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Financial Firms “Staring Into The Jaws of Hell”

Wednesday, March 12th, 2008
Posted in Theories by Joel Gross

The title of this post is a diirect quote from Martin Fridson, the leading expert on junk bonds, speaking of financial firms and buyout companies.

I hate being right.

The private equity kings and warlords who for the past decade have been making monster paychecks are suddenly seeing their investments sink. The Titanic was a rubber raft compared to what’s happening to these guys. Blackstone, KKR and others are seeing their buyouts, which were financed by cheap credit, suddenly change into multi-billion dollar losses. I actually think that a lot of these private equity guys saw this coming ahead of time, which is why they went public with their companies last year. The kings of finance saw the warning signs and got their money out of the investments and now everyone who was too slow, too optimistic, or too stupid to do the same is about to get slapped in the face by a boulder.

In the last few days, the stock market has dropped toit’s lowest point in two years. Word on the street is that there is a bigtime Wall Street bank about to be in deep, deep doo-doo. Blackstone’s earnings have crashed 89% in the last three months and there is no sight of bottom.

First, the subprime market crashed. Then the credit market for corporations completely froze up. Now private equity banks are gazing into the eyes of death. Companies that have been purchased by the private equity banks have their loans and junk bonds trading at rates so ridiculous that investors are obviously betting that they will go bankrupt. Many of these businesses, while still current on their debt, have investors trading it at 70 cents on the dollar- investors think there is a very good chance the companies won’t pay.

Citigroup, Goldman Sachs and the Lehman Brothers are currently holding $130 billion dollars in leveraged loans supporting their private equity deals… and a lot of that money could be worthless. This is just symptomatic of the larger market right now- things are looking very dreary indeed. Even the chairmen of the major Fed banks have been making statements that, coming from them, sound like a desperate plea to avoid the falling axe.

The president of Blackstone, Hamilton James, has publicly stated that “Our view is that things will get worse before they get better”.

Our economy has many strong signs of trouble ahead: rising fuel prices, energy and water shortages, massive debt load, financial markets that are drying up and slowing consumer spending. My recommendation to everyone out there is to prepare for the worst.

5 thoughts on “Financial Firms “Staring Into The Jaws of Hell”

  1. I love how you write “prepare for the worst” because I know your dream is complete chaos in society. Then you can go and buy a semi-automatic rifle with night vision, a 357 magnum, a shotgun and bullet proof full body armor and go mental. That is Joel’s ultimate fantasy.

  2. How bad will it be, oh masterful one? Will globalization increase the damage or help to moderate it? Should I flee to another country and buy up land and minions? Guide us!

  3. True globalization and freeing the economic markets from overbearing regulatory pressures and ridiculous tools like changing the base interest rates & cash in the market will be one of the only things that can solve the coming global recession. If I was you, I’d buy a bomb shelter, 10,000 pounds of food and water, a multitude of guns and dig in for the Apocalypse. Or diversify your investments, whichever you prefer.

  4. I am so disappointed to discover that the Carlyle Group doesn’t actually run the worldfrom blog.pmarca.com by Marc Andreessen There goes another illusion shattered. Hat tip to Paul Kedrosky for pointing out the choice sentence in the story: The secret to making money was borrowing massive sums. You don’t say. The story: Carlyle Capital Corp. said late Wednesday that it expects that its lenders will seize its assets, causing the likely liquidation of the fund. “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,” the fund said in a statement. [Well, thank heavens they were "working diligently" and not just slacking off.] The fund’s likely collapse is a major black eye for Carlyle Group, the powerful Washington, D.C.-based private-equity firm whose executives own 15% of the fund [but not a big enough black eye that they felt the need to put up more capital and bail it out]… The news comes just one week after Carlyle Group had pleaded with some of the world’s largest banks to hold off on margin calls and the liquidation of its mortgage assets. Several of the lenders, led by Deustche Bank and J.P. Morgan Chase & Co. ignored Carlyle’s request. Wednesday night, they began selling the fund’s $21.7 billion in mortgage securities, which were committed as collateral against huge borrowings. By Monday, dealers had sold $5.7 billion of the fund’s $21.7 billion in assets, which were committed as collateral against huge borrowings. Other dealers that sold off Carlyle Capital’s collateral included Merrill Lynch & Co. and Bear Stearns Cos., according to people familiar with the fund. But some other dealers who didn’t sell, including Citigroup Inc., had hoped to resolve the fund’s crisis amicably. The fund’s collapse shows how Wall Street’s biggest players have begun playing hardball with some of their best clients. And they reveal how jittery banks have become about their own loan exposures. In the case of Carlyle, 12 banks had lent the fund about $21 billion, or $20 for every dollar of initial capital. [Here's the really cool part:] It also illustrates how the credit crunch has moved far beyond subprime mortgages. Carlyle Capital’s portfolio consisted exclusively of $21.7 billion of triple-AAA mortgage backed securities issued by Fannie Mae and Freddie Mac. They are considered to have the implied guarantee of the U.S. government and pay par at maturity. Carlyle Capital’s investment strategy looked like easy money at first. The fund would exploit the difference between the interest earned on its investments in mortgage securities and the costs of financing those investments. [What could possibly go wrong?] The secret to making money was borrowing massive sums. Carlyle Capital managed only $670 million in client money, but used borrowings to boost its portfolio of bonds to $21.7 billion. Until the dealers started selling off the fund’s collateral, it was about 32 times leveraged, a level one mortgage-company analyst called “astronomical.”

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