"Then I need say no more," said Celeborn. "But do not despise the lore that has come down from distant years; for oft it may chance that old wives keep in memory word of things that once were needful for the wise to know."
— J.R.R. Tolkein, The Fellowship of the Ring
Well, it seems that the geniuses at The Carlyle Group have finally shit the bed. And in public, too. Oops.
Another crop of yahoos, drunk on their own power, reputation, and greed steered themselves (and their trusting investors) into a ditch by ignoring the most basic rules of the road:
- Do not borrow short and lend long
- Do not overlever securities which might become illiquid
- Do not believe your own hype
- Do stick to your knitting
Prior to this, the Carlyle troika of Rubenstein, Conway, and Aniello were almost universally believed to be nearly as smart as Albert Einstein before he started smoking weed and hanging out with the fruitcakes at the Institute for Advanced Study. I guess they knew better.
As Felix Salmon points out, it's all happened before. Long-Term Capital Management, anyone?
And, if I read the timeline right, Carlyle Capital kept doubling down and throwing more capital at the problem even after conclusive evidence had surfaced that the Great Prime Broker Leverage Unwind of 2007/2008 was well underway. By the end of last year, those yahoos were running a portfolio of $21.7 billion of securities on a base of $670 million worth of equity. That's thirty-two times leverage. You read correctly: 32x. I'm sorry, but I wouldn't leverage even a sure thing like Giselle Bundchen on quaaludes, mojitos, and Spanish Fly thirty-two to one.
Of course, the people running Carlyle Capital were convinced that their strategy made sense, that the mortgage securities in their portfolio were worth more than what the market said they were, and that, given time, all would work out for the best:
John Stomber, Chief Executive Officer, President and Chief Investment Officer of the Company, said, “The last few days have created a market environment where the repo counterparties’ margin prices for our AAA-rated U.S. government agency floating rate capped securities issued by Fannie Mae and Freddie Mac are not representative of the underlying recoverable value of these securities. Unfortunately, this disconnect has created instability and variability in our repo financing arrangements. Management is actively working with the Company’s repo counterparties to develop more stable financing terms.”
Sound familiar? It should.
In addition to the delicious irony that Mr. Stomber comes to Carlyle from Cerberus Capital, the hedge fund that is making a royal hash of its forays into private equity, this is yet another example of why you should not rely on subject-matter experts like traders to drive your risk management strategy. For the same reason, it is not wise to put an arboreal botanist—no matter how smart and experienced—in charge of forest management: they tend to have trouble seeing the forest fire for the trees.
But this is nothing new. This should not be a surprise. In addition to the numerous empirical examples we can all point to throughout history, there has been an endless parade of wise men promulgating pithy aphorisms perfectly designed to penetrate the brain of any thinking person and lodge there. I think now, in particular, of a well-known adage coined by John Maynard Keynes which might have saved Mr. Stomber and his colleagues a great deal of pain, embarrassment, and money, had they taken heed of it:
The market can stay irrational longer than you can stay solvent.
Or this little beauty, from the pen of George Santayana:
Those who cannot remember the past are condemned to repeat it.
I begin to worry that Messrs. Conway, Aniello, Rubenstein, and Stomber cannot read at all.
Nevertheless, in the devout hope that I am wrong, I will leave behind my own little chestnut as a guide and a warning to the readers of these sentences:
Those who do not read this blog are condemned to be featured in it.
Put that in your pipe and smoke it.
© 2008 The Epicurean Dealmaker. All rights reserved.