Fannie times

Introducing… Fannie and Freddie: Fannie Mae and Freddie Mac are two government-sponsored enterprises (or GSEs) established by Congress to promote the laudable (and politically popular) objective of home ownership.

How do they do that? They go out and buy large quantities of so-called “conforming loans” from conventional mortgage lenders (e.g. your local bank). They then pool them together and repackage them into “mortgage-backed securities” (MBS), which they sell on to private investors. We’ll call that securitization. This allows your local bank to offload the burden of these loans from its balance sheet and extend new mortgages, so that your neighbor, too, can join the homeowners’ club.

On top of securitizing mortgages, Fannie and Freddie also invest in MBS issued by themselves and by other issuers. They have thus helped create a vast and liquid market for MBS, which has allowed investors like you and me invest in mortgages as a (higher-yielding) alternative to, say, government bonds. In turn, this means that potential losses from mortgage defaults are no longer borne by just a few banks, but by a much wider pool of investors. Ergo a more stable financial system and lower interest rates for borrowers.

Now, given that “home ownership” is synonymous with “political points” on both sides of the aisle, Fannie and Freddie enjoy a number of special benefits under federal law. Among them are income tax exemptions, large savings from not having to register their securities with the Securities and Exchange Commission and, importantly, eligibility of their securities for use by the Fed in its conduct of monetary policy.

Many have interpreted the latter as implying a hidden government guarantee on the securities issued by the GSEs. And even though the government has gone at lengths to deny it, you can’t blame investors for believing that Fannie and Freddie are simply “too big to fail”: Their mortgage portfolios are gigantic and Congressional support for their social role strong enough to ensure that, if stuff hit the fan, the government would bail them out. In all, this has meant lower borrowing costs for both GSEs as well as very low capital requirements to support their investment activities.

Dangerous? Perhaps. But few are those complaining, as Fannie and Freddie are ultimately passing on their lower funding costs to mortgage borrowers: You, that is, unless you are one of these “non-conforming” types (meaning “filthy rich” or “jobless and hopeless”). If so, you could try your luck with more expensive alternatives, such as the “jumbos” (loans above $417,000) or the now-famous “NINJA” mortgages, so coined for their ridiculously lax lending standards (No Income No Job No Assets).

Those economists! As I said, some have been complaining calling, inter allia, for caps in the GSEs’ portfolios and higher capital requirements. Unsurprisingly, many are economists, and not because they’re filthy rich non-conformists. The argument goes that the enormous expansion of the GSEs' investment portfolios is potentially very risky for the mortgage market and (yes!) the American taxpayer. And why is that?

Too extended for their capital: Since Fannie and Freddie can get away with very little capital, they have been financing their acquisitions of MBS with (vast amounts of) debt, which is now held by a very wide base of investors, from commercial banks, to your mutual funds to the Chinese Central Bank. So these guys would suffer heavy losses if the GSEs got into trouble. And while you might care little about the Chinese, losses by domestic banks could have serious implications for the functioning of the financial system. Unless the government stepped in of course..

Too big for the markets: Fannie and Freddie are big players in the markets for derivatives such as options or interest rate swaps. These are instruments that help the GSEs match the (less predictable) profile of their income from mortgages (i.e. interest and principal payments) with the (more predictable) profile of their own debt payments. Now, because of their size and the nature of their investment needs, the GSEs can exacerbate price movements in derivatives markets. And that’s not that desirable, particularly at a time when bond prices are already on a downward spiral. Participants in those markets are thus exposed to the vagaries of Fannie and Freddie’s “mood,” and not just them; holders of traditional bonds are also exposed, due to “feedback” effects from the derivatives “universe.”

Add to this a couple of multi-billion-dollar accounting scandals by both GSEs (designed to keep Wall Street happy and inflate the bonuses of top Fannie and Freddie executives) and calls for greater regulation were finally answered.

Plus ça change… But times have changed, again! With the Fed and the Treasury desperate to stop the downward spiral in MBS prices, Fannie and Freddie have been summoned into action. Caps on their investment portfolios lifted, requirement on the surplus capital they need to hold reduced, and the definition of “conforming” expanded to include some jumbos. Thus armed, the GSEs have been given instructions to provide a couple of hundred billion dollars of badly-needed liquidity and help resuscitate the mortgage market.

