Watch Out Below !

I’m not sure all that many people realize just how fragile the financial system ostensibly led by the United States is looking these days (warning and caveat … I am NOT a professional economist).

But the way I see it, this news of default (NY Times excerpt below) by Carlyle Capital , which by and large invests in government-backed mortgages, means that the lender of last reserve has quite a few faulty and relatively worthless assets upon which to rely / fall back when the shit really hits the fan (which IMO should have happened by now).

By "lender of last reserve" I basically mean the government of the USA, which is essentially the proprietor of Fannie Mae and Freddie Mac (there are important distinctions - the companies are owned by shareholders but operate under a government charter for the purpose of providing confidence and stability to credit markets).  When mortgages held by these agencies cannot back the leverage of large, high-profile funds like Carlyle Capital it means, I think, that more trouble is on the way.

It will also be criminal if eventually the government(s) act to bail out such funds or the wealthy reprobates which manage them.

UPDATE:  The USA Federal Reserve just lent $200 billion of taxpayers’ money to help prop up Bear Sterns.  Which bank will come close to failing next ?  Added bonus - Eliot Spitzer has been sidelined, just in the nick of time.

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Carlyle Fund Expects Assets Will Be Seized

[ Snip ... ]

Carlyle Capital, an Amsterdam-listed affiliate of the Carlyle Group, the private equity fund, said it “has not been able to reach a mutually beneficial agreement to stabilize its financing.” Its shares fell more than 70 percent Thursday. They have fallen more than 90 percent since the company’s problems became public last week.

“It has become apparent to the company that the basis on which lenders are willing to provide financing against the company’s collateral has changed so substantially that a successful refinancing is not possible,” Carlyle Capital said in a statement late Wednesday.

Carlyle Capital invested in triple-A rated mortgage debt issued by Fannie Mae and Freddie Mac, and like other investment vehicles it had leveraged its capital aggressively, borrowing $31 for every dollar of equity. As of February, it had $21.7 billion worth of assets in its investment portfolio. But as those investments lost value, creditors demanded that it put up more and more money in margin calls. A $150 million line of credit from its parent, the Carlyle Group, was not enough to keep it out of trouble as lenders demanded more collateral to back up their loans.

By Wednesday, it had already defaulted on about $16.6 billion of debt and some lenders started to liquidate assets. Talks to halt liquidations and revive the fund’s finances failed Wednesday night after the value of collateral declined further, prompting additional margin calls worth $97.5 million.

The announcement sent shudders through Asian and European markets as investors fear more funds, even those investing in highly-rated assets, could run into trouble. Banks are calling in loans or ask for more collateral as the value of assets backed by mortgage-securities continue to decline.

The collapse of talks between Carlyle Capital and some of its lenders, which include Bear Stearns, Bank of America, Citigroup and Merrill Lynch, shows that a plan earlier this week by the Federal Reserve to back some assets like private mortgage bonds has not stopped banks from demanding more collateral.

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