Carlyle Capital Brings Back the LTCM Memories

Remember Long Term Capital Management? The problem there wasn't that it was investing in risky securities, like Russian bonds. Instead, Russia's default set off a more generalized spread widening and flight to liquidity, which hit super-safe assets like off-the-run US Treasuries. Because those assets were super-safe, LTCM had been able to invest in them with enormous amounts of leverage. And so when the sell-off arrived, LTCM went under.

Do the markets ever learn from prior mistakes? Because what happened to LTCM in 1998 seems to be exactly the problem facing Carlyle Capital in 2008.

Carlyle Capital isn't investing in risky bonds: it's investing in securities issued by Fannie Mae and Freddie Mac. But the problem is that it's doing so with enormous leverage: "The company leverages its $670 million equity 32 times to finance a $21.7 billion portfolio," notes the WSJ today. The result? A failure, yesterday, to meet a margin call. Which, in my day, used to be known as "default".

Carlyle Capital will probably survive, unlike LTCM; I even have a certain amount of sympathy for a company which is hit by seven margin calls totalling $37 million in one day, despite investing only in assets which have an implicit US government guarantee. But that's the kind of risk you take when you take on 32x leverage.

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