Hedge Funds: Mortgage-Backed Securities Do In Carlyle

Adrian Ash - Thu 30 Aug, 2007

"We designed CCC's business model to withstand a liquidity event equal to the events of October 1998," says the head of Carlyle Capital Corporation, John Stomber, in a letter screwed out of him by angry investors, "when the demise of Long-Term Capital Management threatened the financial markets. [But] we believe the recent liquidity disruption is significantly worse than the events of 1998." Worse than 1998, eh? Who'd have thought it! And who would have been brave enough to plug a worse-than-LTCM event into their portfolio model...before pitching their hedge fund to prospective new clients?

- If your portfolio's taking on water faster than the Lusitania – and you fail to take heart from Collins Stewart, the stock broker, claiming that banking shares now offer "a once in 10 years opportunity" to buy cheap – then perhaps prayer might help?

- Step forward St. Teresa of Ávila to guide you. Patron saint of headache sufferers, the 15th century Spanish mystic is well placed to help investors wrestle with their troubles today. For their headache has rarely been bigger.

- "We designed CCC's business model to withstand a liquidity event equal to the events of October 1998," says the head of Carlyle Capital Corporation, John Stomber, in a letter screwed out of him by angry investors, "when the demise of Long-Term Capital Management threatened the financial markets. [But] we believe the recent liquidity disruption is significantly worse than the events of 1998."

- Worse than 1998, eh? Who'd have thought it! And who would have been brave enough to plug a worse-than-LTCM event into their portfolio model...before pitching their hedge fund to prospective new clients?

- You'll never get rich in a credit-led bubble putting caution before risk. To sit on the leading-edge of financial profiteering, investment managers must borrow freely and boldly, buying the best-yielding junk they can find with the cash. But sitting further back inside the bubble won't mean you’re safe when the inflation goes bang.

- Only last month, Carlyle Capital Corporation – an offshoot of private equity firm Carlyle – raised $332 million by floating itself on the Euronext stock exchange in Amsterdam. Just ahead of that happy day, CCC claimed it only invested in triple-A rated securities "as far away from sub-prime as you can possibly get." And thanks to planning for mere-LTCM-sized disasters, it's also come to hold around $22.7 billion on behalf of its investors, mostly in – oops! – mortgage-backed securities.

- Now CCC has gone back to Carlyle, its parent, asking for a $200 million loan to help it meet demands from its lenders. It's already dumped 5% of its assets for a $40 million loss, according to The Guardian. By last night's close, its shares had lost 21% of their value from their flotation in July.

- But what's to fear from the mess in the haute finance kitchen down here in the scullery of real jobs and mortgages, Chinese-made sofas and Inside Soap magazine? Well, according to the official data, the UK economy grew by 0.8% between April and June, as Matthew Lynn points out at Bloomberg today. The business-and-finance sector grew by 1.5%, nearly twice the pace of everything else. And that extra inflow of cash helped keep the wider United Kingdom in disability allowance and shiny new "No Smoking" signs as the summer drew nigh.

- "The London economy continues to outperform the UK in terms of annual output growth," gushed Ken Livingstone, mayor of London and former Communist, in a recent speech. "This strong performance has been led by the financial and business services sector."

- Now that strong performance has vanished, and where the financial and business services led, poor lumpen investors now find themselves dumped. Asian stock markets fell hard overnight – down 1.4% on the MSCI Asia-Pacific index – after the Japanese Yen spiked on the currency markets and US equity investors suffered their worst day in three weeks.

- The S&P 500 closed 2.3% lower on Tuesday, despite minutes from the Federal Reserve's latest policy meeting that claimed it "expected a return to more normal market conditions." The Fed's meeting was held on Aug. 7th. Since then, inside three weeks, the Dow Jones Index has lost 3.4% of its value.

- Should these market conditions prove to be "normal" for much longer, equity investors would do well to quit now.

- Here in London, meantime, the FTSE100 gapped down at today's open after Cheyne Finance – yet another young fund at the cutting-edge of highly geared finance – said it may have to liquidate its entire $6 billion in assets. The move comes after it breached a key ratio, "due primarily to mark-to-market losses".

- Only last week, Cheyne Finance drew on $275 million of bank credit, giving it more than $1 billion in cash according to the FT. But it's still not enough for Cheyne Finance, a spin-off from Cheyne Capital Management – "the best CDO manager of 2006," according to EuroMoney magazine in June of last year.

- "The alternative investment manager has rewritten the rule book in structured credit thanks to its breathtaking pace of innovation," the magazine said. Trouble is, however, the cycle of bubble and bust forgot to read the new rulebook. And so for investors now hoping the world's central banks will bail them out with a fresh flood of cheap money, the patron saint of headaches – St. Teresa of Ávila – offers this thought:

- Be careful what you wish for. "There are more tears shed over answered prayers than over unanswered prayers..."

Regards

Adrian Ash
For The Daily Reckoning

Adrian Ash is head of research at BullionVault.com the world's fastest-growing and best-value gold ownership service.

http://www.bullionvault.com/from/dailyreckon