Last year, a variety of Chinese dairy firms got embroiled in a major scandal. Some milk contained melamine, which resulted in the deaths of four infants. As a result, the Chinese government took swift action.

Now, it looks like the situation is getting much better. In fact, private equity firms are starting to invest in the sector.

The latest deal: The Carlyle Group has agreed to purchase a 17.3% equity stake in Yashili, which is one of the largest infant formula operators in China (the amount was not disclosed). The company got its start in the early 1980s.

Private equity is about continuous dealmaking. But, with the wrenching credit crunch, activity has been horrible.

So, what to do? Interestingly enough, it looks like some of the top private equity operators are signing up for board duties.

Look at GM, which this week announced five new members to its board. In fact, three of them are from major private equity firms: The Carlyle Group's Daniel Akerson, S. J. Girsky & Co.'s Stephen Girsky and TPG's David Bonderman.

What's going on here? True, private equity has taken quite a few lumps over the past couple years. For example, Bonderman lost a bundle on his Washington Mutual transaction (which was one of the worst private equity deals in history).

The Carlyle Group, which is an $85 billion private equity powerhouse, recently published its annual report. It's a sobering document.

However, there are some interesting tidbits. For example, despite the financial turmoil -- where three deals went bust -- Carlyle was still able to raise $19.9 billion. What's more, the firm invested $12.6 billion in equity last year.

What about the future? Well, Carlyle's co-founder, David Rubenstein, who gave a presentation at the Aspen Global Leadership Network conference, offered some insight on what's ahead, according to BusinessWeek.

Like most other private equity firms, the Carlyle Group is in the process of cleaning things up. For example, the firm has taken write downs on funds, such as the Carlyle Partners IV platform. The fund was launched in the heyday of 2005, with $7.9 billion in assets.

But, at the same time, Carlyle is trying to find ways to capitalize on the low-valuation environment or even find growth opportunities. Just take a look at the latest fund: the Middle East and North Africa (MENA) fund, which has commitments of up to $500 million.

At the SuperReturn conference this week, some of the biggest players in private equity are giving their opinions on the market. For example, the Carlyle Group's David Rubenstein says there are some compelling values as in energy and even finance -- so long, of course, as the federal government is willing to pitch in some capital and provide a backstop.

However, don't expect the go-go days to come back any time soon. In fact, Rubenstein believes that the balance-of-power has shifted to major investors, such as pension funds and endowments. Essentially, they are going to require more discipline, transparency and lower fees. This is assuming that a private equity firm can raise any capital (after all, it's likely that the 2006-2007 vintage funds will sustain losses for some time).

As layoffs have spread across banking, investment banks and hedge funds, things have been fairly quiet for private equity firms. Then again, these operators tend to have small employee bases.

But, interestingly enough, we may be finally seeing some pink slips for the private equity folks. According to The Wall Street Journal, 3i will announce a 15% cut in its staff and that there will be a 19% cut at American Capital.

And now it looks like the tier-1 firms are not immune. The Carlyle Group is gutting 10% of its staff this week (which comes to about 100 people). There's not much deal-making to do right now. Besides, it looks like it will be tougher for private equity firms to raise new capital. If anything, the focus will be on trying to manage the existing portfolios.

What's more, Carlyle has had a variety of blunders. There was the implosion of its mortgage fund (Carlyle Capital) and the recent bankruptcy of its Hawaiian Telecom holding.

Of course, Carlyle is not alone. So, it's a good bet we'll start seeing more layoffs in the private equity world.

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Streetsmart Guide to Short Selling: Techniques the Pros Use to Profit in Any Market. He is also the founder of BizEquity, a valuation website.

When getting the pulse on the credit markets, the private equity firms have a good sense of things. Credit is the lifeblood of the business. And, of course, the credit freeze has essentially stopped private equity activity.

But, according to some veteran private equity dealmakers, it does look like things are stabilizing. For example, the Blackstone Group LP's (NYSE: BX) CEO, Stephen Schwarzman, is optimistic that the environment is improving. The main reason: the massive government interventions.

And, this week we also got KKR's chief, Henry Kravis, to chime in. However, his sentiments are somewhat qualified. After all, he thinks that the real economy is in a fragile state and that investor confidence is still a big problem. What's more, he believes that it will take awhile for growth to comeback.

In the meantime, Kravis predicts a surge in consolidation in the financial services industry. Interestingly enough, some of the leaders in this trend could be operators like Blackstone and KKR, which don't have leveraged balance sheets.

Emphasizing this point is another private equity bigwig, the Carlyle Group's David Rubenstein. According to him, there's a huge opportunity for private equity firms to provide capital to the ailing financial services industry. In fact, the Federal government has recently relaxed some of the investment rules for such deals, which should make returns even more lucrative and give dealmakers more incentive to get transactions done.

