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Topic: The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going (Read 1679 times) |
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MoEnzyme
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The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going
« on: 2010-04-11 15:01:04 » |
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I heard about this story, "Inside Job", on National Public Radio This American Life. The hedge fund, Magnetar both participated as an "investor" in the housing bubble and bet against it. I put "investor" in quotes because the fund managers did not actually expect to make money on their investments. They rather used their investments to 1) manipulate the market by encouraging investment banks to create larger risky collateralized debt obligations (CDOs) where Magnetar would agree to buy the smallest riskiest "equity" part, and the banks then sold the rest to other investors and then 2) using its income from these "investments" to bet against those very same CDOs by purchasing credit default swaps - in a sort of self-funding bet until the CDO went bust at which point the bet paid off.
Quote:| With this, Magnetar solved a conundrum of those who bet against the market. An investor might be confident that things are heading south, but not know when. While the investor waits, it costs money to keep the bet going. Many a short seller has run out of cash at the gates of a big payday. |
Magnetar instead made its money on these credit default swaps, growing from a $1.7 billion into an $7.6 billion fund while the rest of the economy collapsed. Magnetar's activities contributed to the loss of an estimated $40 billion by investors in the CDOs it helped to create.
The NPR story should be available on MP3 download by tomorrow at http://www.thisamericanlife.org/radio-archives/episode/405/inside-job. There are eight chapters to the ProPublica story. I only pasted in the first one. To read the rest of the story click on one of the links below.
-Mo
The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going
by Jesse Eisinger and Jake Bernstein, ProPublica - April 9, 2010 1:00 pm EDT
Chapter 1
http://www.propublica.org/feature/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going
In late 2005, the booming U.S. housing market seemed to be slowing. The Federal Reserve had begun raising interest rates. Subprime mortgage company shares were falling. Investors began to balk at buying complex mortgage securities. The housing bubble, which had propelled a historic growth in home prices, seemed poised to deflate. And if it had, the great financial crisis of 2008, which produced the Great Recession of 2008-09, might have come sooner and been less severe.
At just that moment, a few savvy financial engineers at a suburban Chicago hedge fund helped revive the Wall Street money machine, spawning billions of dollars of securities ultimately backed by home mortgages.
When the crash came, nearly all of these securities became worthless, a loss of an estimated $40 billion paid by investors, the investment banks who helped bring them into the world, and, eventually, American taxpayers.
Yet the hedge fund, named Magnetar for the super-magnetic field created by the last moments of a dying star, earned outsized returns in the year the financial crisis began.
How Magnetar pulled this off is one of the untold stories of the meltdown. Only a small group of Wall Street insiders was privy to what became known as the Magnetar Trade. Nearly all of those approached by ProPublica declined to talk on the record, fearing their careers would be hurt if they spoke publicly. But interviews with participants, e-mails, thousands of pages of documents and details about the securities that until now have not been publicly disclosed shed light on an arcane, secretive corner of Wall Street.
According to bankers and others involved, the Magnetar Trade worked this way: The hedge fund bought the riskiest portion of a kind of securities known as collateralized debt obligations -- CDOs. If housing prices kept rising, this would provide a solid return for many years. But that's not what hedge funds are after. They want outsized gains, the sooner the better, and Magnetar set itself up for a huge win: It placed bets that portions of its own deals would fail.
Along the way, it did something to enhance the chances of that happening, according to several people with direct knowledge of the deals. They say Magnetar pressed to include riskier assets in their CDOs that would make the investments more vulnerable to failure. The hedge fund acknowledges it bet against its own deals but says the majority of its short positions, as they are known on Wall Street, involved similar CDOs that it did not own. Magnetar says it never selected the assets that went into its CDOs.
Magnetar says it was "market neutral," meaning it would make money whether housing rose or fell. (Read their full statement.) Dozens of Wall Street professionals, including many who had direct dealings with Magnetar, are skeptical of that assertion. They understood the Magnetar Trade as a bet against the subprime mortgage securities market. Why else, they ask, would a hedge fund sponsor tens of billions of dollars of new CDOs at a time of rising uncertainty about housing?
