For years I've been warning that buy now pay later ("BNPL") industry was built on a pretty fragile foundation. The quality of the loans was always the obvious problem. The entire business model revolves around extending instant credit with minimal underwriting to consumers making small purchases.

Companies whose primary innovation is allowing consumers to split a $40 online purchase into four installment payments probably aren't lending to the most creditworthy segment of the population.

If anything, the model practically guarantees the opposite. When financial companies create products that allow consumers to finance extremely small discretionary purchases, they are effectively targeting borrowers who either don't have the liquidity to cover those purchases outright or who have already exhausted more traditional forms of credit. When consumers are putting things like f**king Chipotle Burritos and Hostess Twinkies on layaway, the borrower pool you are dealing with is not exactly prime.

It is the same dynamic that has been visible in peer to peer lending and fintech credit for years. Platforms like Affirm, along with payment ecosystems tied to firms like Block, built massive growth stories by expanding credit access to people who historically would not have qualified for traditional lending products. For a while that looked like financial innovation, especially when they could find buyers for the loans. In reality it mostly meant pushing unsecured credit deeper down the credit spectrum.

That approach worked beautifully in a zero rate environment where capital was abundant and investors were desperate for yield. It worked great during a 3 year period of Covid where liquidity was unlimited from the Fed. It is slightly less impressive once interest rates rise and credit markets start behaving like credit markets again. In fact, we are watching the "con" of this being called "innovation" being laid bare…first in names like Carvana, then in private credit, now in BNPL. Subprime lending and accounting tricks are simply not innovation, no matter how much of a polish you put on them.

The latest example comes from a report in The Wall Street Journal describing stress inside a private credit fund managed by Stone Ridge Asset Management. The firm runs the Stone Ridge Alternative Lending Risk Premium Fund, commonly known as LENDX, which buys whole loans and securities tied to loans originated by fintech lenders. That includes buy now pay later loans from Affirm along with personal loans from LendingClub and Upstart. The portfolio also includes merchant financing tied to payments platforms like Block and Stripe.

Recently investors in the fund tried to withdraw far more capital than the structure allows, and Stone Ridge informed clients that it would only be able to honor about 11% of the redemption requests. The fund is structured as an interval fund, which means investors cannot simply exit whenever they want. Instead they are given limited redemption windows and the manager is only required to repurchase a small percentage of shares each quarter, typically around 5% with some flexibility above that. This structure works perfectly well as long as investors remain calm and redemption requests stay modest. The problem appears when investors collectively decide they would prefer their money back. The underlying loans in these portfolios are illiquid and cannot be sold quickly without taking significant discounts, which means the easiest solution is simply to gate withdrawals.