Few investment funds have ever really made much of an impression on the public consciousness. The Quantum fund did; the hedge fund with which George Soros attacked the British pound in 1992, busting it out of the European exchange rate mechanism. If there is another, it is surely the Carlyle Group. The US$76 billion private equity fund is notorious mainly for the way its managers have so assiduously cultivated political connections. The roll-call of past advisers and directors includes United States President George W. Bush - and his father - as well as former US secretary of state James Baker and former British prime minister John Major. Just last week Carlyle recruited Oliver Sarkozy, half-brother to French President Nicolas Sarkozy, as managing director of its global financial services group. So people sat up and took notice last Thursday when regulators suspended trading in the shares of Carlyle-affiliated hedge fund Carlyle Capital Corp after it failed to meet margin calls, prompting its creditors to begin selling assets of the fund held as collateral. The danger now is that other hedge funds with similar exposure will also default, triggering a mass fire sale of assets that will plunge financial markets into a vicious downward spiral. In retrospect, Carlyle Capital always looked like a disaster waiting to happen. Like other hedge funds, it borrowed heavily from banks in order to buy mortgage-backed securities. Those securities were then lodged with the banks as collateral for its loans. At the end of last year it had leveraged up 32 times, holding US$22 billion worth of assets on just US$670 million of equity. The trouble is that since the US property market has rolled over, the mortgage-backed securities the fund owns have been falling in value. As a result, the banks which provided Carlyle Capital with its leverage have been demanding more money to shore up the value of their collateral. On Wednesday, the fund received a demand for US$37 million it was unable to meet. The share price crashed (see chart) and more lenders made margin calls. Some began selling the assets they held as collateral. This is a dangerous situation. The market in mortgage-backed securities is already shaky. Forced sales of collateral will only damage sentiment more and further depress prices. That could prompt more margin calls to other funds, triggering more defaults and prompting yet more asset sales in a deadly bear cascade. Worse, the fallout may not be confined to the mortgage-backed securities market. Hedge funds with broader holdings could be forced to sell unrelated assets, like equities or commodity-backed paper, to meet margin calls triggered by declining values in the mortgage market. That could start a downward spiral in other asset markets, leading to yet more defaults and new fire sales across a range of markets. Pessimists warn the result could be a general financial meltdown. That is unlikely to happen this time around. The Carlyle Group has deep enough pockets to bail out Carlyle Capital if its managers choose to. They may even make a profit on the deal. But even if Carlyle Capital is rescued, the risk is acute. Hedge funds are losing money (see chart) and lenders are nervous, which means that more margin calls are inevitable. Sooner or later a less well-known fund could default, triggering a mass de-leveraging that will hammer financial markets around the world.