But what’s wrong with a little regulatory transgression? Well, nothing, really, other than the fact that there seemed to be a pretty good reason for having introduced the (now-lifted) regulations in the first place. Oh yes, and the fact that the transgression may end up being longer than “temporary”, at the cost of fresh build-ups in the concentration of risk in the MBS markets. Not to mention the tremendous linguistic appeal in calling a spade a spade (or a bailout a bailout): I mean, since the ultimate bearer of risk is the government, would it not be more “clean-cut” if the government were to buy the MBS itself, instead of creating potential time-bombs for the taxpayer?

In the end, officials are making a brave bet: That the crisis is at heart one of liquidity rather than solvency, that current prices don’t make sense, and that (hence) the downside risks to the Fed or the Fannies of this world are limited. So let’s see. Markets seem indeed a touch happier these days, though I’d dare observe they looked particularly happy on Monday, on rumors that the Fed was considering purchases of MBS to support prices… that’s right, the B(ailout)-word!

Glossary: mortgage backed securities (MBS), securitization, capital requirements, interest rate swaps, bailout, spades.

Mortgage lingo for dummies

Forget the past and you make the same mistakes again

Big Ben

You have to give Ben top marks for imagination at least.

Policy makers have been fretful for weeks about how to stop the market carnage without being seen as bailing out all those “reckless,” “opportunist,” even “fraudulent” I-bankers who helped create the mess in the first place.

So, over the weekend, Ben came up with a fine idea: “I can have my cake, and eat it too!” he thought.

Which, in the Fed’s lingo, translates into: “I’ll let a few “bad guys” go bust, but then come in Big to stop the bleeding.”

And so it went. Bear Stearns was allowed to collapse; its owners left in disbelief as they saw their shares plummeting from $86 a share in early January, to $30 last Friday, to a staggering $2 on Sunday—the price JP Morgan offered to pay for the company and “save” it from winding up. Then comes Ben’s turn.

“We have a situation here,” he thought. “If Morgan starts fire-selling all the crappy securities in Bear’s books in order to reduce its risk, this will lead to a new bloodbath. What to do?.... I’ll take it over!”

So comes the Fed and basically tells Morgan not to worry, it will assume the credit risk for $30 billion worth of (precisely!) the crappiest securities in Bear’s books that Morgan would rather not hold. Mainly mortgage-related, but also some corporate debt.

“To put it plainly, Morgan, do NOT go out and sell these in the market! If things go bad and their prices plummet, I’ll be there for you, I’ll cover the losses.” No, no bailout here. We’ll just call it a 30-billion-dollar “non-recourse facility.”

But Ben had a second ace in his sleeve, which looks like of the spades variety. He called that one the “Primary Dealer Credit Facility” (or PDCF). “We will now allow you I-bankers to come to our windows and borrow directly from us. The hell with tradition!”—whereby the only institutions that could borrow from the Fed are “depository institutions” (aka commercial banks or savings and loans institutions)… “These are exceptional times!”

“Indeed, we’ll break with tradition in more than one ways!” So not only can investment banks now borrow directly form the Fed, but the collateral they have to commit has been expanded to include securities that are less safe than the high-quality Treasury bills or Fannie and Freddie debt.

Now, let me say, this is Big! Extraordinary and BIG!

Big because it allows those in the eye of the storm to run directly to the Fed for help. Big because these guys can now pledge a larger set of securities as collateral, and therefore borrow more if they need to. And big because the Fed set no limit to the amounts it’s prepared to lend, though penalty fees (and potentially the Fed’s own balance sheet) may ultimately constrain the amounts lent.

To give you an idea: Let’s say I’m a bank and I hold pretty large amounts of securities whose prices are discovering new nadirs every day. So my creditors get nervous and start calling, demanding that I put in more capital in my margin account (remember those margin calls that brought Carlyle Capital down?) Now, if I fail to find the cash to pay them back, I’ll be forced to close down, even though I am solvent in principle. And that would be a rather unfortunate event of value destruction, wouldn’t it?

So here comes Ben and says “If it’s just liquidity you need, I will lend you the money, I will lend you unlimited amounts of money! But will the real insolvent ones among you please... fail?”

Now is Ben showing signs of genius here or is he just creating fancy synonyms for “bailout”? History will give the final verdict, obviously, though at least from a semantics point of view I would dare answer “a bit of both.” You see, a bailout is defined as a “rescue from financial distress” but there is a catch: That you, who bail me out, will pick up the bill. (Better yet, you pass it on to someone else!)

