Carlyle fund was 28x leveraged
Front page of FT companies and market section this morning. Margin calls came hitting the fund and the shares in the fund plunged 60% on the news. But the bit that *really* caught my attention is:
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.
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.
Comments
My calls: Hold the gold. Buy the silver. Short the S&P. LEAPS on select financials. Oh, and get out of hedge funds. Party on.
how long can the commodities party go on? I mean the run-up is not linked to real consumption or a fall off in demand (except maybe corn and oil that is paid in dollars)... is it just speculation?
Also LEAPS??? what is it?
I am out of hedgefunds... Actually trying to reproduce some of it (the hedging) without the debt leverage. I am not paying the outrageous fees either :)
Options. But LEAPS doesn't seem to indicate position and return profiles, does it? What is your view on financials...
Can you believe I am 40 and I have only really recently understood the math behind the options... my brother explained the structure of a product I bought (abs return). Went through the "corporate finance" book on options :)
But then I am actually 39 and only recently understood the concept of money (I mean M2 :)
if 400bn are evaporating in real capital due to losses in sub-prime adn banks are 10x extending leverage, then shouldn't we see an evaporation of 4Tr in M2?
Doesn't M2 link directly to demand? Since the GDP of "world" is 50T, doesn't it means an 8% fall in asset prices???
If you're still into financial reading, check out When Genius Failed, a story of the Long Term Capital Management from just one decade ago. LTCM was routinely running around at 30 times leverage and I think might have doubled that before flashing out. The geniuses behind the fund included Nobel prize winners, including none other than Mr. Scholes, famous for the Black-Scholes option pricing model :-)
It goes to show how people working in the financial industry have very short memories. At least Carlyle did, as they were just putting themselves into the same predicament that LTCM did. There are no risk free hedges, and eventually too much leverage will bite you. Black swans, and all that.
I went through the audio book which is nice, just put it on your iPod and you're still free to do other stuff while listening.