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Saturday, March 15, 2008



Big American finance houses have collapsed before. Continental Illinois required a $4.5bn (£2.25bn) bail-out in 1984 after coming to grief in Texas as the oil boom deflated.

The giant hedge fund Long Term Capital Management was saved by a club of banks in 1998 under the guidance New York Federal Reserve. The fund blew up after Russia's default, which ravaged its portfolio of Danish, Italian and Spanish bonds.

Bear Stearns bank: Bear Stearns has been exposed as a bank saddled with toxic sub-prime debt
Bear Stearns bank has been hit
by the sub-prime mortgage crisis

On both occasions the US economy was in rude good health. The damage was quickly contained.

The implosion of Bear Stearns is more dangerous.

A host of other banks, broker dealers, and hedge funds have played the same game, deploying massive leverage at the top of the credit bubble to eke out extra yield. Dozens of them are saddled with the same toxic debt - sub-prime property, credit cards, auto loans, and mountains of unsold paper from the merger boom.

This time the market for default insurance is flashing bright red warning signals across the entire spectrum of US finance.

The swap spreads on Lehman Brothers rocketed to 465 yesterday, mirroring the moves in Bear Stearns debt days before. Fannie Mae and Freddie Mac - the venerable agencies created by Roosevelt that underpin 60pc of the $11 trillion mortgage market - had a heart attack on Monday. Their bonds were in free-fall, threatening to set off another cascade of bank writedowns.

These are not sub-prime outfits. They sit at the apex of the US mortgage credit industry. Hence the dramatic move by the Fed this week to offer a $200bn lifeline, agreeing to accept Fannie Mae and Freddie Mac issues as collateral.

Had the Fed delayed, many traders believe Wall Street would have plunged through resistance levels risking a full-fledged crash.

The 'monoline' bond insurers - MBIA, Ambac, and others - that guarantee most of the $2,600bn market for US municipal bonds have seen their shares collapse by 90pc since the Autumn.

They are still battling to raise enough to capital to save their 'AAA' ratings. Should they fail, the insured bonds will be downgraded in lockstep. Pension funds would be forced to liquidate huge holdings. As New York Governor Eliot Spitzer said before his own liquidation, such an outcome is too dreadful to contemplate.

You have to go back to the banking crisis of the Great Depression to find a moment when the financial system as a whole seemed so close to the precipice.

Although 4,000 US banks failed in the early 1930s (mostly small ones), it was a long-drawn out affair. The bank runs began in the Prairies as falling food prices caused farmers to default in 1930. It seemed to be a local problem.

The crisis reached New York in December 1930 when the Bank of the United States succumbed to panic withdrawals. Legend has it that the 'WASP' clearing banks refused to back a rescue because of the bank's Jewish links.

In those days the contagion spread slowly to the rest of the world. It is much swifter now. The Swiss bank UBS has suffered US sub-prime losses on a scale to match Merrill Lynch and Citigroup, thanks to the curse of mortgage securities.

"We are now experiencing the first truly major crisis of financial globalisation," said the Swiss central bank governor Philipp Hildebrand this week.

"Never before have banks seen such destruction of their balance sheets in such a short time. Moreover, there are signs that the problems are spreading. The risk premiums on commercial property, consumer credit and corporate loans have risen sharply," he said.

Debt levels have been much higher than in the Roaring Twenties; the new-fangled tools of structured credit are more opaque: the $415 trillion nexus of derivative contracts is untested. Nobody knows for sure if the counter-parties are able to deliver on vast IOUs, or whether the construct is built on sand.

What keeps Federal Reserve officials turning at night is fear that the "financial accelerator" will now set off a vicious downward spiral. There is a risk of "very adverse economic outcomes," said Fed vice-chair Don Kohn.

Albert Edwards, global strategist at Societe Generale, said the toppling banks are merely a symptom of a deeper rot. "The banks are not the problem. Nor even the grotesquely leveraged funds. The problem is that an economic bubble financed by ridiculously loose monetary policy is unravelling," he said.