In this case, the Fed is picking up the “bill” of riskier securities on its balance sheet and the implications of potentially higher (much higher) liquidity in the system. The former could lead to market losses by the Fed (which would be ultimately be picked by you and me in the form of higher inflation and/or taxes); and the latter could lead to higher inflation, the cost of which would, once again, be picked up by you and me.

Yet, life is short, growth is the current mantra, and, if anything, markets seem a touch more comfortable as they are digesting the news. And in this kind of environment, it may turn out to be the case that the only ones to get whacked are the Bears.


Glossary: bailout, liquidity, solvency, inflation, Big Ben.

Infidelity: Nature or nurture?

Infidelity is not usually the first thing that comes to mind at a friend’s wedding. Yet, that’s exactly what happened to me over the weekend. Bride and Groom were on the dance floor, grooving to the tunes of “Love is in the air...,” she in her super-slick Prada creation, he it doesn’t matter! Both exuded an aura of elation and unconditional devotion to each other, yet there was I, a few glasses of wine later, unable to rein in the following thought:

Evolutionary biology suggests that both men and women are “natural cheaters,” each for their own reasons. So what is it that makes two human beings commit to sharing the same bed, roof and room temperature for the rest of their lives?

Naturally, I sought an answer in Economics. After all, our partners are arguably a resource; a resource for offspring, obviously, but also (depending on the dynamics of a partnership) food, housing, inter-personal communication, emotional fulfillment and, quite often, sex. As such, they are critical drivers of our “utility”—our overall happiness and satisfaction. And economics is all about identifying the choices that will maximize our utility in the presence of constraints.

Sure enough, some economists out there have written studies about this. And even though those I’ve read are not among the most outstanding pieces of literature, they served to me as inspiration for dissecting the whole “infidelity vs. monogamy” trade-off. So here is my take.

Let’s talk evolutionary biology first (biologists, feel free to attack!). Accordingly, men and women are natural cheaters—a state of mind driven by their congenital mission to reproduce. Men will cheat as indiscriminately as possible to maximize the probability their genes are disseminated. Women will cheat in order to ensure their offspring are of the best quality, while also ensuring that they themselves are provided for—the underlying assumption being that the best “provider” may not necessarily be the man with the best quality genes.

Technically speaking, this means that the utility from cheating increases with the number of partners for both men and women —though in the case of men the extra pleasure out of an extra partner would tend to be much higher than for women (We’re still talking strictly biology!)

But more partners also mean higher costs. In the case of men, the cost has to do with monitoring: The higher the number of women you sleep with, the more difficult it is to monitor that the child they actually bear is yours (and remember, that’s the only thing you care for!). You see, women tend to hide their fertility cycles pretty well and—being the natural cheaters that they are—they may well give birth to someone else’s baby, which you will be asked to care and provide for. Not good!

In the case of women, the cost stems from their bodily limitations. The “production” of a baby takes nine months of “incubation,” and then a few years of breastfeeding, spoon-feeding and brain-feeding. This means that there are only so many babies a woman can produce during her lifetime—which, of course(!), means that there are only as many partners she can mate with. Effectively, this makes the cost of mating with any additional partner beyond this limited number infinite.

So if biology were the whole story, the equilibrium would look like this: Men would marry one (any) woman and monitor her closely, while going around town spreading their genes as widely as possible at little extra cost. Women would say “I do” to a man (any man) who would offer to be the “provider,” but then cheat on him with a better quality male to ensure their offspring makes it to Harvard. So both get their cake, and eat it too.

Now, economics introduces a dose of realism into the story. I mean, when you spot an attractive woman at a bar, you don’t really think “I feel like reproducing tonight.” Instead, you say “great legs” and reach for your condoms. Likewise, if I bump into Matt Damon, it’s not exactly my fertility cycle that will spring to mind.

Technically speaking, economics introduces new “arguments” in our utility and cost functions. No, not marital arguments; I’m talking about the different parameters that determine the levels of our utility and our costs when (sorry, IF) we cheat. Mathematicians like to call these “arguments.” So let’s see what they might be.

First of all, the utility from cheating does not only depend on the number of people one sleeps with. Statisticians have found it also depends on one’s age, in a way that resembles the shape of an “inverted U.” Meaning that you tend to cheat less when you’re young and innocent, more as life shows you otherwise, and less so again when you “mature.” Secondly, your utility from cheating also depends on the length of time you’ve been married… the seven-year itch and all that. The longer you’re married, the higher the perceived benefits of extra-marital affairs—especially for those of you who have missed out on Oprah’s invaluable sex advice.

