifteen years ago.

The problem with this belief is that a mountain of evidence reveals that the opposite is more likely to be true. The unconventional investing methodology pioneered by Yale University in 1985 is now conventional. In fact, the greatest irony today is that the most unconventional strategy is to rely heavily (if not exclusively) on low-cost index funds.

An Unconventional Education for Trustees

“People who are honest nowadays are accused of being mad.”

—HETTY GREEN, the Queen of Wall Street (1895)

One hundred and ninety years ago on this very day, Henrietta Howland “Hetty” Green was born in New Bedford, Massachusetts. Nobody fathomed that this young girl would rise to become one of the greatest investors in U.S. history. Even to this day, her story is rarely told correctly. She was mocked as a miser and derisively referred to as the “Witch of Wall Street” because her patience, thrift, modesty, and integrity were uncommon during the Gilded Age.

Over the past two years, I have documented many of the most important insights that explain why most institutional investment plans are destined for mediocre performance at best if they continue to embrace the status quo. This perspective is often dismissed and ridiculed, but I have yet to see anybody pose a compelling counterargument.

So, for trustees who are looking for an “unconventional” perspective, I encourage you to review the “Essential Reading” section of a site we assembled at IFA Institutional. It is a collection of seven articles that address key issues related to governance, investment strategy, and financial history. The perspectives are quite different from what trustees are accustomed to hearing. Regardless of whether you agree or disagree, it is always helpful to look at things in a new way.

ESSENTIAL READINGS FOR TRUSTEES

Governance

The Unexpected Legacy of a Prudent Man
Financial History magazine — Winter 2024

The Unspoken Conflict of Interest at the Heart of Investment Consulting
CFA Enterprising Investor — January 25, 2024

Active versus Passive Management

Denying the Odds: The History of Active Management in U.S. Securities Markets
Financial History magazine — Summer 2024

The Active Management Delusion: Respect the Wisdom of the Crowd
CFA Enterprising Investor — January 25, 2024

Alternative Asset Classes

A 45-Year Flood: The History of Alternative Asset Classes
Financial History magazine — Fall 2024

Vanguard’s Former OCIO Clients Must Stand Their Ground
CFA Enterprising Investor — July 3, 2024

Wall Street’s Latest Flood: Private Credit
CFA Enterprising Investor — October 24, 2024

Financial History

Investing in U.S. Financial History: Understanding the Past to Forecast the Future

Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.

“You will perceive, Sir, I have neither flattered the state nor encouraged high expectations. I have thought it my duty to exhibit things as they are, not as they ought to be.”

—ALEXANDER HAMILTON (August 13, 1782)

In the summer of 1782, the Revolutionary War had taken a devastating toll on the American colonists. Robert Morris, Superintendent of Finance for the Continental Congress, dispatched several trusted leaders to report on economic conditions throughout the land. Alexander Hamilton was assigned to the colony of New York. He was deeply troubled by what he saw, but unlike many of his compatriots, Hamilton refused to encourage false confidence. Instead, on August 13, 1782, he drafted a letter to Morris that reported conditions exactly as he saw them – no worse and no better. He did this because he believed that reporting the truth would benefit everybody in the long term—even if it painted a picture that was painful to accept in the short term.

I recalled this quote often while writing Investing in U.S. Financial History because my research led me to several deeply contrarian conclusions that many people do not want to hear. This is because human beings tend to instinctively reject such messages. Many go even further and attempt to disparage the messenger. If your insights are wrong, you risk being labeled a fool. Even if your insights are right, you often still bear the scarlet letter of a fool until the slow passage of time validates your position. That is the reality that one must accept when choosing to release deeply contrarian perspectives into the wild.

Several such insights are scattered throughout Investing in U.S. Financial History, as well as several articles I have written over the past few years. Examples include a markedly different perspective on the unsustainable and irresponsible accumulation of public debt over the past 75 years; a lonely view that the Federal Reserve’s pivot on monetary policy tightening in September 2024 constituted a grave, unforced error; and finally, a strong view that many widely accepted practices in the investment management profession are counterproductive and wasteful.

The third insight is the focus of this newsletter. It summarizes several observations from two articles that I published today, October 24, 2024. The first appears in the Fall issue of the Museum of American Finance’s Financial History magazine, and the second appears in the CFA Institute’s Enterprising Investor. I anticipate that many subscribers will disagree vehemently with these insights—and they have every right to maintain their position. Nevertheless, I hope you can approach this newsletter with an open mind. Even if the insights have no effect on your philosophy, perhaps they will at least encourage more rigor in your investment decisions—and that is never a bad thing.

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Article #1—A 45-Year Flood: The History of Alternative Asset Classes

“Once a majority of players adopts a heretofore contrarian position, the minority view becomes the widely held perspective.”1

—DAVID SWENSEN, late CIO of the Yale Investments Office

Link: https://fhmagazine.org/mag/0040396001729770149/p12

The first article recounts the 45-year flood of institutional capital into alternative asset classes, such as venture capital (VC), buyout funds, hedge funds, private real estate, and private credit. The rain began in 1979 after the Department of Labor tweaked its guidance on the “Prudent Man Rule” under ERISA. This provided trustees with the flexibility they needed to invest in VC funds, which, in turn, provided desperately needed capital to fuel the technological revolution blossoming in Silicon Valley. Since then, allocations to alternatives have massively increased, but with each passing year, allocators seem to apply less discretion when assessing the overall prospects of these asset classes and selecting fund managers to fill allocations.

The most important lesson from this article is to recognize that alternative asset classes follow a distinct cycle, which is summarized below.

1. Formation: A legitimate void appears in capital markets. For example, in the aftermath of World War II, U.S. companies had a wealth of opportunities to commercialize war-related technologies, but banks remained skittish because of their experiences during the Great Depression. This prompted the formation of the VC industry.

2. Early Phase: Innovative capital providers generate exceptional returns as the number of attractive opportunities exceeds the supply of capital available to fund them. The experience of early VC and buyout fund investors, such as the Yale University Endowment in the 1980s, is an excellent example.2

3. Flood Phase: In pursuit of new revenue streams, amateurs and opportunists launch a barrage of new funds, and then a stampede of followers eagerly provides capital to fund them. This invariably compresses future returns because the supply of capital far exceeds the number of attractive investment opportunities. In 2024, all major alternative asset classes — including VC, private equity, private real estate, hedge funds, and now private credit — have attributes that are squarely consistent with the flood phase.

