More than four years after Serena Ng and Carrick Mollencamp of the Wall Street Journal first took notice of the highly destructive ways of the Chicago hedge fund Magnetar, which created a series of toxic CDOs, the SEC finally appears to be taking a serious look at some of their deals. More accurately, it seems to be dusting off and perhaps expanding a probe that it started last June (hhm, wonder if this flurry of activity has anything to do with polls showing how independents in swing states are giving Obama thumbs down for his complacency on Big Finance?) The SEC is also reportedly looking at the deceptive role played by collateral managers, something we discussed in ECONNED and that Tom Adams has written about extensively on this blog.
The short version of the story is that Magnetar constructed the perfect trade. It would fund the equity tranche of CDOs, usually 4-5% of their total value. Deal sponsors like Magnetar got significant influence over the deal, at a minimum veto rights over the assets chosen to go into the CDO. Magnetar took a much bigger short bet on these same CDOs (either by buying the CDS that were the majority of the assets in these deals) or by buying CDS on the CDO itself. The equity paid a very high interest rate (15% to 20%) until the deal started to fail. The interest on the equity funded the CDS premiums on the short bet. But these deals paid big money only if they failed, which they did with impressive speed. (For more background, see this post).
Key points from the Wall Street Journal article:
U.S. securities regulators are investigating hedge-fund firm Magnetar Capital LLC, which bet on several mortgage-bond deals that wound up imploding during the financial crisis, according to people familiar with the matter….
If the SEC were to file civil charges, it would be its first enforcement action against hedge funds related to CDOs. No decision has been made on whether to file charges, the people said…
Investigators are looking at whether Magnetar had such a strong influence in designing any of the deals that in effect it took over the role of collateral manager, a person familiar with the probe said.
The article then discusses at some length a lawsuit filed by Rabobank against Merrill Lynch on a Magnetar-sponsored CDO called Norma. That suit was settled but the SEC is apparently looking into that deal.
It is also possible that a suit by Intesa over another Magnetar deal, Pyxis, got the SEC’s attention. Here is the guts of the argument, per Bloomberg:
Intesa claims Calyon told investors that the CDO — known as Pyxis ABS CDO 2006-1 — was based on residential mortgage- backed securities that had been chosen by an independent investment firm, Putnam Advisory Co., when the underlying securities were really selected by Magnetar.
Putnam was also named as a defendant in the case.
“The scheme was designed by Magnetar,” Intesa alleged. “Calyon collected fees on the deal and, through the Pyxis swap, shifted losses on the CDO which it would have otherwise borne itself.”
The Intesa filing is a road map for SEC action. It is detailed and solid on the tradecraft:
It would be nice to see the SEC get serious on this front. But it’s been poking around Magnetar for a while (it looked into its behavior on a JP Morgan CDO, Squared, and decided not to pursue Magnetar) and has not gone forward. Some of this hesitancy is no doubt due to the fact that disclosure requirements are lower in CDO-land than for SEC-registered offerings. But a lot also appears to be due to a reluctance to try financial complex cases. And until it is willing to do so, the perps will retain the upper hand.
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SEC=perps. Fin
French Whore: correct – the SEC is far too busy watchin pr0n to bother with *complicated* issues.
sigh.
All in good time since to everything there is a season.
Been a lot of seasons pass already. This is similar to the local DA rounding up a bunch of street level dealers a month before an election – except they won’t really perp walk anyone.
Nice, you should send them a nice letter offering to be a material witness, maybe with Rahm back in Chicago, you can interview him.
Maybe they’ve hired interns from planet money on (N)ot (P)progressive (R)adio
Abacus and Magnetar were bad news, but does it serve justice if we just investigate the companies and fine the share-holders. At a certain level, conduct must be punished at the individual level.
And sitll waiting for MF Global, which was extremely damaging to the public’s faith in the financial markets.
Prosecuting Magnetar would necessitate going after the individual(s) who ran and made the decision to construct such a conspiracy to defraud. Selling to public long, betting big short and manipulating the choice of underlying mortgage assets to ensure the probability of the short turning out would require inquiry into individual action, implicating individual liability, civilly.
“a conspiracy to defraud” – exactement. There are so many threads to pull, but the most “golden” thread of fraud paying exponentially to top dogs will snake through the entire fabric, meant to be hidden through the complexity of design. Maybe some expert weavers should be consulted in the “discovery” process.
The argument of “It’s too complicated” “It takes up to much of our resources” are a little off.
If a federal regulator cannot investigate and prosecute who can ?
The feds can and do spent untold resources to chase after the odd bit player but never go after the big boys. This is part of our present two tier justice system.
Sorry folks this is another bit of pre election theater nothing more.
Somebody who worked in the CDO space told me that there is a lot of history behind the development of the term “portfolio selection agent”, which Putnam Adviory “acted” as (where the real decision-making was done by Magnetar).
Apparently, eaerlier in the history of CDOs, these actors were called “portfolio managers”. Once hedge funds like Magnetar and Paulson came on the scene and began to play the role of hidden constructors of the CDOs, the sponsoring banks recognized that they were clearly misleading CDO buyers into thinking that the portfolio manager was calling the shots as a fiduciary for the CDO buyers. The banks convinced themselves that they were somehow less exposed legally if they changed the name for the portfolio manager to something that sounded (to the banks) less fiduciary-sounding, hence the birth of the “portfolio selection agent” term. Of course, this name change was a distinction without a difference, clearly intended to assuage the consciences of the bankers, and also intended to give them some kind of defense if caught red-handed subverting the portfolio managers’ fiduciary responsibility, while conveying no information or meaning to customers.
Meaningless words, a hallmark of fascism, like Jamie Dimon’s use of the words, “economic hedge”.
