The news came out yesterday that Carlyle was defaulting on over $15 billion in mortgage-backed assets ("MBA"). What wasn't really covered was:
- Carlyle was carrying in excess of a 30 to 1 leverage. That means that Carlyle investors had less than $1 billion of their own money in the fund. (The original fund estimates were over $20 billion fund value).
- That means that the banks (remember - the guys the Fed has been printing money to help save - tanking the dollar in the process) that lent them the money just got left holding a $15 billion dollar bag of steaming goodness in return for probably less than 7% of the cost in return.
- The walk away won't hurt the ability of the parent to raise money - just probably means they will have to put more money at risk next time.
The Fed is really in a bind. Even the talking heads on CNBC and Bllomberg are now saying that any cuts by the Fed will tank the dollar, raise commodities and feed inflation.
The curtain is torn - the Fed (and the US economy) is screwed.
More below:
Sect of the Treasury has leaked his 10:30 AM speech already. The shocker:
He says that the regulation of financial products has lagged their development. That regulation needs to be improved to control the risks associated with new derivatives.
He calls for national licensing of mortgage brokers (a Bushie calling for regs?)
He says the industry must come up with a derivatives clearing mechanism. That is going to be expensive - here's why:
A clearing house requires margin on a trade - if you are selling something or buying it, both sides put up margins. In physical markets, the credit is determined between the parties. Two good credit parties may just accept the risk of doing business - thereby removing the need for margin and decreasing the need for working capital. If both trade through a cleared market - they may need at least 5% more working capital and possibly more on margin calls.
The dealers don't have the exposure - if you both buy and sell, you have to post margin on for the difference between your buys and sells. In essence, as markets become more intermediated (i.e., more middlemen) in a cleared market, the willingness to accept credit risk declines. When it reaches the threshold of needing clearing, the market requires the ultimate buyers and sellers to recapitalize all that risk (its what happened in the US electricity and natural gas markets after deregulation).
If this happens in MBAs, you can looks for a 5% increase in working capital needs. That will go right to mortgage costs. This, in my mind, will greatly exceed the savings of securitization.
So, expect the end result to be that mortgages require more upfront in points - just to cover their clearing risk.