Federal Reserve bailout

March 12, 2008 5:29 PM

Without sounding conspiratorial... I'm wondering how much arm twisting it took by political/economic elites to get the Fed to adopt its current Liquidity Plan. Will Carlyle Capital directly benefit from it? A couple of days ago I read this story about their recent notice of default on a margin call.

So the story basically describes a situation where the equity firm was unable to meet several payment demands by its lenders. Of course the collateral in question is "residential mortgage backed securities" which I assume have been falling in value because of market forces in the mortgage backed securities market.

So a day later, I read about the Feds plan to solve the liquidity crisis. basically exchanging these same mortgage backed securities that are plummeting to zero for US Treasury bonds.

Then, considering the Carlyle Group and who its principals are (is Carlyle Capital a subsidiary of Carlyle Group? If so, it includes George Herbert Walker Bush and James Baker). Is this an action to protect them from possibly billions in losses?

Is the Fed's move really a plan to bail out well connected political elites?

Here's one of the reasons why I ask: If the value of my mortgage in the secondary market is falling... I would love to have the opportunity to buy it back at a lower price! (or refinance with someone else at its current market value)

Why should the Federal Reserve bail out investors in one particular market? There's definitely not much sympathy for the little guys who are losing their houses to foreclosure.

Does the public have access to information about who will be exchanging mortgage backed securities for Treasury Bonds?

ok, this does sound stupidly conspiratorial. sorry about that.
=)~

posted by purenitrous to work & money (8 comments total)

Umm, why is that "conspiratorial" as ooposed to conspiratorial?
They obviously breathe the same air together...why would any arm twisting be needed whatesover? You dont suppose the fed might share some interests with the banksters do you?
posted by dougiedd at 6:23 PM on March 12

It it unambiguously the job of the Federal Reserve to ensure the smooth functioning of the financial system. The financial system is functioning poorly now in ways which are not necessarily correctable by the feds usual toolkit. Bernanke's work before he became Chairman strongly suggests that he is open to using non traditional means in special circumstances and by that measure expanding the set of collateral which financial institutions can put up for a loan - the distinctive part of this weeks announcement - is not very surprising. If this does not work expect more radical action.

So I do not think there is a conspiracy to save any particular group.

I would also point out that if you have a house which you bought for $100 and you took out a mortgage for $100 and its now worth $80, if you refinance it for $80 you still need to pay back the $100 you borrowed. So no luck there.
posted by shothotbot at 6:46 PM on March 12

Carlyle Capital a subsidiary of Carlyle Group?

Not exactly. Carlyle Capital is a publicly traded entity of which the Carlyle Group owns something like 15%. And the Carlyle Group has a $150 revolving credit line out to Carlyle Capital as well. Though last year they lost some additional money on other lower-quality assets (i.e., not Agency RMBS) that CCC borrowed from Carlyle Group and which had to be sold to make margin calls.

So, while the Carlyle Group stands to lose hundreds of millions of dollars, it won't lose billions. And also, the Carlyle Group mostly just manages funds on behalf of its Limited Partners, which tend to be pension funds, university endowments, insurance companies and high net-worth individuals. As the General Partner of its funds, the Carlyle Group certainly suffers when its investments fail, but most of the burden falls on the LPs.

Why should the Federal Reserve bail out investors in one particular market?

The Agency mortgage-backed securities market is something like a $6 trillion market and had been considered one of the most liquid asset classes outside US Treasuries. Illiquidity in that market has far-reaching effects beyond just Carlyle Capital and similar investors. Unlike bonds backed by sub-prime and non-Agency prime mortgages, bonds issued by GSEs are not thought to carry credit risk (i.e., risk from borrower defaults) because of the implicit guarantee from the US government (which is actually explicit in the case of Ginnie Mae). The current turmoil in the Agency market is indicative of a nasty credit crunch that is rocking all the financial markets at the moment.

If the value of my mortgage in the secondary market is falling... I would love to have the opportunity to buy it back at a lower price! (or refinance with someone else at its current market value)

Well, two points here: 1) your mortgage is included in a trust with a bunch of others which all back a bond issuance. Unraveling these things is a long, drawn-out nightmare. So you can't go buy an individual mortgage on the secondary market; and, 2) if borrowers, en masse, could buy their mortgages at current market value, all the lenders would then realize cash losses. That would be a disaster. Right now, most losses are on paper only. Part of the general lack of liquidity in the markets (this applies to the Agency RMBS market and others) has to do with banks and other investors refusing to trade what are normally liquid assets because they are afraid of revealing and/or realizing actual losses. If the Fed can induce liquidity in high-quality asset markets, it thinks it can avoid this reckoning.

All of this is a long-winded way to say that there may be a conspiracy amongst the monied elite, but it involves a whole hell of a lot more players than just the Carlyle Group and the latest Fed move (which, in the scheme of things, is really just a drop in the bucket).
posted by mullacc at 6:49 PM on March 12

This is a fairly short, cogent explanation of what the Fed is trying to do with the alphabet soup of liquidity programs and the landscape in which they are working.
posted by milkrate at 7:25 PM on March 12

Thank you all for the responses. This has been really helpful.

I really liked reading the Washington Post article. The author of the article also participated in an online Q&A that was great. It will be interesting to see how all this unfolds. And yeah, I guess Carlyle Capital is just one of many drops in the bucket.

It will be interesting to see who the final losers will be in this current financial crisis. Will it be the people who created the mess? Back in late 2000 I wish I had someone helping me with a couple margin calls. (sigh... I learned my lesson).

So here's another question. I have a second mortgage with a variable rate. With more inflation possibly around the corner should I consider refinancing and converting to a fixed rate as soon as possible (even if it means a slight bump over its current rate)?? I assume the only way for the Fed to counteract inflation is to raise interest rates... so with the variable rate loan I could possibly be screwed.
posted by purenitrous at 9:58 PM on March 12

If your thesis is that inflation will be increasing then locking in a fixed rate that you can afford is reasonable. Of course the actual details of your current mortgage, what fixed rate is available and the closing costs all matter. You might want to talk to a financial adviser.

It will be interesting to see who the final losers will be in this current financial crisis.
Some smart, middle of the road people put some serious thought into this paper. If you want the doom scenario check out the RGE Monitor blog.
posted by shothotbot at 5:22 AM on March 13

JPD's comment was deleted, but his comment was relevant: Carlyle Capital announced this morning that it failed to come to an agreement with its lenders and will likely have its assets taken-over by the banks. Clearly the Fed move was too little too late to help Carlyle and the banks ultimately decided that they had no choice but to cause the Carlyle Group to lose money.
posted by mullacc at 8:58 AM on March 13

From March 14th article about Bear Stearns demise.

"For Bear, the crisis started when market speculation grew that it might have to seize collateral _ mostly mortgage-backed securities worth next to nothing _ from the private equity firm Carlyle Group.

Carlyle runs a bond fund and has come under intense pressure during the past week from creditors demanding collateral to back their investments.

As speculation swelled in the market, investors, customers and lenders raced to withdraw their money or rescind their credit lines. By Thursday night, Bear Stearns Chief Executive Alan Schwartz said, the bank realized the withdrawals might outpace the bank's resources _ so it reached out to JPMorgan for help."
posted by zerobyproxy at 4:19 AM on March 15