Carlyle Capital went into technical default today as it failed to meet four of seven margin calls. This is despite receiving $150 million in credit from its parent, the Carlyle Group.
While it is amusing to see the evil Carlyle Group have financial trouble, that wasn't the most important part of this news story. The significant item was three paragraphs down:
The fund used loans to buy about $22 billion of AAA rated mortgage debt issued by Fannie Mae and Freddie Mac, securities that Carlyle says have the ``implied guarantee'' of the U.S. government. Even those bonds have slumped, leading to the failure of hedge funds led by Peloton Partners LLP.
It's one thing for Fannie Mae and Freddie Mac equities to go down. It's totally another to see their bonds, which have the implied backing of the U.S. Government, fall. Yields on these agency bonds are at their highest levels since 1986.
What exactly is going on in the credit markets these days? No one really knows for certain, but it isn't good.
"There's basically a buyer's strike right now."
- Don Brownstein, chief executive officer of Structured Portfolio Management LLC
The financial markets have acted a lot like a roach-infested house recently. If you see one roach, then you know there are thousands behind the walls.
Agency mortgage-backed securities total about $4.5 Trillion, which is roughly the same amount as the entire U.S. Treasury market. So volatility in this market can destabilize an entire financial sector - in this case, hedge funds.
Since November, 24 hedge funds have barred investors from withdrawing their funds. That's billions of dollars that are locked into assets where investors can't get at them.
Hedge funds have been heavy buyers of agency bonds for years.
This credit trouble that the Federal Reserve once called "contained" to the subprime market has also spilled over to the corporate bond market.
Spreads on U.S. corporate bonds on Thursday approached their widest levels since the bankruptcy wave of 2002 on worries about hedge fund selling of a wide range of corporate, mortgage and municipal bonds.
"Basically the gears of capitalism are pretty much grinding to a halt," said Mirko Mikelic, portfolio manager for Fifth Third Asset Management in Grand Rapids, Michigan. "What started as a little subprime problem has kind of morphed into a bigger problem for the bigger economy."
Corporate bond issuance has been almost non-existent since the credit crunch of last summer.
You can blame leverage for this. For instance, Carlyle Capital was borrowing at 32 times capital resources, and this is not unusual on Wall Street. It maximizes profits on the way up, but it also maximizes losses on the way down.
All these losses are making banks wary of lending money. Without the investment banks, the liquidity in the market has almost completely dried up.
"Everything is telling you the financial system is broken."
- Scott Simon, head of mortgage-backed bonds at Pacific Investment Management Co.
At the enter of all this is the derivative market - specifically credit default swaps. I did a diary about how these work a few weeks ago here, so I won't bother to repeat myself. Nonetheless, you'll be hearing about them much more in the near future.
The higher costs are an unintended consequence of securities that allow investors to speculate on corporate creditworthiness. So-called correlation models used to value them have become unreliable in the fallout from the U.S. subprime mortgage crisis. Last month some showed the odds of a default by an investment- grade company spreading to others exceeded 100 percent -- a mathematical impossibility, according to UBS AG.
``The credit-default swap market is completely distorting reality,'' said Henner Boettcher, treasurer of HeidelbergCement in Heidelberg, Germany, the country's biggest cement maker. ``Given what these spreads imply about defaults, we should be in a deep depression, and we are not."
Well, we aren't in a deep depression yet.
The markets keep getting more and more distorted and illiquid. This can't go on for much longer without the financial markets completely breaking down.
Of course this isn't altogether bad news for the investment banks. They may lose money on one hand, but they are making more money with the other.
The collapse of the auction-rate bond market may cost borrowers from New York to California at least $1 billion in fees, enriching JPMorgan Chase & Co., Goldman Sachs Group Inc. and the rest of Wall Street that let the market fall apart.
The firms that pulled their support of the market where states, counties, hospitals and universities raised $166 billion are offering to convert the securities for a price. Banks may be paid as much as $525,000 for every $100 million of securities, based on the average price for arranging municipal bond sales in 2007.
"There's always a shiny new deal, and the banks make money every time they participate," said Houston City Councilwoman Anne Clutterbuck, head of the council's budget and fiscal affairs committee.
[...]
``The taxpayers are clearly losing,'' Weitzman said.
No matter what the circumstances, there is always the chance for abig corporation to steal from someone, whether it be taxpayers or stockholders.
Three chief executives with ties to the mortgage crisis were paid $460 million over five years, according to a congressional report issued Thursday.
The panel, chaired by Rep. Henry Waxman, D-Calif., will hear testimony from Charles Prince, former CEO of Citigroup Inc.; Stanley O'Neal, former CEO of Merrill Lynch & Co.; and Angelo Mozilo., chief executive of Countrywide Financial Corp., the nation's largest mortgage lender.
These three made enormous amounts of money even while their companies were hemorrhaging investor money. And speaking of Angelo Mozilo, one of the worst culprits, who does he blame for all his troubles? Why the left wing anti business press, or course. Who else?
One group of executives that are not on this list, but should be, are the executives from Washington Mutual.
The board's Human Resources Committee last week established 2008 bonus targets and performance measures for the company’s executives, including CFO Thomas Casey. Citing "the challenging business environment and the need to evaluate performance across a wide range of factors," the thrift giant said the bonus formula would not take into account the huge losses the financial services giant has suffered from the housing crisis.
So in other words, the executives did a great job at WaMu, except for all the spectacular losses in their primary business.
Meanwhile, on the consumer side, there is nothing but bad news.
For instance, household net worth fell for the first time in five years.
Home foreclosures hit a new record.
Homeowner equity dipped below 50%, the lowest on record. 10.3% of homeowners have no equity at all.
[Personally, if you own less than half of your house then you aren't a homeowner. You are simply renting it from the bank.]
We are staring into the abyss. There's been a complete lack of leadership in the White House, the Federal Reserve, and the financial community. What started last June is morphing into a monster.
A few more months like this and the entire system will start breaking down. We aren't going to make it to the election in November. Not like this. We won't even make it to Independence Day unless something drastic is done.
The entire credit market is in danger if freezing up. Once that happens major banks will start failing. And considering all the counter-party risk in the derivative contracts out there, it will quickly spread worldwide and no one's life savings will be safe unless you have it stuffed in your mattress.
This can still be stopped, but the clock is ticking.