What about the costs? Economics has a say here too, by better capturing the incentives for cheating. You see, in a day an age where contraception (God forbid!) is an option, my cost of sleeping around does not stem from my bodily limitations as a child-bearer. My costs are quite different. For example, if I’m married to a guy with the physical symmetry of Matt Damon, the financial resources of Bill Gates, the unconditional devotion of my mother and a Harvard education, my incentive to cheat on him will likely be low. Likewise, men are not the blithe sperm-disseminators biologists portray them to be. They do care! (right??)

So as an economist, I would introduce two more arguments in the cost function. The first is the relative “quality” of your spouse—how much better-looking and/or smarter your partner is compared to the average in your community. For both men and women, their cost of cheating would be expected to rise, the higher the relative quality of their partner.

The second parameter is the spouse’s ability (again, relative to the community average) to act as the “provider,” not necessarily of financial resources but, more importantly, of emotional support. (A professor of Family Studies and Human Development at the University of Arizona, Bruce Ellis, went as far as creating an index for that—the “Partner Specific Investment” index—or PSI). So the higher your partner’s relative PSI, the higher the cost of cheating on him/her.

Where does this leave us? How can we stop our partners (and ourselves) from cheating? The model above seems to offer a whole range of options, the relative appeal of which I leave up to you to decide. But here they are:

• Marry the Damon/Gates/mother combo (or the female equivalent depending on your predilections);
• Raise his/her cost of cheating by vowing to break your entire crockery collection on his/her head before kicking him/her out of the door;
• Relocate with your spouse to an uninhabited isle in Turks and Caicos to minimize the “community options” for both of you;
• If you’re a woman, wait till you’re at least 40, then marry a man who is at least 55—the ages where your respective “inverted Us” begin to decline (or so they say);
• Marry into Ivy League (ok, possibly Stanford, if you’re into the west coast thing). No, seriously. Some economists found that the probability of cheating decreases with the level of education, purportedly because a college degree enhances one’s ability to assess the costs of cheating.
• Accept cheating as an evolutionary necessity and, thus, good for human kind.

Alternatively, you can ignore economic models, tune into Oprah, and join me as I take another sip of wine and sing along: “Love is in the air.. everywhere I look around...”


Glossary: Resource, utility, constrained optimization, argument, cost function, seven-year itch, love.

Reality bites! Further readings...

Infidelity: It may be in our genes

The myth of monogamy: Fidelity and Infidelity in Animals and People

Even Harvard cheats!

Markets prefer (petite) brunettes..

It’s one of these days when you wake up in the morning and you think “Finally, I can write the word “sex” on a (strictly!) economics blog and keep my conscience clear!”

That’s thanks to Eliot Spitzer, New York Governor and one of the most “self-righteous” (or “ruthlessly opportunistic,” depending on who you ask) former Attorney Generals for the state of New York. In case you missed the news, Mr. Spitzer was caught paying a four-digit amount for premium sexual services offered by a “pretty petite brunette” in Washington, DC on the eve of Valentine’s day.

(Correction! His sin was not supporting prostitution, nor cheating on his wife… it was the act of “transporting the petite brunette across states” for immoral purposes. Yes, quite tellingly for the nation’s capital, Mr. Spitzer had to pay for a New York call-girl to come over. The rest is history).

Then, a couple of hours into my morning, Ben steps in… and makes the Spitzer affair seem sooo passé. So, I’m sorry to say that, rather than my economic model on morality, I’ll give you my quick take on the Fed’s new measures aimed at restoring liquidity in credit markets:

“Big Deal!”

I hope you sensed the irony there. Because it’s not a big deal. But let me first give a quick and dirty explanation of what’s going on.

So the credit markets have been bleeding, as securities linked to the performance of mortgages (subprime and, gradually, prime) have seen their prices plummeting, causing severe losses to major banks, smaller banks, “shadow” banks and non-bank financial institutions, prompting more forced sales and leading to a downward price spiral.

With the downward spiral underway, few nutters out there are prepared to buy mortgage-backed securities (or MBS). So the banks (and other institutions) who own these MBS have been seeing more and more losses every day, and their balance sheets are at risk.

So Ben becomes increasingly worried with how illiquid the market is and throws out the following offer:

“Why don’t you give these illiquid mortgage-backed securities (or MBS) to me? I’ll exchange them with liquid stuff, like, U.S Treasuries. The downward spiral in the price of MBS’s must stop!”

How nice of him, thought the markets.. so stocks rallied!

But then the “economists” began to mutter.

