Wednesday, March 12, 2008
Carlyle Capital Nears Collapse
Wall Street Journal - Carlyle Capital Corp. said late Wednesday it expects its lenders will seize its assets, causing the likely liquidation of the fund, which until recently owned $21.7 billion in mortgage securities. "Although it has been working diligently with its lenders, the Company has not been able to reach a mutually beneficial agreement to stabilize its financing," the fund said in a statement. The news comes just one week after Carlyle Group began pleading with some of the world's largest banks to hold off on margin calls and the liquidation of its mortgage assets. Several of the lenders, led by Deutsche Bank and J.P. Morgan Chase & Co. ignored Carlyle's request. Wednesday night, they began selling the fund's assets, which were committed as collateral against huge borrowings. By Monday, dealers had sold $5.7 billion of the fund's assets.
Thsi is what happens when you use borrowed money for leveraging and then the market craters. I've written in detail about the absolute stupidity and dangerousness of hedge fund leveraging. Leveraging is a big gamble at the best of times. When you factor in the astronomical sums, the borrowed capital and top that off with a credit crunch, what you end up with is hedge funds with billions of dollars' worth of unmet margin calls. To make it simple, I'll explain Carlyle Capital's problems with margin calls in plain english, instead of econospeak.
The London based Carlyle Capital Corp. Ltd bought into $16 billion of AAA-rated mortgage backed securities, using about $20 billion in loans from banks like Bank of America Corp., Citigroup Inc. and Merrill Lynch & Co., with the mortgage backed securities as collateral. This was back when the housing market was strong. Now the market has tanked and those securities are worth considerably less. Which means the banks need Carlyle to bring in more capital, to offset the fall in the value of the securities, and this is what we call a margin call. Carlyle has been trying to bring in some fast funding, but it could not pull it off. Which left the banks with no choice but to start selling the pledged assets in a firesale.
Now this is where it gets ugly. Because such firesales in bad times tend to bring in much less than what is owed. Which leads to bankruptcy. And even if Carlyle survives by a miracle, it virtually destroys the company and its reputation. Secondly, this could be a harbinger of similar problems at other hedge funds. Congress will start eying legislation to tighten the screws and investors won't touch hedge funds which are already heavily leveraged. It sort of sets the dominoes off, and lenders will start washing their hands off one hedge fund after another.
I don't think it'll come to that, but you have to face the fact that Wall Street is too leveraged for its own good, and using other people's money, at that. (Update - The Times UK, is reporting that a number of hedge funds are on the brink of collapse. The potential closure of six funds came as a leading private equity executive, who declined to be named, said that such funds were “snapping like twigs”, with one failing every day.)
A single fund manager sitting in a small cubicle with a big rolodex can convince a few investors to cough up a couple of million dollars, and with that as a base, the fund can borrow upto a billion dollars and leverage it to several billion. In good times, the fund manager is the king of Wall Street. He takes home hundreds of millions and tucks them away safely in some blue chip stocks and bonds. But when the shit hits home, the fund still has got only a couple of million to call its own, and the rest is owed money. How on earth is a fund in a small cubicle, with $2 million to call its own, be expected to repay several billion worth of obligations? So it declares bankruptcy. Since the fund manager has no personal liability, the hundreds of milions that he has tucked away are safe and sound from the mad-as-hell lenders.
If the fund manger gained hundreds of millions, someone must have lost them. Right? Now multiply this one rogue fund manager by several hundred or maybe a thousand, and then watch the ripple as all these funds pack up and leave the banks holding hundreds of billions in unsettled debt. The lenders then pass it on down the chain in the form of reduced earnings to investors, who actually lose money. These investors are ordinary people, pension funds and other Wall Street investment funds. This affects consumer spending and business bottomlines and then we enter what is commonly known as a downturn. If you're wondering how we started from Carlyle Capital's margin call problems and ended up with a recession, just read the whole thing again.
Thsi is what happens when you use borrowed money for leveraging and then the market craters. I've written in detail about the absolute stupidity and dangerousness of hedge fund leveraging. Leveraging is a big gamble at the best of times. When you factor in the astronomical sums, the borrowed capital and top that off with a credit crunch, what you end up with is hedge funds with billions of dollars' worth of unmet margin calls. To make it simple, I'll explain Carlyle Capital's problems with margin calls in plain english, instead of econospeak.
The London based Carlyle Capital Corp. Ltd bought into $16 billion of AAA-rated mortgage backed securities, using about $20 billion in loans from banks like Bank of America Corp., Citigroup Inc. and Merrill Lynch & Co., with the mortgage backed securities as collateral. This was back when the housing market was strong. Now the market has tanked and those securities are worth considerably less. Which means the banks need Carlyle to bring in more capital, to offset the fall in the value of the securities, and this is what we call a margin call. Carlyle has been trying to bring in some fast funding, but it could not pull it off. Which left the banks with no choice but to start selling the pledged assets in a firesale.
Now this is where it gets ugly. Because such firesales in bad times tend to bring in much less than what is owed. Which leads to bankruptcy. And even if Carlyle survives by a miracle, it virtually destroys the company and its reputation. Secondly, this could be a harbinger of similar problems at other hedge funds. Congress will start eying legislation to tighten the screws and investors won't touch hedge funds which are already heavily leveraged. It sort of sets the dominoes off, and lenders will start washing their hands off one hedge fund after another.
I don't think it'll come to that, but you have to face the fact that Wall Street is too leveraged for its own good, and using other people's money, at that. (Update - The Times UK, is reporting that a number of hedge funds are on the brink of collapse. The potential closure of six funds came as a leading private equity executive, who declined to be named, said that such funds were “snapping like twigs”, with one failing every day.)
A single fund manager sitting in a small cubicle with a big rolodex can convince a few investors to cough up a couple of million dollars, and with that as a base, the fund can borrow upto a billion dollars and leverage it to several billion. In good times, the fund manager is the king of Wall Street. He takes home hundreds of millions and tucks them away safely in some blue chip stocks and bonds. But when the shit hits home, the fund still has got only a couple of million to call its own, and the rest is owed money. How on earth is a fund in a small cubicle, with $2 million to call its own, be expected to repay several billion worth of obligations? So it declares bankruptcy. Since the fund manager has no personal liability, the hundreds of milions that he has tucked away are safe and sound from the mad-as-hell lenders.
If the fund manger gained hundreds of millions, someone must have lost them. Right? Now multiply this one rogue fund manager by several hundred or maybe a thousand, and then watch the ripple as all these funds pack up and leave the banks holding hundreds of billions in unsettled debt. The lenders then pass it on down the chain in the form of reduced earnings to investors, who actually lose money. These investors are ordinary people, pension funds and other Wall Street investment funds. This affects consumer spending and business bottomlines and then we enter what is commonly known as a downturn. If you're wondering how we started from Carlyle Capital's margin call problems and ended up with a recession, just read the whole thing again.
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