In hindsight, 32 times leverage seems excessive. That we are now referring to Carlyle Capital with hindsight is astounding.

Stock market futures sold off hard this morning on news that Carlyle Capital, a division of private equity firm Carlyle Group, is on the verge of collapse. According to The Wall Street Journal, lenders led by Deutsche Bank (DB) and JP Morgan (JPM) are set to seize and sell what's left of the fund's assets.

The Journal reports Carlyle is delinquent on about $16.6 billion of its remaining debt. Lenders have already begun to liquidate assets, further depressing the already stressed market for mortgage debt.

At its peak, Carlyle Capital owned $21.7 billion in mortgage-backed securities, primarily AAA-rated bonds guaranteed by Fannie Mae (FNM) and Freddie Mac (FRE). The portfolio was backed by just $670 million in equity. The fund's high leverage left it susceptible to margin calls, where lenders ask for money or additional collateral to support their loans.

Yesterday, Mr. Practical wrote that commentary blaming depressed asset prices on credit market illiquidity is evidence that many still don't understand the problem:

"The problem isn't one of liquidity. It's one of solvency: loans banks made (especially through the derivatives market) are worth less now than when they made the loans. Because they made way (100 ways) too many of them, banks in general have no capital left. You can't make loans if you don't have capital."

Writedowns on their own mortgage-related holdings are forcing banks into capital preservation mode. Under normal circumstances, lenders would be willing to work with a fund like Carlyle to sell assets, raise money, roll over debt or find some other solution that would prevent the fund's liquidation. These, however, are not normal times and banks have enough problems without having to worry about their clients blowing up, too.

That such a large block of agency paper -- securities backed by Fannie and Freddie -- is about to flood the market is worrisome. Mr. Practical is correct that illiquidity is the result, not the root, of the problem, but illiquidity will force firms holding similar assets to mark them down to lower prevailing prices.

One need only look to Thornburg Mortgage (TMA) for insight as to what happens when forced selling invades a market.