Key details of the Magnetar Trade remain shrouded in secrecy and the fund declined to respond to most of our questions. Magnetar invested in 30 CDOs from the spring of 2006 to the summer of 2007, though it declined to name them. ProPublica has identified 26.
An independent analysis commissioned by ProPublica shows that these deals defaulted faster and at a higher rate compared to other similar CDOs. According to the analysis, 96 percent of the Magnetar deals were in default by the end of 2008, compared with 68 percent for comparable CDOs. The study was conducted by PF2 Securities Evaluations, a CDO valuation firm. (Magnetar says defaults don't necessarily indicate the quality of the underlying CDO assets.)
From what we've learned, there was nothing illegal in what Magnetar did; it was playing by the rules in place at the time. And the hedge fund didn't cause the housing bubble or the financial crisis. But the Magnetar Trade does illustrate the perverse incentives and reckless behavior that characterized the last days of the boom.
At least nine banks helped Magnetar hatch deals. Merrill Lynch, Citigroup and UBS all did multiple deals with Magnetar. JPMorgan Chase, often lauded for having avoided the worst of the CDO craze, actually ended up doing one of the riskiest deals with Magnetar, in May 2007, nearly a year after housing prices started to decline. According to marketing material and prospectuses, the banks didn't disclose to CDO investors the role Magnetar played.
Many of the bankers who worked on these deals personally benefited, earning millions in annual bonuses. The banks booked profits at the outset. But those gains were fleeting. As it turned out, the banks that assembled and marketed the Magnetar CDOs had trouble selling them. And when the crash came, they were among the biggest losers.
Some bankers involved in the Magnetar Trade now regret what they did. We showed one of the many people fired as a result of the CDO collapse a list of unusually risky mortgage bonds included in a Magnetar deal he had worked on. The deal was a disaster. He shook his head at being reminded of the details and said: "After looking at this, I deserved to lose my job."
Magnetar wasn't the only market player to come up with clever ways to bet against housing. Many articles and books, including a bestseller by Michael Lewis, have recounted how a few investors saw trouble coming and bet big. Such short bets can be helpful; they can serve as a counterweight to manias and keep bubbles from expanding.
Magnetar's approach had the opposite effect -- by helping create investments it also bet against, the hedge fund was actually fueling the market. Magnetar wasn't alone in that: A few other hedge funds also created CDOs they bet against. And, as the New York Times has reported, Goldman Sachs did too. But Magnetar industrialized the process, creating more and bigger CDOs.
Several journalists have alluded to the Magnetar Trade in recent years, but until now none has assembled a full narrative. Yves Smith, a prominent financial blogger who has reported on aspects of the Magnetar Trade, writes in her new book, "Econned," that "Magnetar went into the business of creating subprime CDOs on an unheard of scale. If the world had been spared their cunning, the insanity of 2006-2007 would have been less extreme and the unwinding milder."
Chapters 2 thru 8
http://www.propublica.org/feature/magnetar-gets-started
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I will fight your gods for food,
Mo Enzyme
(consolidation of handles: Jake Sapiens; memelab; logicnazi; Loki; Every1Hz; and Shadow)
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Re:The Magnetar Trade: The Goldman Sachs vector
« Reply #2 on: 2010-04-26 10:35:14 » |
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http://www.newsweek.com/id/236937
Goldman Sachs is caught spreading the Magnetar meme. -Mo
Goldman Wasn’t Alone
The practices at the center of the current controversy didn't begin with Goldman—and they didn't end there, either.
By Matthew Philips | NEWSWEEK
Published Apr 23, 2010
From the magazine issue dated May 3, 2010
excerpt [with rich text links and text emphasis added by MoEnzyme]:
Quote:Goldman says all investors knew exactly what was in Abacus. It has vowed to "vigorously defend" itself against the SEC charges and has hired former White House lawyer Gregory Craig. So it could be many months before we know who's right or if the bank broke the law. What we do know, however, is that as the housing market peaked in 2006 and 2007 several other big banks, including Merrill Lynch and UBS, did deals very similar to Abacus. The charges against Goldman provide a window into the nature of these arcane financial instruments, which were integral to Wall Street's meltdown.
