After the announcement late last night that Carlyle Capital could not come to an agreement with its creditors and that its assets would be seized as soon as possible, futures were down sharply as a result. Since March 12, the company has defaulted on approximately $16.6 billion of its indebtedness, with the remaining indebtedness is expected soon to go into default.
But interestingly enough, this instance of banks seizing assets of a hedge fund unable to meet margin calls might be the unintended consequence of the Fed’s recent announcement a couple of days ago to allow banks to swap mortgage-backed (most of which is essentially worthless) debt for Treasuries. Via Robert Peston of the BBC:
In fact, it’s arguable that the banks’ seizure of Carlyle’s $20bn-odd in assets has actually been encouraged by the Fed’s mortgages-for-Treasuries offer. Because the Fed’s new lending emergency lending facility allows the banks to swap mortgage-backed debt for Treasury Bills in a way that Carlyle could not do.
So it would be rational for the banks to take Carlyle’s assets and exchange them for top-quality, liquid US government bonds, rather than leave loans in place to a business, Carlyle, whose assets remained highly illiquid.
If that’s the case, there will be some very scared people in hedge-fund land today. Hedge funds that have borrowed from banks against the security of mortgage-backed debt could be about to see their assets sucked into the banking system and their businesses vanish.
It’s not unusual for policy-makers to come up with a seemingly rational and well-considered plans, plans that in the end actually hurt more than they help. I wonder if the Fed foresaw this possibility? For some reason, I highly doubt it.
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