Blood in the Water on Wall Street

The stock market opened down big this morning (30 minutes into trading, the S&P 500 is down well over 1% with no bottom in sight). The news in the Wall Street Journal is alarming: the private equity fund Carlyle Capital failed to meet a margin call last night.

A margin call is the second worst thing which can happen to any investor. It means that the investor borrowed money against its portfolio, and the bank or brokerage is demanding more collateral for the loan because the value of the portfolio dropped too much. The usual response is to add more cash to pump up the portfolio value and reduce the loan amount.

Normally when an investor gets a margin call, there's only a matter of hours to put up enough collateral (or "meet the margin call"). If the problem isn't fixed by the start of trading the next day, the bank or broker will force the investor to start selling part of the portfolio to pay back enough of the loan to satisfy the collateral requirements.

This forced selling is the worst thing which can happen to an investor.

That a private equity fund as prominent as Carlyle Group would fail to meet a margin call is nothing short of astonishing. Aside from the fact that they should have been smarter than to get themselves in this situation in the first place, this was the group all the conspiracy nuts liked to weave their dark theories around, because of the number of prominent politicians (including ex-Presidents) associated with the fund.

There's an old saying among stock traders that you should buy when there's blood in the water. In other words, when a big player is wounded or dying, the forced selling will push prices to an irrational place and that's the time to step in and buy.

This morning there's blood in the water. Too bad I'm already invested.