When investment consultants, OCIOs, and staff encourage trustees to maintain, increase, or just further complicate allocations to alternatives, they often frame it as if is an attractive, contrarian opportunity. The truth, however, is that it is highly conventional. To give you a sense of how conventional it has become, even Vanguard’s former OCIO clients—which once resided in a rare oasis—appear to be at risk of succumbing to the lure of alternatives following the acquisition by Mercer earlier this year. Ironically, the most unconventional strategy is to take a passive approach. The $60+ billion Nevada Public Employees’ Retirement System (PERS) adopted this approach and allocated almost entirely to index funds. This strategy has outperformed 89% or more of their peers consistently over the past 20 years—and that is before their substantial fee advantage is taken into account. Sadly, hardly any trustees emulate this unconventional strategy.3

In 2024, alternative asset classes are heavily flooded. According to Equable, the average public pension plan held 33.8% in alternatives in 2023 versus only 9.3% in 2001. The flood of capital forces allocators to navigate murky waters that are teeming with naïve amateurs who lack the skills to succeed and free-roaming opportunists who lack the will to be fiduciaries. Many fund managers, as well as the consultants and advisors who recommend them, qualify for both unseemly titles. This is why trustees must apply maximum skepticism when presented with alternative asset class investment recommendations.

Article #2—Wall Street’s Latest Flood: Private Credit

“They seemed to spring up like mushrooms—practically overnight and often in the dark—and like mushrooms, they could be dangerously difficult to distinguish between.”4

—ANDREW BROWNING, author of The Panic of 1819

Link: https://blogs.cfainstitute.org/investor/2024/10/24/wall-streets-latest-flood-private-credit/

After Congress failed to renew the charter of the nation’s first central bank in 1811, state-chartered banks proliferated throughout the country. These banks issued private loans with little discipline and almost no regulatory oversight. The deterioration of lending standards accelerated rapidly in 1816 and 1817, when farmers and speculators rushed to obtain loans to purchase large tracts of land in the Midwest to grow wheat and cotton. Prices of both crops had skyrocketed after global crop yields collapsed in the wake of global cooling caused by the eruption of Mt. Tambora in 1815. But when temperatures returned to normal in 1818, crop yields recovered, commodity prices collapsed, farmers defaulted on their loans, approximately 30% of state-chartered banks failed, and the United States descended into its first Great Depression.5

The article in the CFA Institute’s Enterprising Investor explains the dynamics of the more recent, twenty-first-century private credit boom. Although it is highly unlikely to end as catastrophically as the one in the 1810s, the underlying causes of the explosive growth bear many similarities. The current private credit boom began after the 2008/2009 Global Financial Crisis (GFC), which forced the U.S. commercial banking system to tighten lending standards and restrict loan issuance in several market segments. This enabled banks to restore their depleted reserves and strengthen their balance sheets, but much like the demise of the First Bank of the United States in 1811, it created a temporary void in capital markets. This, in turn, triggered a sharp rise in demand for private credit. Figure 1 shows the rapid increase of private credit fund assets under management (AuM) since 2005. Most studies project that investment in private credit will only accelerate in the coming years.

Figure 1: Total Private Credit Assets Under Management (AuM) (2005 - 2023)

Sources: Financial Times, Prequin, The Wall Street Journal; CION Investments.

Private Credit is Not an Allocation; It is a Skill

“You don’t want to be average; it’s not worth it, does nothing. In fact, it’s less than the [public] market. The question is ‘how do you get to first quartile?’ If you can’t, it doesn’t matter what the optimizer says about asset allocation.”6

—ALLAN S. BUFFERD, treasurer emeritus at the Massachusetts Institute of Technology (2008)

There are many red flags that indicate when an alternative asset class has breached a levee. Several are plainly visible today in private credit markets. One subtle red flag is when managers stop emphasizing return enhancement, and, instead, favor vague claims of diversification. Such claims are far more difficult for trustees to verify, and far easier for consultants and staff to exaggerate (or even fabricate entirely). Another bad sign is when the practices of asset managers shift to accommodate a more challenging investment environment. A recent article by Steven Kelly, associate director of research at the Yale Program on Financial Stability, noted several examples of such shifts occurring in private credit markets. Finally, an especially troubling red flag is when fund managers begin targeting retail investors. Sadly, individuals are almost always the last victims to have their heads dunked in alternative asset class floods.

Despite many red flags, private credit recommendations are now seemingly ubiquitous on the meeting agendas of institutional investment plans. This also happens to be a red flag in and of itself. Trustees must exercise extreme skepticism when presented with such recommendations. Once an alternative asset class breaches the levee, only a small subset of highly skilled investors is qualified to venture into the treacherous waters. It is a skill-based decision, not an allocation choice.

Track Records are the Only Private Credit Assets in Short Supply

“No box score is kept in the investment-counsel game and no batting averages. My own method of research was to ask a number of investment counselors how their clients were doing. They all replied that their clients were doing quite well, thank you, taking into consideration, of course, this, that and the other.”7

—FRED SCHWED, JR., author of Where are the Customer’s Yachts? (1940)

The need for skill in private credit—and all alternative asset classes for that matter—is a critical prerequisite that few consultants, staff, and OCIOs address. If consistent and sustainable “first quartile” performance is essential for entry into an alternative asset class, then by far the most important decision criterion is the track record of the firm and/or individuals recommending fund managers to fill the allocation. Advisors must prove convincingly that they have recommended top quartile managers consistently for many years. They also need to provide rock-solid assurance that the people responsible for the track record are still at the firm and are capable of training the next generation of specialists.

The problem is that unlike the oversupply of private credit recommendations, there is a chronic undersupply of credible track records. It would be prudent, therefore, for trustees to assume that advisors, consultants, and staff members who refuse to provide compelling track records either have something to hide regarding their skills, or perhaps they simply lack a track record because they are really just amateurs and opportunists seeking to boost their careers and profits by needlessly plunging their clients into the latest flood.

Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.