“You know, Ben is not being that generous.” And this for a number of reasons:

First, banks don’t really need someone to hold the crying baby. They want someone to take it away from them… for good! But the Fed did not offer to buy the MBS. It will only hold them temporarily until market conditions improve, confidence is restored and prices begin to reflect the “real stuff”, that is the capacity of you and me to repay our mortgages—not liquidity shortages…

…Wishful thinking! The measure is predicated on the assumption that the crisis is a crisis of liquidity rather than one of solvency. But I (and not just I) beg to disagree. There is a solvency (or, rather, insolvency) problem in the housing sector and, unless it is resolved, it is difficult to see how confidence and liquidity can be restored.

Secondly, despite the psychological impact of the announcement, the Fed’s “intervention” in the MBS market is

(a) small, at “only” 200 billion dollars; and

(b) limited to the “high-end” triple-A-rated stuff.

“Small” because, even at $200 billion, it is still a drop in the bucket compared to the six-trillion-dollar worth of mortgage-backed securities. And when it comes to (b), the point there is that the non-AAA junk that is lingering in the financial system’s balance sheets, and whose value has dropped calamitously, will… remain there!

Third, the Fed did not reveal at what price it will accept the MBS in its books. That’s right, when the Fed lends cash or US Treasuries to the dealers, it asks for collateral, and it typically prices this collateral at a discount, depending on the quality of that collateral.

For example, if I am a dealer and I want to borrow $10 million worth of US Treasuries, I will have to give collateral so that if I go bust the Fed can recoup its money. If my collateral is, say, municipal bonds, I will have to deposit around $10.5 million worth of these with the Fed, because they are riskier than the US Treasuries and the Fed wants a cushion in case their price falls.

So the issue at stake is that, if the Fed is conservative and says “I’ll be happy to accept your MBS as collateral, but only at 70% discount”—a number I just made up—it might not go down well with the markets! In other words, the usefulness of the measure will depend on how the Fed's discount compares with the discount these securities are trading in the market.

So, repeat after me: “Big Deal!” Well, unless something bigger is in the offing: A big fat bailout of homeowners and their bankers, whereby banks are kindly asked to bail out homeowners, the Fed steps in to bail out banks, and the Federal government steps in to “save” the Fed.

So why did the markets rally? Did they really see today’s measures as a precursor of a bailout? Maybe.. otherwise, I’d be really (really!) tempted to speculate it was the “petite brunette” effect!

PS And a note to Silda Spitzer.. Could you please punch your husband on the nose, hard, rather than standing beside him like a sorrowful accessory of a wife? On tape please..

Glossary: mortgage-backed securities, liquidity vs. solvency, collateral, big fat bail-out, call-girls.

Sorry, I missed your call...

Some market players are becoming a bit “antisocial” these days. The latest one to breach the market etiquette was Carlyle Capital, a multi-billion-dollar investment fund and offshoot of the powerful private equity group, Carlyle Group. Apparently, Carlyle’s bankers had been calling for days and, after days of silence, the company came out last week to simply say “Sorry… I missed your calls!”

Now these are not any calls. They’re margin calls, and missing them is a pretty serious matter! Indeed, the news added fuel to the fire that has been burning in credit markets for months, sending risk premia to scary new heights as investors began to wonder who else might join Carlyle’s in its antisocial behavior! And sure enough, later on Friday, another company, Thornbug, a provider of “jumbo” (large) mortgages said it couldn’t meet its margin calls, putting its survival in doubt.

So what are margin calls? I mean, who’s calling? And are Carlyle & co. being plain rude?

Telling the tale: Let’s say we’re back in July 2007. You take a look at the latest economic data releases—rising mortgage delinquencies, falling house prices and all—and somehow decide that, nonetheless, it’s still a fabulous time to invest in mortgage-related securities. So you go to your broker and say:

“Hey, I see some high quality stuff out there.. but I only have one thousand dollars to invest. Why don’t you lend me another couple of thousand? I can make more money this way! And if it makes you feel better, I can give you collateral for the loan. Some good, low-risk bonds I own, maybe some cash…Deal?”

Now that’s smart! So now you have two thousand dollars to invest, which means that you can make much more money. How?

Working out the multiples: Say you only had your own $1,000 and the price of your chosen investments went 20% up. You gain—20% (or $200). But now you have $3,000 invested so a 20% price increase translates into a $600 profit. So you take your $3,600, pay back the $2,000 you owe to your broker (with some interest) and you are left with $1,600—a hefty 60% gain on your initial investment!

