US sweats as Carlyle fund goes south

Even $200bn can't calm US jitters. A Carlyle hedge fund has gone bust, and several others could follow...

Last Updated: 31 Aug 2010

On Monday the Federal Reserve poured a whopping $200bn into the financial market in a desperate bid to jump-start the moribund economy. But after an initial bounce, it looks as though the move has failed to have the desired effect. Today Carlyle Capital Corporation, a unit of private equity behemoth the Carlyle Group, admitted that it hasn’t been able to cut a deal with its lenders – who are now likely to liquidate the fund’s remaining assets to get their money back. And there’s a lot at stake. The $21bn CCC fund, which invested in US mortgage-backed securities, only contained about $600m of real money – the rest was borrowed from banks to ramp up returns.

In the last week, CCC has been besieged by margin calls – demands from its lenders that it should increase the collateral it holds to protect their credit risk – which it hasn’t been able to meet, due to the fund’s declining value. As a result it’s already defaulted on $17bn in debt (with the rest soon to follow) and despite frantic negotiation with its lenders, it hasn’t been able to dissuade them from winding up the fund.

Big US hedge fund pays the price for betting the house on the US mortgage market – we can understand if you’re not desperately sympathetic. But the alarming thing about CCC’s collapse is that it wasn’t investing in pools of dodgy sub-prime mortgages, diced and sliced into products that nobody really understood. These were AAA-rated securities – supposedly the safest you can get. And the whole point of the Fed’s intervention on Monday was to make them even safer.

So what happens next? Well, the people with money in CCC will probably lose it. But the broader point is that the $200bn clearly hasn’t had the intended effect – it hasn’t stopped banks foreclosing on borrowers even when they’ve got cast-iron collateral.

Worse still, some think the Fed’s move will actually do the opposite. In practice, the $200bn rescue package allows banks to swap mortgage-backed securities (like Carlyle’s) for rock-solid Treasury bills. So if you’ve got a big exposure to those securities via a hedge fund, it presumably makes sense to claim them back and swap them for the safer Treasury bills instead.

So there are likely to be a few hedge fund managers looking nervously over their bespoke-suited shoulders in Mayfair this morning...

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