“A new era hardly renders the Great Inflation irrelevant. To the contrary, its history holds important lessons for the future. The simplest is this: Inflation, if it reemerges, ought to be nipped in the bud; the longer we wait, the harder it gets to rein in.”1

—ROBERT J. SAMUELSON, author of the Great Inflation and Its Aftermath

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Image courtesy of the Library of Congress

On August 23, 2024, Federal Reserve Chairman Jerome Powell used his speech at Jackson Hole to announce the FOMC’s intended pivot toward looser monetary policy.2 In my previous newsletter published on August 27, 2024, I argued that this was a mistake. Then, on September 18, 2024, the FOMC upped the ante by cutting the federal funds rate by 50 basis points, signaling a base case plan to enact a series of additional cuts by the end of the year, and then forecasting several more cuts in 2025. Financial history strongly suggested that this was a BIG mistake.

Surprisingly, most economists, investors, and financial journalists applauded what they believed to be the Fed’s commendable foresight rather than lamented what is more likely to be their tragic amnesia. I truly hope the future vindicates the Fed, but financial history strongly suggests that it won’t—and that was before the recent releases of the employment and CPI reports for September 2024, both of which exceeded expectations. The addition of 254,000 jobs and a 3.3% annualized increase in core inflation suggest that inflationary pressures are, at best, sticky and, at worst, already reigniting.

In short, faith that the Fed’s pivot will produce a victory over post-COVID-19 inflation now feels like the desperate hope one feels when a quarterback lobs a wobbly Hail Mary pass into a crowded end zone with no time on the clock. It’s possible that they are on the verge of victory, but it certainly doesn’t appear likely. It is, therefore, hard to consider the Fed’s play call as anything other than a grave, unforced error that is likely to have very real consequences.

The Fed’s Costly Habit of Overcompensating for Recent Mistakes

The Fed has made many mistakes over the past 110 years, but the worst ones tended to occur when they attempted to overcompensate for their most recent error rather than avoid a far more costly one. In the late 1920s, the Fed maintained loose monetary policy for far too long, in part, because they feared being blamed for the aggressive tightening in 1920 that triggered a deep recession in 1921. In the early 1930s, the Fed failed to backstop the banking system, in part, because they were blamed for overly accommodative monetary policies in the late 1920s. The subsequent implosion of the U.S. banking system unnecessarily deepened and prolonged the Great Depression.3

In 2024, the Federal Reserve seems utterly determined to loosen monetary policy early and prevent weakening of an otherwise strong labor market and economy. Once again, it appears the Fed is attempting to correct a recent mistake. In this case, the mistake was mislabeling inflation as “transitory” in 2021, and then belatedly tightening monetary policy to contain it.4 Loosening monetary policy early appears to be an overreaction to the Fed’s tardiness in 2021.  The problem, however, is that financial history strongly suggests that loosening policy too early at the tail-end of a prolonged period of high inflation is far more likely to reignite inflation rather than extinguish it.

The Price of Unbalanced Monetary Policy

“‘Maximum’ or ‘full’ employment, after all, had become the nation’s major economic goal—not stability of the price level…Fear of immediate unemployment—rather than fear of current or eventual inflation—thus came to dominate economic policymaking.”5

—ARTHUR BURNS, former chairman of the Federal Reserve Board

In the 1960s and early 1970s, the Fed prematurely ended monetary policy tightening cycles on several occasions due, in large part, to a visceral fear of unemployment. Each time, it allowed inflation to reignite and burn even hotter. These failures caused the American people to lose faith in the Fed’s commitment to price stability, which allowed inflation expectations to become unanchored. As wages failed to keep pace with prices, strikes became more common and contentious. Unions negotiated progressively higher cost of living adjustments in labor contracts. Politicians called for (and even enacted) price controls after accusing companies of price gouging. Companies planned progressively higher price increases, and Americans altered their budgets to pay for them. Is this starting to sound familiar?

By the 1970s, higher inflation expectations were entrenched in the U.S. economy, making it increasingly difficult for the Fed to reestablish price stability with each passing year. The Great Inflation of 1965-1982 was a miserable period of U.S. history. Americans accepted that unaffordable mortgages, chronic shortages of gasoline, and paltry real returns from stocks were phenomena beyond their control. It was not until Fed Chairman Paul Volcker had the fortitude to initiate and sustain a draconian monetary policy from October 1979 to August 1982 that the Great Inflation finally concluded. But ending the vicious cycle was painful. The U.S. suffered a deep recession that lasted from July 1981 to November 1982, and unemployment that peaked at 10.8% in December 1982.6 Nevertheless, the benefits were worth the cost, as the end of the Great Inflation marked the beginning of a new era of economic prosperity.

The Financial Media is Channeling the Wrong Message

The airwaves are currently packed with pundits who talk endlessly about the intricacies of technical rules, such as the Taylor Rule and Sahm Rule, while they all but ignore a far more important rule established after the Great Inflation.7 The rule is quite simple: It is not enough for the Fed to merely extinguish the visible flames of inflation; they must also extinguish the embers that threaten to reignite it. In the fall of 2024, this meant that coming close to hitting the Fed’s two percent inflation target was not enough to justify a pivot in policy. The Fed will likely need to overshoot the target—and each time they fail, they will need to overshoot it by a progressively wider margin on the next attempt.

Contrary to the wishful thinking that now dominates the financial news, the September employment and CPI reports are not preliminary evidence of an impending soft landing. Instead, they are compelling evidence that the inflationary embers remain aglow and are at serious risk of reigniting. By pivoting prematurely to accommodative monetary policy, the FOMC likely recorded its first failure in the battle to end post-COVID-19 inflation—and the American people will pay a price for it.

Extinguishing Inflation Requires the Heart of a Hawk

In February 2022, my mother-in-law drafted the picture below. It shows a dove releasing a hawk from a cage in which it was imprisoned for forty years. At the time, it appeared that the hawks were free, and the doves would, at least temporarily, take their place in the cage. The aggressive monetary policy tightening that followed seemed to confirm this thesis. Unfortunately, it now appears that the Fed hawks were really just doves in disguise. By abandoning monetary policy tightening prematurely, they revealed their true nature.

The Great Inflation was a dreadful seventeen-year stretch, and the prospect of repeating it should strike fear in the hearts of the Fed leadership. It is a fear that should be felt far more intensely than the fear of incremental weakening of a strong labor market. I hope the FOMC redevelops this fear because history clearly demonstrates that once inflation becomes entrenched, each passing day makes it more difficult and painful to eradicate.

