The fund listed in Amsterdam by the Carlyle Group last year, has been hit by a fal in the value of its $21.7bn portfolio of triple-A rated residential mortgage-backed securities, illustrating that even the safest investments can be perilous when combined with the use of massive amounts of borrowed money. Carlyle had $28 of borrowings for every $1 of its own money
Whaaaa??? did you get that? 28 to 1 leverage??? I find that amazing. Clearly the magic of leverage cuts both ways. For those of you that are not familiar with it, here is the simple math. Say you put $1 to work... you go get 28 dollars of debts. Say those $28 cost you 7% and you make 9% on them (some ARS muni yield 15% right now!), your profit is 2% or 56c. But really since I invested a dollar and get back 56c, it is showing a 56% return which is like "i waaaalk on waaaaaaater fantastic" in the financial world. And notice that I did that purely on munis!!! aren't I a genius? clearly I should charge 20% of the profits!
That by the way is the reason the hedge funds started leveraging like crazy, you goose your returns... as long as the markets go up.
But if the markets go down, your equity (the one dollar you put in it) is what gets wiped out first. Hence the 60% drop of the equity. The equity is going negative quick. This is what is happening with the "jingle mail" tsunami in the housing US market. If the prices go down you end up owing more to the banks than your house is worth so ...you walk away.
What is to prevent firms to do the same? they lose YOUR money and then walk away from the commitment to the banks? Oh please don't give me the crap about their "reputation" and all that... watch!
This is how the credit mess spreads, the fat lady isn't even close to singing.