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Streetsmart Guide to Short Selling: Techniques the Pros Use to Profit in Any Market He is also the founder of BizEquity, a valuation website

Private equity powerhouse, The Carlyle Group, has more than 500 investment professionals across 21 countries. Of course, some of them are corporate luminaries like Louis Gerstner.

Well, after being the chairman of Carlyle since 2003, he is now departing -- his last day will be September 30th. Although, he will remain as a Senior Advisor to the firm.

Gerstner has had a stellar career. In 1993, he took the challenge of becoming IBM's (NYSE: IBM) chairman. At the time, the company was crumbling.

Despite not having much tech experience, Gerstner set forth an ambitious strategy that not only saved IBM but returned the company to greatness. He even wrote a book about his experience in a book called Who Says Elephants Can't Dance?: Leading a Great Enterprise through Dramatic Change, which is definitely worth reading.

Before his tenure at IBM, Gerstner was the CEO of RJR Nabisco, where he had to deal with the debt-load from a mega leveraged buyout (from KKR). He was also the president of American Express (NYSE: AXP) and a director of management at McKinsey & Co., Inc.

While at Carlyle, Gerstner made a big impact. He helped globalize the firm as well as diversify the investment base. As of now, Carlyle manages about $75 billion in assets across 57 funds and controls a portfolio that has aggregate revenues of $87 billion.

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Edgar Online Guide to Decoding Financial Statements. He also operates MergerBook.com.

Like other tier-1 private equity firms, the Carlyle Group has been expanding into a variety of investment categories. After all, with the evaporation of the buyout business, it's really a necessity.

However, it's far from an easy process. For example, in March the Carlyle Group suffered tremendous losses -- $16.6 billion of debt went into default -- from its publicly traded mortgage vehicle (Carlyle Capital Corp.). In fact, the company had to be shutdown.

Well, unfortunately, this hasn't been an end to the bad news. This week Carlyle had to unwind another fund: Blue Wave, which is a $600 million hedge fund (focused on mortgage-backed securities). Last year, the fund posted a horrible 17% negative return. The poor numbers were the result of bad timing and leverage.

True, Blue Wave was able to stabilize things, with a 2% return for this year. But, for Carlyle to generate substantive fees, the returns would need to be much larger – and that would likely require taking on lots of risk.

So, in the end, it looks like Carlyle made the right decision on Blue Wave.

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Edgar Online Guide to Decoding Financial Statements. He also operates MergerBook.com.

When the Carlyle Group got its start in the late 1980s, the founders leveraged their extensive political backgrounds. It was certainly smart as the private equity firm struck some key deals (especially in the defense area).

Well, Carlyle is using its political savvy once again. This time, the firm wants to take advantage of the distressed valuations in the banking sector.

Basically, there is a complex set of regulations that make it extremely difficult for private equity firms to invest in banks. For example, there is an equity cap of 25% (which is often lower if the private equity firm wants more control).

So, in the Wall Street Journal, the Carlyle Managing Directors, Olivier Sarkozy and Randal Quarles, weighed in with an opinion piece.

The essential argument: the regulations are outmoded.

In fact, the rules may make our financial system weaker since there is tougher access to much-needed capital. After all, it seems that every day there is another bank that needs huge amounts of capital.

No doubt, Carlyle is being self-serving, and it will probably make a fortune from the regulatory changes.

At the same time, capitalism can be a powerful tool, and as a result, move things in the right direction. With $400 billion available in the coffers of private equity funds, this could be a big help to repair the big problems in the banking sector.

Interestingly enough, the issue appears to have some traction. According to a recent Wall Street Journal story, it looks like the Federal Reserve is thinking about relaxing some of the rules.

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Edgar Online Guide to Decoding Financial Statements. He also operates MergerBook.com.

Lost in the flurry of activity over the weekend surrounding The Bear Stearns Companies (NYSE: BSC) is this morning's news that Carlyle Capital, the subsidiary of the Washington-based private equity king Carlyle Group, is 'winding up.' MarketWatch reports that Carlyle Capital, 15% of which is owned by Carlyle Group partners, has more liabilities than assets.

It is interesting that Carlyle can't utter the word 'bankrupt' -- instead preferring the innocuous-sounding term: 'winding up.' But Carlyle shareholders will be left with nothing. And, as I posted, since Carlyle borrowed $32 for every dollar of equity, or $16.6 billion, to buy mortgage-backed securities (MBS), the banks who take possession of those MBSs will probably be eager to dump them as fast as possible -- unless they think they will get a better deal by waiting.

But why wait? After all, the Fed lent $30 billion to JPMorgan Chase & Co. (NYSE: JPM) on a non-recourse basis to take over Bear Stearns's MBSs. This means that if Bear's MBSs go bad, the Fed will take the hit. Is there any active market at all right now for MBSs? If so, should the Fed just dump Bear's MBSs and take the hit now? Won't Carlyle Capital's banks do the same? And who will step in to buy all these MBSs? At what price?

