The collapse of Carlyle Capital and the temporary rescue of Bear Stearns may go down in history as the key events signaling the end of the 'roaring nineties' (which lasted into the 21st century), nearly two decades of easy money, cheap credit and soaring global debt. Exceptional events -- such as the Fed for the first time in 50 years throwing a monetary lifeline to a bank on the verge of bankruptcy -- constitute the choreography of the closing scenes of this financial catastrophe which so much resembles a modern-day Greek tragedy.
The victims, a hedge fund and a bank, systematically ignored the bad omens because they felt omnipotent. Only a few months ago, while the British government struggled to save Northern Rock, the London-based European chairman of Bear Stearns dismissed any future troubles linked to the sub-prime meltdown. The rescuers, the Federal Reserve and J.P. Morgan, are determined to perform against all odds, but unless a Deus ex Machina, which for the Greeks was an impossible, supernatural event, takes place, their efforts will be in vain. Even the chorus, i.e. the market, follows a well known script: in one moment howling for the unlucky fate of the actors, and in the next scheming against them.
For the ancient Greeks the roots of all tragedies lie in men's uncontrollable passions: love, hate, power and greed. Carlyle Capital's and Bear Stearns' destinies confirm this belief. Bear and Carlyle are deeply intertwined because they both jumped on the easy credit bandwagon to make money. In other words, greed motivated them. Both had reputations of being highly aggressive and competitive-ruthless, many in Wall Street would add. But these characteristics are common in globalized finance where the old fashioned rules of the game are ignored or simply forgotten. What brought down Carlyle Capital and crippled Bear Stearns was not their business behavior but the sub-prime house of cards they contributed to building. Their fall was an event that was bound to happen but that none of them was willing to consider. And in the best Greek tragedies, those who fall are given the chance to avoid disaster.
The script for this modern tragedy is a masterpiece of the power of illusion in the hands of those who believe to be gods, Tom Wolfe's 'Masters of the Universe.' Carlyle Capital was indeed half human and half superhuman. An offspring of the Carlyle Group, the "club of the powerful", whose members include former prime ministers such as John Major, presidents of the United States, Bush senior, and the Arab super rich, among whom are the bin Laden family, the fund used its amazing connections at the highest political and financial levels to gather cheap credit. Giants of global finance, Citigroup, Deutsche Bank, Bear Stearns, Lehman Brothers and UBS, got into financial scrums to become Carlyle Capital's lenders at phenomenal and ridiculous conditions: for each dollar in assets held by the fund, they lent $31 more. Carlyle Capital's leverage, the ability to raise money in the world market, was simply unique. When it went down it had $ 22 billion outstanding debt against assets of about half a billion.
Almost $2 billion came from Bear Stearns, a major player in the mortgage-backed securities s secondary market linked to the booming housing market. Over the years, Carlyle Capital had built a portfolio exclusively of such stocks. On paper it was a match made in heaven -- or better, in the Olympus of global finance. Advised by the members of the 'club of the powerful', the fund had bought triple-A mortgage-backed securities, implicitly guaranteed by the US treasury, issued by Fannie Mae and Freddie Mac, two of the most reputable institutions in the metamorphosis of the US housing debt into a global asset. Within the sub-prime secondary market, these stocks were among the most secure. And this is the unexpected twist of this tragedy: that the first ones to fall are those who had invested in 'secure' mortgages.
The game lasted as long as the housing market boomed. Carlyle Capital borrowed money from Bear Stearns money to buy mortgage-backed securities and used their increasing value to keep borrowing more and more. It was a win-win game. Each time the interest rate went down, borrowing became cheaper and housing demand went up while property prices rose. On paper(remember we are talking about a house of cards here) both partners were making money because one held and the other funded purchases of homes that were rising in value. For a decade the deflationary policy of the Federal Reserve fuelled this mechanism. Hundreds of thousands of similar partnerships took place, creating a global web where every financial institution is linked to every other. Then one day the wheel of fortune turned, Americans could not meet their mortgage payments any longer. As prices of properties began to slide, paper assets of companies like Carlyle Capital and investment banks like Bear Stearns vanished. Inside the web of easy credit, people panicked and began calling on their loans. Carlyle Capital fell victim to its own lenders' demands for cashand Bear Stearns, one of Carlyle's lenders, may well share the same destiny for the same reason.
The last scene of this modern financial tragedy will be played out this week. Tickets are already on sale in the major financial centres, from Wall Street to the City of London. Book soon because we are expecting a full house!
Loretta Napoleoni is the author of the bestselling book Terry Inc.: Tracing the Money Behind Global Terrorism. She is an internationally recognized expert on money laundering and terror financing. Her current book is Rogue Economics: Capitalism's New Reality.