The doves masquerading as hawks at the Federal Reserve need to return to their cages. Dovish timidity is a recipe for failure in a battle to end protracted periods of high inflation. Extinguishing post-COVID-19 inflation requires a hawk’s heart, and this job is far too important to be left unfinished.

Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.

“The 4-1/2 percentage point decline in inflation from its peak two years ago has occurred in a context of low unemployment—a welcome and historically unusual result.”

—JEROME POWELL, chair of the Federal Reserve Board1

On August 23, 2024, Jerome Powell, chairman of the Federal Reserve Board, delivered a much-anticipated speech at the Fed’s annual symposium in Jackson Hole, Wyoming. The speech provided an opportunity for Powell to signal whether the FOMC intended to pivot toward monetary policy accommodation at the FOMC’s September 17-18 meeting. Chair Powell left little doubt as to the prevailing sentiment. The most revealing moment occurred when he emphatically declared that “the time has come for a policy adjustment.” Absent a dramatic change in economic data, it is a near certainty that the FOMC will approve its first cut to the federal funds rate since the onset of post-COVID-19 inflation in the spring of 2021.

The financial media has justifiably focused on the impending pivot in monetary policy, but there was a second phrase in Powell’s speech that is equally worthy of attention. When Powell explained how the reduction of inflation over the past two years was unaccompanied by a painful weakening of economic growth and labor markets, he acknowledged that this soft-landing scenario was a “welcome and historically unusual result.”2 The unusualness of this scenario cannot be understated. It would constitute a genuinely unprecedented event in U.S. financial history, and those do not occur often. Over the past 234 years, only two events offer reasonable points of comparison to post-COVID-19 inflation – and both ended in recessions before price stability was reestablished. The closest comparable was the post-World War I/Great Influenza inflation of 1919-1920. The second was the Great Inflation of 1965-1982, although the duration of the Great Inflation make it a bit less comparable. Given these precedents, if the Fed manages to reestablish price stability without triggering a recession and/or material weakening of labor markets in the aftermath of COVID-19 inflation, it will constitute a remarkable feat.3

Many investors and economists are already celebrating the achievement of a soft landing even though U.S. financial history strongly suggests that such celebrations are premature. This is because a third series of historical events suggests that the Fed’s battle with inflation is not over. These events occurred in the late 1960s and 1970s when the Federal Reserve tightened monetary policy on several occasions, but then preemptively eased policy when labor markets began to weaken. After they repeated this mistake several times, Americans lost faith in the Fed’s commitment to price stability, which allowed elevated inflation expectations to become entrenched in the U.S. economy. The start-and-stop monetary policy tightening was a major cause of the Great Inflation of 1965-1982. Figure 1 captures several of these effects.

Figure 1: The Great Inflation of 1965-1982
(Monetary Policy Inflation, and Unemployment)4

Perhaps the most important lesson from the Great Inflation is that monetary policy tightening must be sustained until elevated levels of inflation are decisively extinguished. This is why extended periods of high inflation are typically followed by recessions. It is simply too risky to ease monetary policy in anticipation of lower inflation because the very act of easing tends to reignite inflationary pressure.

Soft Landing or Reignition of Inflation

The question in 2024 is whether the Fed’s pivot to accommodative policy will resemble the premature pivots of the 1960s and 1970s, or whether the Fed truly has threaded the needle and orchestrated an unprecedented soft landing. My hope is that the Fed has deftly combined critical lessons from the past with shrewd analysis of the present and will achieve an unprecedented soft landing. But my belief is that the Fed is merely repeating the mistakes that their predecessors made in the late 1960s and early 1970s.

Only the passage of time will reveal which scenario is correct. If the soft-landing scenario is correct, I will be the first to congratulate the Federal Reserve. It will mean that the leadership saw something that was unapparent in the historical record, and they will deserve credit for having acted boldly. That said, the evidence from financial history seems more convincing in this case. It suggests that a pivot to more accommodative monetary policy in September 2024 is premature and, therefore, constitutes a policy error. The fact remains that, despite progress over the past two years, inflation remains well above its 2% target. Meanwhile, labor markets and the economy remain relatively strong. Therefore, the act of loosening monetary policy carries the risk of reigniting inflationary pressure, and the consequences of this would be far graver than the alternative of maintaining tight policy for too long. If inflation reignites, it will impair the Fed’s credibility, which will make it harder to reduce inflation the next time around – just like it did in the 1970s.

Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.

“You will perceive Sir, I have neither flattered the state nor encouraged high expectations. I thought it my duty to exhibit things as they are not as they ought to be.”1

—ALEXANDER HAMILTON (August 12, 1782)

Nearly one year after British forces surrendered to the Continental Army at Yorktown, the American colonies were in disarray. In the summer of 1782, Robert Morris, a key financier of the Revolutionary War, dispatched colonial leaders to report on economic conditions throughout the colonies. Many drafted reports that downplayed the widespread desperation because they believed reality was too difficult for Morris to bear. A notable exception was the nation’s future Treasury secretary, Alexander Hamilton. Unlike his peers, he believed that the progress of the nation could only be achieved if it was grounded on an accurate assessment of the present. Hamilton’s report described the dire economic conditions in New York exactly as he saw them.

This newsletter describes two unpleasant financial truths. The first must be addressed by trustees of institutional investment plans, and the second must be addressed by all Americans.

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Truth #1: The Burden of Complexity & Fees in Institutional Investment Plans

“The customer may not always be right, but he has rights. And upon our recognition of his rights and our desire to satisfy them rests our chance to succeed.”2

—CHARLES E. MERRILL, founder of Merrill Lynch

On July 24th at 10:00 am PST, I will be hosting a free webinar, entitled “It Pays to be Different: The Rationale for an Indexed OCIO.” The presentation explains why most institutional investment plan trustees now find themselves responsible for portfolios that are overburdened with complexity, active management, and alternative investments. It will also explain why this behavior persists despite a mountain of evidence demonstrating that it is highly unlikely to add value.

Trustees, investment staff, journalists, consultants, and individuals who attend this webinar may wince when they see many of the facts. I confess that when I was a former investment consultant, I initially had the same reaction. I feared that clients would fire me when I migrated them to low-cost index funds. Fortunately, I quickly discovered that their reaction was precisely the opposite. By freeing clients from the burden of non-value-added investment practices, they placed a higher value on my advice, which meant that we all benefited.

