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The collapse of Tricolor, a $1bn subprime private credit lender making loans to those without Social Security numbers, is a rather small canary in a very large coal mine: the $3 trillion private credit industry. That industry has been fueled by “funny money” credit availability and represents a poisoning of the existing global credit system, seeking to increase yield by making loans of yet lower credit quality. It is the blackest impending hole in a world economy that has a lot of black holes and is heading for an inevitable debt deflation.

Sound financial markets depend on two factors. The first is openness, integrity and frequency in audited financial and operating disclosure, so that investors and creditors can spot quickly where corporate management is messing up or stealing. The second is a sober realization by investors that the tradeoff between risk and return is ironclad, so that additional risks cannot be taken without long-term returns being severely imperiled. This essential financial truth was disguised for over a decade by Ben Bernanke, but in the end as Kipling wrote: “The Gods of the Copybook Headings with Terror and Slaughter Return.”

In this respect, President Trump’s recent call to abolish quarterly financial disclosure is a substantial move in the direction of financial obfuscation. In an era when decades of “funny money” and oversized returns to stock options and dodgy accounting have lowered the integrity of the global economic system and of corporate management in particular, investors need the most frequent possible information on what games management is playing in the companies in which they invest.

Given modern IT systems, it would be possible to provide weekly reports on a company’s activities rather than the quarterly reports mandated by the SEC in 1970, but quarterly reports are the minimum necessary to spot in a timely manner when things are going wrong or investor money is being embezzled. Longer reporting periods severely disadvantage retail investors against the institutions, who have analysts visiting the corporations regularly and receiving “whisper” information allowing the big guys to front-run ordinary investors out of badly behaving or unlucky companies. The U.S. and global economic systems are already excessively rigged in favor of large corporations and their unpleasant management cadres; reducing investor disclosure would greatly worsen this problem.

However, publicly listed companies outside the tech sector are unlikely to be the nexus of the next debt deflation, though if Trump’s proposal is adopted they may well be central to the following one. For the current problem areas, we must look to asset classes where risk is prevalent, creators of the asset class have different incentives to its owners and transparency is more or less zero. From the Tricolor saga, private credit lending in general and subprime auto loans in particular fit this paradigm and are an accident long overdue to happen.

As we saw in 2007-08, subprime lending to individuals is very often abusive; high-pressure salesmen target vulnerable individuals with few financial resources and offer them loans that they cannot service and that will permanently worsen their financial position. This is true in subprime real estate lending, where minorities and others of poor credit risk are forced to pay much more than richer people for their home mortgages.

Subprime loans are even more abusive in auto lending, where the asset itself depreciates substantially immediately it is driven out of the showroom, and where simple people are suckered into overpaying both for the car and the loan that finances it. As a relatively wealthy individual, I have never bought a new car and have no intention of doing so; the cost of a 3-4-year-old model is roughly half the cost of a new model, and the used car has far more than half its useful life remaining. Thus, anyone buying a brand-new automobile with a subprime auto loan is destroying their financial position for no good reason. Naturally, high-pressure salesmen, who make commissions on both the automobile and the loan, will make every effort to inveigle them into this ruinous transaction.

In Tricolor’s case, many of the loans were being made to people without Social Security numbers – in other words, to illegal immigrants. Now that immigration controls are being properly applied, the ruinous subprime auto loan is the least of the illegal immigrant’s problems. If he can escape the net of ICE, he will almost certainly return home, ideally with the car but with no intention or ability to service the loan. The entire transaction was contrary to sound public policy and Tricolor’s bankruptcy is to be welcomed; it can only be hoped that fraud authorities can successfully pursue the car dealers and loan brokers who put the disgraceful deals in place. Most illegal immigrants are not criminals (other than by breaking immigration laws). It is however to be hoped that their interaction with the quasi-criminal high-pressure salesmen of the subprime auto loan industry will deter them permanently from returning to the United States.

In general, the private credit business is driven by the availability of cheap leverage, which enables investors to make low-quality loans in large quantities and finance them with medium-term credits from the banks or through securitization. It has expanded in recent decades because of another of Ben Bernanke’s follies: the “quantitative easing” that parked more than $3 trillion of deposits with the Fed on banks’ balance sheets, which at current interest rates yield far more than the “free money” cost of the banks’ retail deposits.

With their balance sheets blocked by this profitable garbage, banks have cut back their lending to small businesses, which in a properly run economy would be the principal purpose of their existence. Lending to large corporations is profitable only because of the fees that can be charged on jumbo acquisition loans; lending to small companies is difficult and expensive, and banks would very much rather avoid it, which they can through the Fed deposits.

The additional layer of expensive intermediation brought by the private credit providers pushes credit, not towards sound transactions, which do not yield enough to provide the sought-after returns, but towards the subprime: junk corporate lending, subprime mortgages and even more subprime automobile and consumer lending. Sound small businesses are starved for finance, as they have been since Bernanke swung into action, though they do have access to the publicly listed business lenders, which have raised a modest $61 billion from the market. (These lenders are a subset of the private credit business but finance themselves from dividend-seeking high yield retail investors, so are less greedy than most of the sector.)

In any kind of downturn, credit losses are heavily concentrated in subprime lending areas and the risk-reward equation turns sharply negative. By pushing up the proportion of lending that is subprime junk, the private credit sector has become thoroughly procyclical, expanding rapidly and shrinking spreads when money is easy and eventually producing a tsunami of losses when monetary conditions finally tighten, as they must.

There may be help coming. Individual investors, whom Trump seeks to disempower further in favor of corporate management by his abolition of quarterly reporting, will soon get a tool that will enable them to manage their own portfolio. That will cut out the unpleasant layer of “financial advisors” all of whom are hopelessly conflicted between their client’s needs and their own, and many of whom are utterly incompetent trend followers, buying high and selling low. Instead, retirees and others with modest portfolios with the help of AI will act like 18th century country gentlemen, choosing local investments and investments where they have special expertise – as Peter Lynch recommended back in 1989.

Artificial Intelligence can potentially give individual investors all the MBA-type knowledge they need to manage their own money, thus liberating ordinary people from parasitic financial intermediaries. This, not the ability to invest in private equity (don’t – you’ll be shown the worst deals) and Crypto (don’t – you’ll be shown the worst scams) or replacing banks by stablecoins (an insanely scammy idea) is the agent that will return true small investor/small entrepreneur capitalism to its rightful place at the top of the world.

Reform of the Federal Reserve System is also essential and is rapidly becoming a priority of the Trump administration. In an ideal world, Trump would do what he knows best and merge the Fed with a casino, hoping to write off the $200 billion of Fed losses against income from punters attracted by the Fed’s dominance of the international financial system.

In an even more ideal move, he could then sell the merged entity to the Native American Iroquois, thus gaining valuable tax benefits from the casino being located on Native American land. This would pay back the Iroquois Confederacy for its economically evil inspiration of the U.S. Constitution, which foolishly does not mandate a Gold Standard or forbid a central bank. One can dream!

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