Abacus is what's known as a synthetic collateralized debt obligation. A CDO is a financial tool that repackages individual loans into a product that can be chopped up, repackaged, and sold on the secondary market. They are "collateralized" in that they are backed by loans, bonds, or other real assets. As interest rates plummeted after 9/11, investors worldwide were eager for the cash flow being generated by millions of new American mortgages. Soon there weren't enough mortgage bonds to satisfy demand, so bankers hit on the idea of the synthetic CDO, basically a bundle of credit default swaps (or insurance contracts) that mimic, or reference, the performance of real bonds. By 2005, the CDO market in the U.S. hit $200 billion, twice the 2004 level. By then, housing prices were sky-high and the Fed had begun raising interest rates. A few smart investors believed the market was overheating and that CDO volume would drop.
Instead, it nearly doubled in 2006, to $386 billion in the U.S., and more than $520 billion worldwide, as banks grew more creative in the way they assembled and marketed the instruments. Some allowed favored clients, often hedge funds, to help choose risky assets, and then bet against the whole thing.
The Chicago-based hedge fund Magnetar Capital was allegedly among the first outfits to employ this strategy. Named for a type of neutron star that crushes anything that gets near it, the fund launched in spring 2005. Magnetar would agree to buy the riskiest piece of a CDO, which helped Wall Street firms draw in other investors. Next, according to an investigation by journalists at the nonprofit ProPublica, Magnetar pressed Wall Street firms to include junky bonds in the CDOs (Magnetar has denied this) so that it could bet against them. When the CDOs defaulted, Magnetar lost the small amount it had invested but made much more on its short bets. The strategy became known in the industry as the Magnetar Trade. From 2006 through 2007, Magnetar sponsored 30 CDOs, most of them synthetic, worth more than $40 billion. By the end of 2008, 95 percent were in default, according to ProPublica." |
full story at: http://www.newsweek.com/id/236937
related links:http://marketplace.publicradio.org/display/web/2008/10/03/whiteboard_crisis_explainer_uncorking_cdos/;
http://www.publicradio.org/columns/marketplace/offair/2008/10/untangling_credit_default_swap.html;
http://www.propublica.org/feature/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going
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I will fight your gods for food,
Mo Enzyme
(consolidation of handles: Jake Sapiens; memelab; logicnazi; Loki; Every1Hz; and Shadow)
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MoEnzyme
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Re: The Magnetar Trade: Rham Emmanuel's cut of the action
« Reply #3 on: 2010-04-29 22:25:11 » |
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And Magnetar has a connection to Rham Emmanuel, Barack Obama's chief of staff, the first person Obama selected for his new administration. This might shed some light on how they edged out Goldman Sachs on the influence scale since no one related to Magnetar is actually being prosecuted in this deal while Goldman a much smaller fish in this shark scheme takes the heat. Magnetar, Rham Emanuel, and Barack Obama are all of Chicago political power.
Blowing Up the Economy: Magnetar and Rahm Emanuel
by goinsouth
Tue Apr 13, 2010 at 12:06:19 PM PDT
http://www.dailykos.com/story/2010/4/13/143251/087
excerpt:
Step 3: Buy some political insurance.
Quote:| And the hedge fund’s cagey bet on Rahm? Litowitz and his wife had never before made significant political donations. In 2005, they started giving to Rahm and his PACs, and only PACs connected to Rahm, just before the Magnetar CDO program began, and continued through the first quarter of 2008, when the trade would have started to pay out handsomely. The Litowitzs gave a total of $8,000 to Emanuel and $10,000 to his Our Common Values PAC in May 2005. In 2006 and 2007, they contributed $51,700 to the Democratic Congressional Campaign Committee, while Emanuel was chairman. We have been advised by individuals involved in political fundraising that the amounts given would be considered significant, and the way the payments were distributed across the PACs is sophisticated. Put it another way: this money was not given impersonally. |
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I will fight your gods for food,
Mo Enzyme
(consolidation of handles: Jake Sapiens; memelab; logicnazi; Loki; Every1Hz; and Shadow)
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