Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [82]
Like the doomed hedge funds managed by BSAM, Carlyle Capital financed its asset purchases with repurchase agreements. It had around $940 million in investor capital backing $22.7 billion in leveraged borrowings. CCC was around 24 times leveraged, meaning that if the price of its assets dropped 4 percent, the initial investment of its investors would be wiped out if it were forced to liquidate assets.18 If the price dropped more than that, its creditors, including a number of U.S. investment banks, would also lose money. Given that there were questions about the quality of the mortgage loans backing AAA rated securities, and given the low prices revealed when the BSAM’s bid lists circulated, a price drop of more than 4 percent was very likely.
By August 2007, the month the Fed indirectly bailed out Countrywide’s asset-backed commercial paper, the Carlyle Group provided CCC with a $100 million unsecured revolving credit facility to help meet margin calls. The value of CCC’s investments in AAA U.S. government agency residential mortgage-backed securities, declined in value. At the end of February 2008, the Carlyle Group increased its credit line from $100 million to $150 million.19 Carlyle Capital reported a net profit for 2007 of $16.8 million while downward price pressure on its assets persisted. In early March 2008, CCC received a notice of default for failing to meet a margin call, and it announced that since August it had sold around $1 billion in assets in an attempt to decrease leverage and increase liquidity. On March 7, 2008, after CCC could not meet additional margin calls, trading in CCC shares was suspended.20
JPMorgan Chase vice chairman James Lee Jr., warned a Carlyle Group founder, David Rubenstein, that unless it could line up a huge capital injection, the funds’ collateral would be seized to satisfy its debts. The problem was that the only likely source of capital for the fund was the Carlyle Group itself. JPMorgan Chase was asking the Carlyle Group to bail out its hedge fund the way Bear Stearns had bailed out BSAM’s doomed funds. If the Carlyle Group bailed out its fund the way Bear Stearns had bailed out the funds managed by BSAM, it could lose some of its own principal, and losses would probably eclipse its $16.7 million in profits reported for 2007. On the other hand, investment banks seizing collateral would use up much needed liquidity. If investment banks were forced to immediately liquidate Carlyle’s billions in assets, they would take losses and drive market prices down even further. As of March 10, 2008, Carlyle Capital stared down the barrel of around $400 million in margin calls it couldn’t meet, and it asked its lenders for a standstill agreement.21
Bear Stearns had its own liquidity problems that week as the market speculated on its exposures. Even the breaking Governor Spitzer pay-to-play sex scandal could not upstage the March 10 Moody’s Investors Service’s downgrade of tranches of mortgage-backed debt issued by Bear Stearns Alt-A Trust. Bear Stearns was one of Carlyle Capital’s creditors and now this. Throughout the day of March 10, rumors circulated that Bear Stearns was sinking fast from lack of liquidity and possibly even insolvency. Bear Stearns officially denied it, saying there was “no truth to the rumors of liquidity problems.”22
In reaction to the market’s reaction, Moody’s clarified that its ratings actions did not affect Bear Stearns’ corporate ratings, which