It may seem strange to include a quote from the founder of Merrill Lynch to promote a webinar dedicated to the benefits of low-cost index funds, but the transformation of Merrill Lynch in the mid-1940s had much in common with the transformation that is now necessary for institutional investment plans. Therefore, to place this quote into clearer context, I have included an excerpt from my book, Investing in U.S. Financial History: Understanding the Past to Forecast the Future at the end of this newsletter.

Truth #2: The Unsustainable Growth of the U.S. Public Debt and Entitlement Spending

My April 26, 2024 newsletter was the first in a series of three newsletters describing the greatest financial challenges for the United States in the coming years. The first challenge was relatively short-term, as it described the challenge of post-COVID inflation. The second newsletter addressed the costs of wars that can escalate unnecessarily. The final newsletter will address the unsustainable growth of the public debt and its root cause, which is the massive growth of spending on entitlements.

In a recent conversation with a friend, I was asked what was the most surprising thing that I learned from researching the financial history of the United States. The answer was the shift in perception on the use of the public debt and the affordability of entitlement spending. Prior to World War II, the public debt was primarily used to address “times of public danger” and then repaid once the danger subsided. This precedent was first articulated by Alexander Hamilton in his January 9, 1790 speech, entitled Report Relative to the Provision of the Public Credit. For more than 150 years, the United States adhered to Hamilton’s principle. Then, in the aftermath of World War II, Americans became emboldened by their exceptional wealth, formidable competitive advantages relative to a world in ruins, and privilege of holding the world’s dominant reserve currency. This set the stage for the steady expansion of entitlement spending which continues to this day.3

The problem that the United States must now confront is that its post-World War II wealth and competitive advantages relative to the rest of the world were historical anomalies. That is not a disparagement of the nation’s current competitiveness; it just means that the gap relative to the rest of the world has narrowed over time. This being the case, entitlement spending that once was deemed affordable is clearly not. This is not an easy problem to solve, but accepting the fact that the problem is very real is the first step to solving it. More to come on this issue.

Pre-Reading for Trustees

For subscribers who wish to attend the free webinar on July 24^th, I have created a web page that provides some optional pre-reading. Included are several articles I have written over the past few years. They cover issues such as (1) the history of the prudent investor rule, (2) the history of active management, and (3) and the conflict of interest at the heart of the investment consulting model. I hope the webinar and these resources help inform trustees’ decisions.

Book Excerpt: The Long-Term Rewards of Honesty versus the Destructive Fear of Obsolescence4

When faced with moral dilemmas, characters in old cartoons consulted with an imaginary devil on one shoulder and an angel on the other. The devil encouraged acts that were wrong but self-serving, while the angel encouraged them to do what was right but seemed self-destructive. In the long term, the angel’s advice always proved to be both right and rewarding, while the devil’s advice provided short-term relief at the expense of long-term self-destruction.

Investment professionals are constantly presented with this dilemma. Serving clients honestly—which is in every investment professional’s long-term interest—often requires accepting truths that seem self-defeating in the moment. This is because the truth forces them to recognize their limitations, alter their behavior, and adapt to a new reality. Those who respond well to these existential dilemmas place themselves in an unexpectedly powerful position because an investment professional’s greatest asset has always been and always will be their willingness to communicate the truth. Over many years, adherence to this principle ebbs and flows. During periods in which collective fear of obsolescence dominates, the few who buck the trend and communicate honestly with their clients are rewarded beyond their wildest expectations.

Merrill Lynch’s commitment to honesty, integrity, and transparency rehabilitated the reputation of Wall Street in the decades following World War II. The firm, its employees, its customers, and Americans in general benefitted from their bold decision. Sadly, their commitment eventually weakened, as it almost always does as companies age. After the firm’s adherence to its core values eroded in the early 2000s under the leadership of Stanley O’Neal, Merrill Lynch nearly disappeared forever beneath the wreckage of the Global Financial Crisis.

Merrill Lynch survived as a subsidiary of Bank of America, but its reputation is not what it was in the 1950s and 1960s. History demonstrates that it is never too late to regain the trust of Americans, but doing so requires them to open-mindedly explore what customers need and humbly accept the limits of what they can provide. It is unclear if Merrill Lynch will resurrect the principles of Charles E. Merrill and Winthrop Smith, but if they do, their employees and customers will once again enjoy benefits that they never anticipated were possible.

Disclaimer: This is a personal newsletter. Any views or opinions expressed herein belong solely to the author and do not represent those of any people or organizations that the writer may or may not be associated with in a professional capacity, unless specifically stated. This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, service, or considered to be tax advice. There are no guarantees investment strategies will be successful. Past performance is no guarantee of future results. Investing involves risks, including possible loss of principal.

“We are told that the American soldier does not know what he is fighting for. Now, at least, he will know what he is fighting against.”1

—GENERAL DWIGHT D. EISENHOWER, (April 12, 1945)
Comments made after liberating the Ohrdruf concentration camp

The following newsletter addresses the economic and financial costs of war. It starts by describing the sheer horrors. In full disclosure, I have no military experience, so I will never know what it is like to endure such horrors. But I have read enough memoirs to know that you can never thank and honor the veterans enough who have endured them on our behalf.

Today is the 80th anniversary of D-Day, and I hope this newsletter honors the sacrifice of the many Allied soldiers who sacrificed their lives, bodies, and minds on the beaches of Normandy. I also hope it honors the sacrifice of all veterans who place themselves in harm’s way for the sake of others. Finally, I hope this newsletter serves as a reminder to those who downplay the risk of escalation in armed conflicts. Two wars that rage today, the war between Israel and Hamas, and the war between Russia and Ukraine, seem unlikely to escalate into larger conflicts, but world leaders can never be too careful when hedging the risk of such an outcome.

The Unspeakable Horrors of War

“I have to tell the story how it really was. I have to let people know the war wasn’t a musical.”2

—ROBERT HUGH LECKIE, Author of Helmet for My Pillow (1951)

In 1951, Robert Leckie and his wife sat down to watch the award-winning Broadway musical, South Pacific, but Leckie was unable to endure what he witnessed. When his wife asked why he walked out, he explained it with the above quote. He then spent the next six years writing his memoirs which revealed his horrific experiences in World War II. Robert Leckie had fought in several of the bloodiest battles on islands, such as Peleliu and Guadalcanal. The TV Series, The Pacific, is based on his memoirs, as well as those of Eugene Sledge.