Where does this all end?

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

Reuters reports that Carlyle Capital -- an affiliate of Carlyle Group that counts former President George H. W. Bush among its advisers -- can't pay back the $16.6 billion it owes banks. So its lenders are taking possession of its assets to try to recoup some of the money they lent. Interestingly, it said that the only assets held in its portfolio as of Wednesday were U.S. government agency AAA-rated residential mortgage-backed securities (MBSs). If these securities are indeed worth their AAA rating, I wonder how much of a "haircut" those lenders will take.

This latest collapse is evidence of two viciously destructive cycles in the global credit markets which government policy decisions are making even worse. The first cycle is driving down the stock market, setting inflation on fire, and hammering the dollar -- which is down 68% since 1/19/01 -- as the economy slows. The second cycle is reinforcing a chest-clutching decline in the value of the $6.1 trillion MBS market:

• The Bernanke call. As I've posted, this means that Federal Reserve Chairman Ben Bernanke's moves mark a ceiling below which the market keeps falling. The basic idea is that when the stock market falls, the Fed responds by flooding the market with money -- interest rates have fallen from 5.25% to 3% and are likely to hit 1% and then there's the "Term Auction Facilities" like this week's $200 billion month long swap of government securities for MBSs. The lower rates and added money spur inflation -- oil (+357% since 1/19/01), food prices rise (e.g., milk prices +12% in 2007) and gold futures hit $1,000 -- but do nothing to solve the basic problem -- which is to recapitalize banks. The market falls on the announcement of a new credit market problem, such as Carlyle's default, and the cycle begins anew.

The Carlyle Group got its start in 1987 and has since morphed into a private equity powerhouse, with more than $75 billion in assets. According to the firm's website: "Carlyle's conservative investment philosophy and disciplined investment process has generated extraordinary returns for its investors."

Well, that doesn't appear to be the case with one of its affiliates, Carlyle Capital, which is traded in Amsterdam.

According to the Wall Street Journal [subscription required], the fund's creditors – including firms like Citigroup (NYSE: C) and Bear Stearns (NYSE: BSC) -- will likely be seizing assets for liquidation; there are $21.7 billion in mortgage securities. Simply put, the fund is near dead. In fact, it's the first time a Carlyle fund has plunged into insolvency.

Ironically enough, Carlyle prides itself on its due diligence and investment timing. But in the case of Carlyle Capital, the fund got its start in the middle of 2006, the top of the real estate frenzy.

Something else: Carlyle was not really using fundamental analysis in its strategies. Instead, the fund had a leverage ratio of 32 and was mostly engaging in arbitrage.

No doubt, it's hard to see how this fits into Carlyle's stated focus on conservative principles and investment discipline.

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Edgar Online Guide to Decoding Financial Statements. He also operates DealProfiles.com.

Samuel Johnson once opined: "Depend upon it, sir, when a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully."

This seems to be the feeling with the private equity folks at the Carlyle Group. Basically, they operate a troubled affiliate, Carlyle Capital. Unfortunately, the fund is chock-full of mortgage securities -- and, as a result, there are a variety of margin calls. Perhaps as much as $16 billion could be liquidated (in a market that doesn't want to make bids on any kind of mortgage paper).

So far, Carlyle's exposure is fairly light, with about $670 in capitalization (which includes Carlyle funds, associated investors and public shareholders). And confidence is at dire lows. After all, the shares of Carlyle Capital have been suspended (the fund is listed in Amsterdam).

The Wall Street Journal [subscription required] reports that banks lent a mind-boggling $32 for every dollar of equity in Carlyle Capital, the credit defaulting mortgage investment joint venture between Carlyle Group and Thornburg Mortgage (NYSE: TMA). This demonstrates that while leverage can magnify returns in an up-market, it can also magnify losses in a down one.

The cause for both bankruptcies was that banks made a margin call -- a request for some of their loan to be repaid immediately -- and neither party was willing to cough it up. In the case of Thornburg's $28 million cash call, it is a bit less surprising that it could not come up with the money. But Carlyle Capital's parent is an $80 billion private equity firm -- so it's interesting that it chose not to fork over the $37 million the banks wanted.

What's going on here is that our capital markets depend on the health of Wall Street banks. The banks are running out of capital because the value of their assets -- particularly asset-backed securities (ABSs) such as Collateralized Debt Obligations (CDOs) -- are plummeting. As those assets drop in value, banks need to write down those values and raise capital to maintain their capital ratios -- for example, Citigroup's (NYSE: C) target ratio of capital to assets -- its so-called Tier One Capital Ratio -- is 7.5%.