Hedge funds, like Carlyle -- that invest in CDOs -- are extensions of the banks -- linked to them through the money they borrow to buy those CDOs. As the value of their collateral declines, the banks realize that the hedge funds will not be able to pay back the money they borrowed. That's because there is no active market for those CDOs that might be willing to pay the hedge funds so they, in turn, could pay back the banks.

The failure of these hedge funds to pay back the money they borrowed makes things worse for the banks. This matters because hedge funds manage $1.9 trillion worth of clients' money. I am not sure about this, but if that $1.9 trillion is treated as equity and those hedge funds borrowed $32 for every dollar of that equity, the hedge funds would owe $60.8 trillion to the banks.

Since hedge funds are so lightly regulated, public information about how much they've borrowed is hard to come by. But let's say that 20% of the hedge funds' assets were invested in CDOs -- assuming they borrowed $32 for every dollar of equity that would mean they owed the banks $12.2 trillion which would be backed by $12.5 trillion worth of CDOs on the hedge funds' books.

But if those $12.5 trillion CDOs are now worth, say, 25% of their stated value, or $3.1 trillion, then the banks are going to be nervous about the $9.1 trillion gap between the value of the collateral and the amount the hedge funds borrowed. And they'll look for a way to force the hedge funds to pay back that $12.2 trillion. If the hedge funds don't happen to have that money available, they'll default just like Carlyle Capital did. This will mean huge additional write-offs for the banks.

And of course investors in these hedge funds will be scrambling to get their sliver of equity out. Unfortunately, for them, the exit doors are barred. But while these wealthy investors knew the risks, many may not have thought that those risks would apply to them.

Unfortunately the hedge funds are not the only ones freezing investors' money. As I posted, The $330 billion Auction Rate Securities (ARS) market is also freezing investors' money. But that's far worse -- because the investors were told that the ARSs were safe.

In 2007, Wall Street liked to brag about how the world was awash in liquidity. I did not find that particularly comforting because liquidity is not cash. As we're seeing now, liquidity is really negative cash -- it's money that has to be paid back. And given the lack of disclosure about how much hedge funds have borrowed and the value of the assets they bought with that leverage, the magnitude of that financial black hole is hard to measure.

And this reverse leverage is causing an implosion that will swallow and digest borrowers across the global economy.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns Citigroup shares and has no financial interest in the other securities mentioned.