When I began writing Investing in U.S. Financial History, I vowed to always stay in my lane as a financial historian. But it is impossible for financial historians to ignore the role that war plays in a nation’s finances. After all, it was the critical need to borrow during “times of public danger, especially from foreign war” that inspired Alexander Hamilton to resuscitate the nation’s credit in 1790. It was the devastation of the Fourth Anglo-Dutch War that led to the fall of the Dutch guilder and rise of the Pound sterling as the world’s dominant reserve currency in the late 1700s. Then, it was the cost of World War II that enabled the U.S. dollar to replace the Pound sterling under the Bretton Woods Agreement.

The truth is that war shapes financial and economic history to a much greater degree than is often appreciated. In addition, nations that shrewdly avoid war often benefit unexpectedly from the unforced errors of others. That does not mean that war should be avoided at all costs. There are situations in which it is the only viable option to preserve one’s way of life. The problem, however, is that nations often set the threshold too low because there is an innate tendency to underestimate the costs of combat and overestimate the probability of victory. Such miscalculations allow conflicts that are reasonably contained to escalate into global conflagrations.

Tragic miscalculation and escalation constitute the foundation of World War I and World II, and it is important to never forget these mistakes. Even though it appears unlikely that today’s regional conflicts will erupt into world war-level events, nations should be on their guard, nonetheless. Once artillery shells and bullets are unleashed, the trajectory of wars are notoriously difficult to predict. Nations which are now watching the conflicts in Israel and Ukraine from the sidelines would be wise to aggressively hedge the risk of escalation. Seemingly small missteps can lead to the fall of nations and collapse of empires.

This newsletter provides a very brief history of World War I and World War II, and then touches on the Cold War. Even this limited historical context may help explain the origins and dangers of two wars that are remnants of these conflicts: the Russian-Ukraine war and the Israel-Hamas war.

The Tragic Origin of the World Wars

“Today we know that World War II began not in 1939 or 1941 but in the 1920s and 1930s when those who should have known better persuaded themselves that they were not their brother’s keepers.”3

—HUBERT HUMPHREY, former vice president of the United States

Eighty years ago today, the Allied Powers launched a daring amphibious assault on the beaches of Normandy, France. Prior to the invasion, the tide of World War II had already turned in favor of the Allies in both the Pacific and European theaters, but the successful establishment of a beachhead on the European continent marked the beginning of the end for the Nazi regime. Within a year, the Third Reich would fall, and Adolph Hitler would finally spare the world of his toxic existence by firing a bullet into his head.

World War II officially began five and a half years earlier when Great Britain and France declared war on Germany on September 3, 1939, but an even deeper root extended back to June 18, 1919 when the draconian provisions of the Treaty of Versailles were established. But even this root does not extend far enough back in time. The deepest root of World War II extends back to June 28, 1914. If not for a tragic wrong turn in the streets of Sarajevo, it is conceivable that neither of the World Wars would have happened.

Image: Meeting to Negotiate Terms of the Treaty of Versailles

Image courtesy of United States Library of Congress

A Fateful Wrong Turn in the Balkans

“While the standing armies of Europe were a constant reminder of possible war, and the frequent diplomatic tensions between the Great Powers cast repeated war shadows over the financial markets, the American public, at least was entirely unprepared for a world conflagration."4

GEORGE HENRY STEBBINS NOBLE, president of the New York Stock Exchange (1915)

Image courtesy of the United States Library of Congress.

On June 28, 1914, the Archduke Franz Ferdinand, heir to the throne of the Austro-Hungarian Empire, arrived in Sarajevo to inspect imperial forces. Sarajevo was the capital of Bosnia-Herzegovina, which was formally annexed from Serbia in 1908. After learning of the archduke’s visit, a pro-Serbian terrorist group known as the Black Hand plotted his assassination.5

Immediately after arriving, the archduke and his wife, Sophie, traveled by motorcade to the Sarajevo Town Hall. Along the route, five members of the Black Hand prepared to ambush the motorcade using crudely constructed bombs. The first conspirator who tossed a bomb missed the target, and it exploded beneath the next car in the motorcade. The cars sped away and arrived at the town hall within a few minutes. After delivering a brief speech, the Archduke demanded to visit the wounded at the hospital. Meanwhile, several members of the Black Hand repositioned themselves, hoping for another opportunity to attack. Armed with only a pistol, a nineteen-year-old co-conspirator named Gavrilo Princip awaited on a side street.6

The motorcade departed from the town hall less than one hour after the initial assassination attempt. To reduce the motorcade’s vulnerability to a second attack, the security team planned to avoid the crowded city center by traveling along the city perimeter. In the rush to depart, the head of security neglected to notify the lead driver of the plan, and he mistakenly led the motorcade directly through the city. After being alerted to his error, the driver stopped and began to reverse course. In a horrible stroke of misfortune, the archduke’s vehicle stalled within feet of Gavrilo Princip’s improvised position. Princip fired into the vehicle striking both the archduke and the duchess. The motorcade raced to the hospital, but the Archduke Ferdinand and Duchess Sophie were pronounced dead soon after their arrival.7

Everybody Bluffs and Nobody Folds

“If there is to-day high probability of a war involving the great Powers of Europe, we are not left in ignorance of the chief cause. No vital interest of Germany, Russia, France, England or Italy is directly threatened. Yet they are all on the verge of war. Why? Not because they approve or disapprove of Austria’s high-handed attack on Servia [sic]. It might indeed be a localized war but for one thing. This, the Alliances, offensive and defensive, into which the leading European Powers are grouped. These treaties have been held up to us for years as the brilliant conception of statesmen to safeguard peace. But at this moment they reveal themselves as the fatal cause of war."8

THE COMMERCIAL AND FINANCIAL CHRONICLE (August 1, 1914)

Few imagined that the death of the archduke and duchess of Austria-Hungary would plunge the entire European continent into one of the most destructive wars in human history. There were numerous miscalculations that explain the escalation, but at the root was the existence of inflexible defense pacts that compelled countries to mobilize their armed forces to support their allies despite having little to gain by engaging in combat. Time pressure also impaired decisions. The clock began ticking when Austria-Hungary granted Serbia only forty-eight hours to comply with a long list of concessions. Serbia failed to satisfy all demands, and Austria-Hungary declared war on July 28, 1914.9

