Carlyle Group Default

News from New York:

Property investment trusts shares have crashed on panic selling in New York after an affiliate of the private equity giant Carlyle Group fell into default on mortgage losses.

As Felix Salmon reminds us, we'vebeen here before:

Remember Long Term Capital Management? The problem there wasn't that it was investing in risky securities, like Russian bonds. Instead, Russia's default set off a more generalized spread widening and flight to liquidity, which hit super-safe assets like off-the-run US Treasuries. Because those assets were super-safe, LTCM had been able to invest in them with enormous amounts of leverage. And so when the sell-off arrived, LTCM went under.

Carlyle too was investing in supposedly extremely safe (Fannie Mae and Freddie Mac backed securities) and so was able to get very high gearing on them: 32 times according to reports. So it only needed a small change in the underlying prices (or rather, relative prices) for the equity capital to get wiped out and thus the margin call to be missed.

Nothing wrong with the original bet and, in fact, nothing wrong with the gearing. Financiers make a big bet: financiers lose their money. Nothing wrong with that at all, that's the way the system is supposed to work.

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