If photos of Jamie Dimon masturbating Dick Cheney, Larry Summers and Tim Geithner while watching Gitmo torture videos are released in the Fall, that would shake things up.
Indeed, the buck stops with the human agent.
But where is the agency when JPM’s Whale is labeled “just a hiccup” by the likes of Michael Furer Bloomberg! Kinda like 1.6 billion “Vaporizing.”
Vive La Linguistique!
But where is the agency when JPM’s Whale is labeled “just a hiccup” by the likes of Michael Furer Bloomberg! Kinda like 1.6 billion “Vaporizing.”
Apparently, it is now sufficiently close to the statute of limitations safety line that an election-year prosecution scam (or at least an election-year investigation scam) can be conducted.
Yes, my cynicism is approaching critical mass.
Another reason to wonder about how deep the SEC’s committment may be to a comprehensive investigation of Magnetar: enforcement chief Khuzami’s former employer Deutsche Bank was one of Magnetar’s early collaborators. According to an independent investigation by ProPublica, “[f]or its maiden CDO [in May 2006], Magnetar enlisted a partner to buy risky equity alongside it, an internal investment fund within Deutsche Bank.” For a later deal done by Magnetar and Deutsche Bank, the CDO they helped to create would have the distinction of being “the first subprime CDO of its kind to be forced into liquidation.”
http://www.dbriskalert.org/2011/08/will-sec-investigate-deutsche-bank/
For more on the Magnetar, Deutsche Bank collaboration on the Carina CDO, see the recent consent order of the Securities Division of the Commonwealth of Masachusetts in the matter of State Street Global Advisors (Carina CDO.)
http://www.structuredfinancelitigation.com/files/2012/03/state-street-order.pdf
marty, even the recent Frontline program showed how DB agents were ground-floor grifters in bed with “American” Finance Top Dogs. The grifts have been global, key agents have been working a global conspiracy to profit most from their execution of complex designs to defraud.
Krueger. Madoff. Jupiter FL-BushDynasty, Carolina Amway (Brit International)-Blackwater-KBR-Carlyle-Halliburton-Afghanistan-Chevron-Rice-BushDynasty. Call it a “round robin.”
Add BCCI-Bush-Afghanistan-Luxembourg-Carbon trading credits grift.
Isn’t 4 years the statute of limitation standard for breach of contract in most states? Fraud is longer, but harder to prove.
My understanding is the reverse, there is no statute of limitations on contract claims, but I am pretty sure only the parties to the contract can sue (as in the SEC can’t).
Yves, generally contract claims are 6 years (unless S/L shortened or lengthened by contracting parties). Fraud S/L’s are much shorter, which is generally the case with theories requiring proof of intent (like fraud or misrepresentation).
again: CONTROL FRAUD. lol. how many times do we have to repeat it.
this is elite control fraud. pure and simple. you grow really fast, you make shitty investments, extremely lever, make it opaque as possible, you’re guaranteed 2 things:
massive profits see, black, akerloff, romer, amar bhide etc et al.
and guaranteed to blowup, see the past 30 years of finance starting from the st germain act of 1982 and the s&l scandal up to today’s jpm 50% tack on.
Right. William K. Black as Special Prosecutor, the sole satisfaction.
haha! i wish!
The WSJ article focuses on Magentar’s role in asset selection and the Norma CDO, which appears to be different from Pyxis in this respect:
With Pyxis, the Ramp-Up Completion Date coincided with the Closing Date, meaning that investors had access to the actual investments being insured by the CDO. (Of course, the entire CDO scam was based on selling these toxic investments to suckers who were unaware that the credit ratings of the investments and the CDOs were bogus.)
With Norma, the Ramp-Up Completion Date occurred on May 15, 2007, ten weeks after the Closing Date of March 1, 2007. In other words, with Norma, investors were relying on the discretion of the asset manager.
By March 2007, Magnetar’s adverse selection merely determined whether the insured toxic BBB tranches would default sooner rather than later. Magnetar, the rating agencies and Merrill knew that all BBB defaults were as certain as death and taxes.
CDO’s, CDS – the TELLS of the complex daisy chains of fraud and the conspiracy to commit fraud.
House flippers and alt-A bubble buyers created 250 Billion in synthetic CDOs?
Unfortunately I don’t think even a criminal investigation would address the key issue about the Magnetar trade: i.e., that it was a doomsday machine intended to blow up the economy for profit, and that the strategy used to do so was not illegal under current financial regulations. Since it clearly should have been (in the sense that actions causing severe and widespread harm to society for personal gain, such as nuking cities for profit, should generally be illegal) the fact that it wasn’t exposes an enormous gap in financial regulation in the US. Somehow I doubt the SEC will be eager to highlight this point.
More generally, the Magnetar trade could be replicated in any tranched product in which it’s possible to go long/short different tranches. I think it raises questions about whether tranching should even be permitted, as it seems to offer multiple angles for abuse. Certainly there should be restrictions around long/short positions across tranches, if only to prevent the construction of crisis generation engines.
Did you read the complaint? I’m pretty sure that deceiving someone into signing a contract is illegal, no matter how you slice it.
USofA slowly but surely into legal, intellectual, financial, political, social and moral morbidity.
In Requim….
WOW… a world were anyone would asign value… too so much electrons of price and call it sociaital value.
Skippy… like it was a physical thing, intrinsic, self evident thingy (my bounus), purpose of life (gawd said so), prosperity (of the individual) or death, toil cherished as sacred (gawd wants *some* people to grow grapes to get others pissed – reduction of mental facilities – unless the master does it)…. This is not life… but a recipe of down ward pressure… by an incresssing few… to live their lifes needs… desire….