"US house prices have a lot further to fall, which will simply crush the global economy. The lesson from Japan in the early 1990s is that the death dance goes on and on and on," he said.

The Fed blundered badly in the Slump, delaying rate cuts for too long. It allowed the money supply to implode.

It is acting with breath-taking speed this time. Rates have already been cut from 5.25pc to 3pc, and will be slashed again this week. New means of showering liquidity on the banking system are being devised each week.

As luck would have it, the world's greatest expert on the financial causes of depressions - Ben Bernanke - happens to be chairman of the Federal Reserve.

Banks to Seize Carlyle Capital Assets

NEW YORK -- The likely liquidation of Carlyle Capital Corp.'s remaining assets sent the fund's shares plummeting more than 90 percent Thursday and rattled stock markets around the globe. It was also a high-profile setback for private equity fund Carlyle Group.

Carlyle Capital said late Wednesday that it expected creditors to seize all of the fund's remaining assets _ investment-grade mortgage-backed securities _ after unsuccessful negotiations to prevent its liquidation.

Its shares, which went public at $19 a share in July and traded at $12 just last week, tumbled 93.6 percent to 18 cents on the Euronext exchange.

The Amsterdam-listed fund shook financial markets last week after missing margin calls from banks on its $21.7 billion portfolio of residential-mortgage-backed bonds. Carlyle's troubles have amplified fears that billions of dollars of depressed mortgage-backed securities will flood the market, reducing their value even further.

"Although it has been working diligently with its lenders, the company has not been able to reach a mutually beneficial agreement to stabilize its financing," Carlyle Capital said in a statement.

Carlyle's troubles heightened worries about the billions of dollars in depressed mortgage-backed securities, one factor that sent stock markets down. The Dow Jones industrial sank more than 200 points, following indexes in Asia and Europe lower.

The sell-off would mark a huge defeat for the Washington, D.C.-based Carlyle Group, one of the largest private equity firms in the world with $76 billion in assets. Carlyle Capital, registered in Britain but managed by New York-based executives, was the first of its 55 funds to go public.

Since the beginning of the credit crunch, Carlyle Group has extended loans to Carlyle Capital to help meet margin calls, including a $150 million revolving loan, Citigroup analyst Donald Fandetti told investors in a research note March 6. "It appears CCC is fully drawn on this line and so far no further loans have been provided."

Andrew Wilkinson, senior market analyst at Interactive Brokers Group LLC, said it didn't make sense for Carlyle Group to keep bailing out its mortgage-focused fund.

"If it's a standalone entity that's vulnerable to failure, then you let it go and you bear the consequences but you certainly don't throw good money after bad," Wilkinson said.

More than a year ago, the fund leveraged its $670 million equity 32 times to finance a $21.7 billion portfolio of AAA-rated residential mortgage-backed securities issued by Freddie Mac and Fannie Mae. It borrowed money from at least a dozen banks and firms, including Bank of America Corp., Citigroup Inc. and Merrill Lynch & Co.

Carlyle Capital posted the securities as collateral under repurchase agreements, so if the value of the securities fall, the lender has the right to ask for more collateral _ a margin call _ to secure the loan. If the borrower does not meet the margin call, the lender may sell the security.

The value of mortgage-backed securities has plummeted as U.S. home prices fall and foreclosures surge, prompting the banks to ask Carlyle Capital for more than $400 million in additional capital. The fund was unable to come up with the money, prompting lenders to start foreclosing on the securities.

As of Wednesday, Carlyle Capital said it has defaulted on about $16.6 billion of its debt, and the rest is expected to go into default soon. About $5.7 billion of the defaulted debt has been sold, the Carlyle Group said Thursday. Spokeswoman Emma Thorpe said she couldn't say what has been done with the rest.

Carlyle Group "participated actively" in the fund's negotiations with its lenders to refinance its portfolio and was prepared to provide substantial additional capital if sustainable terms could be achieved, the fund's statement said.

But hopes for refinancing fell apart after some lenders said the value of the collateral had declined further, which would result in additional margin calls Thursday of about $97.5 million.

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