For those of you who have not picked up Yves Smith's book, ECONned, perhaps you've never heard of the Magnetar Trade.
In the wake of the Goldman Sachs civil fraud charge, Journalists and Bloggers are wondering and hoping where the next investigative shoe will drop. Hence, the Magnetar fund, a hedge fund of synthetic CDOs, where buttloads of CDS bets were placed against them, is being revisited.
From Naked Capitalism:
Assuming that the Goldman suit is the first step in a bigger initiative, where might the SEC and private claimants go next? There would seem to be at least three obvious channels: other John Paulson-related CDOs; non-Paulson Goldman Abacus trades; synthetic CDO programs like Abacus, apparently for the banks’ own accounts (the most notable example being Deutsche Bank’s Start program) and the Magnetar CDOs, which were structurally different than the Paulson program but appear to have been designed with the same intent, namely using a CDO to gain access to credit default swaps on particularly drecky subprime debt at cheap price (since the use of a CDO lured some counterparties into accepting AAA prices for at best BBB risk).
Magnetar’s program was far and away the largest of all the subprime short strategies that used synthetic or heavily synthetic CDOs as a major component.
The Naked Capitalism piece has detailed lists of who make Magnetar trades, valued at $37 billion. I attached one of these documents here for unfortunately they are up on the impossible to read scribd.
In this list, we see Calyon, Mizuho, Citigroup, UBS, Lehman, and Wachovia, all with Mizuho/Calyon alone having a $9.3 billion dollar deal in Magnetar. (Good work Yves Smith, Tom Adams, Andrew Dittmer and Richard Smith!)
Prorepublica has written an opus on the Megnetar fund.
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.
Included are some nice graphic analogies to help illustrate what a CDO is. Propublica also put together a CDO issuance timeline, click on image to view:
This is not a new story, more in the wake of Goldman Sachs, people are regurgitating and reading the old ones. We also have written many a piece on collateralized debt obligations and how credit default swaps stink on every level, from the mathematics to the models to the systemic risk creation.
My own current questions are:
- After 2008, how many CDSes are being issued on CDOs and new MBS CDOs created?
- Is there any connection, incentive for large banks to foreclose on existing mortgages in order to get a CDS payout?
- Is there any pattern with undue foreclosures, forcing of a default by mortgage holders and particular CDOs?
- Is there any connection, any incentives, of obtaining "bad" mortgages" to stuff a CDO, correlated to profits when that CDO failed?
- Are these nullified and purchased through the MBS Federal Reserve and/or Treasury programs or are some CDOs and corresponding CDSes alive and well?
If someone knows the answers to the above, please leave a comment.
Dean Baker claims the financial crisis is not about CDOs, but I beg to differ. When one has a profit incentive for foreclosures, failure and kicking people out on the street, in addition to overinflated home prices, lending fees and the rest of it, all of this creates an implosion.