Of course that’s all great if the market goes up. If it goes down, yes, you guessed it… You’re SCR#($@D! And if you bother to do the calculation, you will note that, the more money you borrow to invest (or the more “levered” you are), the more multiply scr#($@d you are in a downturn!

The collateral you deposited with your broker is the “margin.” Brokers ask for margins because they know the downside can get pretty ugly in Dow-Land. And they want to be comforted that, even if your market acumen were misplaced, and your investments went downhill, they can still get their money back.

Reasonable deals: But let’s go back to last July. So you borrowed $2,000, added it to your own $1,000 and invested all of it in securities that are linked to the performance of residential mortgages. But you didn’t pick any mortgages. You knew that something was fishy in the subprime sector, so you said “I’ll only go for the safe stuff, triple-A-rated securities linked to mortgages issued by Fannie (Mae) and Freddie (Mac).” “These can’t possibly go bad,” you thought. “Not only are they good quality, but Fannie and Freddie are government-sponsored agencies. And the government can’t possibly let them join the fallen.”

“Sounds reasonable,” said your broker. So he lent you the money, but under the following conditions: That at any point in time, you maintain collateral in your account that is at least 15 percent of the market value of your assets. This is the maintenance margin. And that, if your “equity (or the value of your investments minus your debt) fell below the maintenance margin, you would need to find extra collateral and deposit it in your margin account. Otherwise, he reserved the right to start selling part of your existing collateral and use the cash to repay part of your debt, so that your equity goes back up again to acceptable levels.

Now I made up the 15% but, generally, the level of the maintenance margin depends on a number of factors. These include government regulations, brokers’ discretion, the level of competition among brokers to get your business, your overall creditworthiness and how risky the investments you want to make with the borrowed money are.

So, for example, you would expect that when many brokers compete for your business, they might be a bit more lax in the restrictions they place on you, and be happy with a 10% maintenance margin (provided it still lies within the government’s regulatory limits). Similarly, if a certain type of investment is very volatile, your broker will want a bigger cushion since the value can go down very rapidly.

When margins hit the fan: Come August 2007. Markets are getting nervous, as a series of land-mines explode in the credit world—mortgage delinquencies, bankrupt hedge funds, defaulting “SIVs”, major banks under threat. Your investments begin to shake. Your equity is still in positive territory but it’s getting dangerously close to the maintenance margin level. Indeed, as the crisis continues through November, ooops, the equity drops below the margin. And… you receive a call!

“Hello?” (It’s your broker!) You panic… and don’t pick it up! He leaves you a, message, a kind reminder that you need to replenish your margin account, else…

Shoot! Markets are cash-strapped and there is little hope you will find any investor willing to fund you. What to do? You call your mother!

“Hey mom, how are ya, not sure you’ve been following the news… but my investments are in a bit of a strain these days. And I’m short of cash. So when I heard Carlyle Capital managed to get a $150 million credit line from its own mother, Calryle Group, I got inspired and thought you might be able to lend me a few hundred bucks.”

Your mom is upset. “I can’t believe you refused your broker’s calls! What the hell will he think of me??” “I spent years teaching you manners, helping you build your reputation, and now this!” So she sends you the cash, together with a sweet, motherly note saying that this is your last chance.

But the credit-market carnage continues and is spilling over even to “safer” securities, the Fannies and Freddies of this world. This time it’s very serious. Not only are your investments going down. Not only is there more volatility in the market. Not only are you short of cash. But so is your broker, which makes him more nervous about his clients potentially going bust. So as soon as your equity falls below the margin, he calls again… and again and again. And as you “miss” his calls, he leaves you a message notifying you that he just took over your collateral, sold it for cash and used it to reduce your debt. And that, in light of the abysmal market conditions, you’re likely to get more calls soon.

That’s the Carlyle story.. kind of. One important difference being that Carlyle was not two, but thirty times leveraged, so start doing the math to see by which multiple it’s getting scr#^$%d.

But there is a bigger issue.. bigger than Carlyle, Thornbug & co. The more companies are facing margin calls, the more “fire sales” you would expect either by themselves (to reduce their exposure to risky assets with plummeting value) or by their brokers (as they want to recoup at least part of the cash they lent). This is driving prices down to obscenely low levels, even for securities that (in "normal" circumstances) would be safe.

So fasten your seatbelts, because the next few weeks will be bumpy. And, unlike most circumstances, calling your mother won’t help.


Glossary: Maintenance margins, equity, leverage, margin calls, etiquette