Leverage Wipes Out Carlyle Capital: Implications are Ominous

The Wall Street Journal is reporting Carlyle Capital Nears Collapse As Accord Can't Be Reached.

The credit crisis has claimed another victim. 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.

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.

The fund's collapse shows how Wall Street's biggest players have begun playing hardball with some of their best clients. And they reveal how jittery banks have become about their own loan exposures. In the case of Carlyle, 12 banks had lent the fund about $21 billion, or $20 for every dollar of initial capital.

Leverage Licks Carlyle

Selling begets when you use leverage like that. I talked about that in Margin Selling Chain Reaction a few days ago.

Today Professor Andrew Jeffery is writing Leverage Licks Carlyle.

In hindsight, 32 times leverage seems excessive. That we are now referring to Carlyle Capital with hindsight is astounding.

Stock market futures sold off hard this morning on news that Carlyle Capital, a division of private equity firm Carlyle Group, is on the verge of collapse. According to The Wall Street Journal, lenders led by Deutsche Bank (DB) and JP Morgan (JPM) are set to seize and sell what's left of the fund's assets.

Writedowns on their own mortgage-related holdings are forcing banks into capital preservation mode. Under normal circumstances, lenders would be willing to work with a fund like Carlyle to sell assets, raise money, roll over debt or find some other solution that would prevent the fund's liquidation. These, however, are not normal times and banks have enough problems without having to worry about their clients blowing up, too.

That such a large block of agency paper -- securities backed by Fannie and Freddie -- is about to flood the market is worrisome.

Lehman Recommends MBS

Given that a "flood" of paper is hitting the market today I am more than a little suspicious about the timing of this recommendation yesterday: Lehman Brothers moves to MBS overweight.

Lehman Brothers Holdings Inc (LEH) said it raised its U.S. mortgage-backed securities recommended allocation to an overweight position.

The Wall Street investment bank said late Tuesday it raised its allocation from a 3 percent underweight to a 5 percent overweight in response to the Federal Reserve's action to inject liquidity into credit markets.

The new Term Securities Lending Facility, or TSLF, is the Federal Reserve's latest proposal that contains provisions especially targeted to mortgages and operates among primary dealers instead of depositary institutions.

And in taking another look at The Fed's Swap Meet , the picture becomes even more clear. Part of the rationale behind TSLF deal was simply to give banks liquidating Carlyle Capital a place to dump that flood of supply of MBS. For what happens 28 days later, please read the above link. The implications are ominous.

Comments

[ballsschweaty]

Gold is over $1000 and oil is $110. Is that Deflation?

LOL!!!!

Keep forecasting deflation. One of these years, you're bound to be right.

You've been forecasting Deflation since oil was at $40 and gold was at $500.

[Mr. SafeInvestor]

I have no sympathy for these jerks.

Carlyle's Fund, by implementing Leverage of 32:1 to make a razor thin spread provides no margin of safety, is not a value-add investment and is merely financial alchemy in an effort to generate massive fees.

As for Lehman recommending an "overweight" position is MBS, it is entirely self serving given the massive amount of exposure that they have to these toxic instrument. They did the same thing in 2001 by recommending telecom stocks & bonds when they had too much of that exposure at that time. Where is the "independent"... research that Wall Street was supposed to provide after the "clean up" ? Now that Eliot Spitzer is "out of favor" is Wall Street allowed to go back to its self-dealing ways?

[iThinkBig]

Hey Bals Sweaty and Brain obtuse. When Americans are bankrupt from one area of hyperinflation like oil you lose in the end. Enjoy the Rolls-Royce for now buddy. Invest in a big house with a ten foot fence and security guards for later.

[Scott Teresi]

Can't say this is very disappointing. From what I understand, Carlyle was a corrupt war profiteer, encouraged by the Bush administration. Its no-bid contracts and enormously wasteful spending during the war directly benefited George H. W. Bush (an investor and advisor to Carlyle). The best info I can find on this is a video:

video.google.com/video...

(ignore the first two minutes, in a foreign language)

Scott

[Scott Teresi]

Not sure how to post a link here, but here's the URL without the HTTP at the beginning:

video.google.com/video...