The tragic irony of World War I is that the alliances that caused the war were designed specifically to prevent it. Europeans repeatedly downplayed the risk of escalation because the defense pacts had worked well for several decades. But the strategy failed in the summer of 1914, and the great powers of Europe careened toward an unwanted war to honor alliances. On one side were the Allied Powers of France, Russia, and Great Britain, and on the opposing side were the Central Powers of Germany, Austria-Hungary, and a reluctant Italy. Few politicians realized that a war of this scale was possible, and even fewer envisioned the magnitude of human suffering and economic devastation that would accompany it. Instead, as is often the case, the public greeted the initial war declarations with ad hoc celebrations to display national pride, giving little thought to the potential costs that would soon come.10

An estimated 20 million people perished in World War I. At least another 50 million died in the 1918-1919 Great Influenza, which was a pandemic made considerably worse by war-related censorship policies, crowded barracks, and horrific sanitary conditions on battlefields. Finally, from the perspective of the British, it weakened their grip on their global empire and accelerated the rise of the United States as its heir.11

The High Price of Victory but Steeper Cost of Defeat

“War is never cheap, but let me remind you that it’s a million times cheaper to win than to lose.”12

—HENRY MORGANTHAU, U.S. secretary of the Treasury (January 4, 1942)

Image: Stacked Cash during the Weimer Hyperinflation (1921-1923)

World War II is so named because it was a continuation of World War I. After hostilities ended on November 11, 1918, the Allied Powers blamed Germany, and the Treaty of Versailles placed punishing conditions on them. This included draconian reparation payments, painful loss of territory, and forced demilitarization. The Treaty of Versailles contributed to the impoverishment of many German citizens and the destabilization of its government in the early 1920s. However, by the end of the 1920s, it appeared that the German economy was well on its way to recovery. The influence of Adolph Hitler’s Nazi Party — which was a menace in the early 1920s — was diminishing, and it appeared it would be relegated to a fringe movement. But the onset of the Great Depression in 1930 devastated the German economy once again and reignited the appeal for the Nazis.13

During the 1930s, Hitler steadily tightened his grip over his own people and expanded German territory by threatening his enemies with a return of the horrific trench warfare of World War I. After several years of appeasement, the British and French belatedly realized the nature of Hitler’s deceit when the Nazis invaded Poland on September 1, 1939. The years of appeasement, however, proved catastrophic to the Allies. During that time, Nazi forces strengthened considerably, which enabled them to launch a successful attack on Western Europe in May 1940. After overrunning British, Dutch, Belgian, and French forces in a matter of weeks, the Nazis controlled continental Europe.14

After five years of brutal combat, Germany officially surrendered to the Allied Powers on May 7, 1945. Rewinding the clock back to 1919, it must have seemed unimaginable that World War II could be worse than World War I. But the human and financial costs of World War II were far greater. An estimated 70 to 85 million people perished. Systematic genocide took the lives of tens of millions of Jews, Slavs, Chinese, and other compromised groups. Atrocities suffered by survivors and victims prior to their murders were indescribable. Cities throughout the world lay in ruins from relentless bombing and apocalyptic firestorms. Atomic weapons were used for the first (and thus far last) time in human history. And even after the defeat of the Nazis and surrender of the Japanese, horrific conditions persisted for many years throughout much of the world.

Post-War Prosperity and Onset of the Cold War

“The position of the United States after World War II was entirely abnormal and unsustainable. We came through the war unscathed. Our industrial power actually strengthened, while our potential competitors were substantially destroyed and needed our help to rebuild themselves.15

—PAUL VOLCKER, former chairman of the Federal Reserve Board

The United States was an oasis amid the wreckage of World War II. The U.S. possessed nearly 70% of the world’s gold and had a significantly strengthened industrial and technological infrastructure that was not only untouched by the devastation, but was significantly enhanced by America’s role as supplier to the Allied Powers. Many Americans remain nostalgic about the quality of life in the late 1940s and 1950s, and the exceptional wealth of the United States during this era explains much of it.

The rest of the world was less fortunate. In the decades following the end of World War II, civil wars and regional wars erupted throughout the world, as the British, Dutch, and French withdrew from their former colonies. Meanwhile, scarred by the devastating and indiscriminate killing of the Nazi war machine, the Soviet Union descended on Eastern Europe and greatly expanded its sphere of influence.

The brief alliance between the Soviet Union and United States during World War II soon transformed into a bitter rivalry, known as the Cold War. The Soviets sought to expand a communist/autocratic sphere of influence, while the United States sought to expand a capitalist/democratic sphere of influence. Proxy wars involving these two superpowers erupted in nations, such as Cuba, Vietnam, Nicaragua, and Afghanistan.

On November 9, 1989, the Soviet Union began to crumble under the weight of central planning. Soon after East Germany liberalized travel beyond the wall separating east and west Berlin, frustrated citizens began demolishing the wall with sledgehammers, and resistance quickly spread. Within a few weeks, the Dresden headquarters of the East German secret police was under siege. This event turned out to be a formative experience for future Russian president Vladimir Putin, who was one of the occupants defending the building. He has since recalled frantically burning confidential papers before fleeing from the mob.

The signing of the Beloveszha Accords on December 8, 1991 marked the official end of the Soviet Union. But even more so than the scars of World War II, the scars of the Cold War have not fully healed in Russia.

Embers of Past Wars are Now Glowing in the 2020s

Many armed conflicts over the past several decades were a product of the World Wars and Cold War. In 2024, there are two especially volatile conflicts that trace their origins to these wars. The first involves Israel and Hamas, and the second involves Russia and Ukraine. Both of these wars have the potential to escalate into something much deadlier if the combatants and their allies behave carelessly.

Israel and Hamas

The formation of Israel in May 1948 was the culmination of a long process that is impossible to summarize in a single book, much less a newsletter. A major driver of Jewish settlement in the region was the persecution that they experienced throughout the world — especially in Europe. This culminated in the Holocaust, which claimed the lives of more than six million Jews. Since Israel was established, some Middle Eastern countries and Palestinian groups have sought to negotiate a peaceful settlement. But others have sought to destroy each other entirely. Hamas, which has controlled the government of Gaza since 2006, falls squarely in the latter category.

On October 7, 2023, Hamas breached Israel’s security perimeter and proceeded to indiscriminately torture, rape, and murder more than 1,100 Israeli citizens. An additional 250 Israelis were taken hostage. Roughly half of the hostages are dead, and the fate of those who remain captive is uncertain. On October 8, 2023, Israel declared war on Hamas. The subsequent invasion of Gaza resembles a siege, which has resulted in casualties to both combatants and civilians. As of the writing of this newsletter, it is estimated than more than 30,000 Palestinians have died.

The Telltale Signs of Wars of Annihilation

There is only one attribute shared by all wars in human history: they are much more horrific than non-participants can imagine. Nevertheless, it is also true that some wars are more brutal than others; and the worst are wars of annihilation. The goal of at least one side in a war of annihilation is not simply to defeat an enemy, but rather it is to eradicate their presence altogether. Initial tactics often entail forced relocation and deportation, but when these inevitably become impractical, genocide typically follows.

There are few if any limits to the depravity of combatants in wars of annihilation. Torture, rape, killing, and mutilation of bodies are the norm rather than the exception. In 1937, Japanese soldiers killed more than 200,000 Chinese in the massacre of Nanking. Among the victims were prisoners who were used for bayonet practice or beheaded in contests in which Japanese soldiers competed to determine who could decapitate the most victims in a fixed amount of time. In the 1940s, the Nazi rampage through the Soviet Union resulted in the murder of millions of Slavs and Jews who were caught in the warpath and/or placed in concentration camps. These acts are the unmistakable signs of wars of annihilation.

Criticism of Israeli policies do not automatically equate to antisemitism — it is fair to say that Israeli governments (as well as Palestinian groups) have made mistakes and missed opportunities over the past eighty years. But those who highlight Israel’s mistakes would be unwise to persuade themselves that the savagery of the October 7th attacks was merely a tragic but anomalous war crime. Making such a categorization is only possible if one ignores the fact that the attack was meticulously planned and consistent with Hamas’s publicly stated goals: the destruction of Israel and elimination of the Jewish population from Palestine. Given this set of facts, it is unsurprising that Israel interpreted Hamas’s attack as the first act in a war of annihilation.

Risk of Escalation in the Middle East

The attack by Hamas and response by Israel is polarizing. Israel’s most powerful ally, the United States, continues to provide critical support. Iran, an outspoken enemy of Israel, remains steadfast in its support for Hamas. Many other countries throughout the world have offered varying levels of support for the two combatants, although most countries appear to lean in favor of the Palestinians.

The World Wars and the many proxy wars that occurred during the Cold War era resulted in millions of casualties. It is important to acknowledge that every casualty in war is tragic and excruciatingly painful for those affected, but by historical standards, the human cost of the Israeli-Hamas war is relatively contained. This could change, however, if the war escalates and compels allies to join the ranks of the combatants rather than remain on the sidelines.

Currently, it appears that the risk of escalation has declined after it peaked on April 13, 2024 when Iran launched more than 300 missiles and drones toward Israel in response to an Israeli attack on Iranian interests in Syria. Israel intercepted nearly all of these weapons, which halted further escalation. Nevertheless, the risk of escalation remains if only because wars are notoriously unpredictable. The emergence of a particularly cruel act or a strike in the wrong place could raise the risk of escalation considerably.

Russia and Ukraine

“First and foremost, it is worth acknowledging that the demise of the Soviet Union was the greatest geopolitical catastrophe of the century. As for the Russian people, it became a genuine tragedy. Tens of millions of our fellow citizens and countrymen found themselves beyond the fringes of Russian territory.”16

—VLADIMIR PUTIN, president of the Russian Federation

On April 25, 2005, Vladimir Putin gave an annual address in which he lamented the state of affairs in Russia. At the opening of the speech, he characterized the disintegration of the Soviet Union as one of the greatest catastrophes of the past one hundred years. This statement foreshadowed Putin’s attempts to reclaim lost territory over the next two decades.

On February 24, 2022, the Russian army began a full-scale invasion of Ukraine. The stated reasons were typical of such wars. Putin falsely cited provocation on the part of Ukrainians and expressed his desire to rescue Russians from oppression by Ukrainians. But the deeper, underlying motive appears to be Vladimir Putin’s simmering resentment for the disintegration of the Soviet Union and his desire to reclaim lost territory.

Initially, the attack on Ukraine seemed to present a terrifyingly high risk of escalation. Military experts expected Russia to quickly take control of Ukraine and then set its sights on another Eastern European country. The risk was that the next target could be a member of NATO. If this were to occur, NATO countries would be compelled to honor Article 5, which states that an armed attack on one NATO ally should be treated as the same as an attack on all NATO allies. Alternatively, NATO countries could refuse to honor Article 5 and thereby diminish the power of the alliance to deter armed conflicts.

Fortunately, the Russian military proved considerably less capable than originally feared, while Ukrainian forces demonstrated a will to resist that was far stronger than anticipated. More than two years after the war began, Russia remains mired in what seems to be an unwinnable conflict. As of the writing of this newsletter, Russia had ceded territory formerly held in northern Ukraine and only marginally expanded territory held in eastern and southern Ukraine.

World Leaders Must Tread Carefully

“America is especially fortunate in that she has no great military burden. Militarism is the nightmare and the ruin of every European financial minister.”17

—SERGEI WITTE, Russian foreign minister (1902)

In 1902, a leading American financier, Frank Vanderlip, toured the European continent to gain a deeper understanding of how the United States had suddenly leaped past Europe as the world’s dominant industrial power. Toward the end of the trip, he met Sergei Witte, the Russian foreign minister, who presciently described the effect that militarism would have on the fate of Europe in the twentieth century. The combination of World War I and World War II emptied Europe’s coffers and allowed the United States to replace the fading British empire.

World War II embers that are now aglow in eastern Europe and the Middle East seem to be relatively contained at the moment, but leaders of the great powers of the twenty-first century would be wise to take every step possible to ensure that they remain that way. War often explains the rise and fall of countries and empires. World leaders should tread carefully if they wish to prevent their people from joining the graveyard of the fallen.