Purchase risky debt on a massive scale and then place a bet that the debt will fail!

April 15, 2010 9:36 PM

Betting Against the American Dream. In 2005, just as Wall Street started to get cold feet about the housing market, the Magnetar hedge fund helped create a new wave of billion-dollar mortgage-backed securities, pushed bankers to include riskier sub-prime mortgages, and then shorted the securities, making millions when the bubble finally burst. Traders on both sides of the deals pocketed enormous fees even if their banks went under when the securities failed. Pulitzer Prize-winning ProPublica, This American Life, and NPR's Planet Money track down some of the big winners in the housing/financial crisis. No time to read or listen? It seemed so much like a scheme from The Producers, they even recorded a show tune to explain it all. (Previously, 2, 3)
posted by straight (30 comments total)

Needs more tags. You left out creditdefaultswap.

Seriously, though, I listened to the TAL piece on Magnetar yesterday and it's very good.
posted by neuron at 9:38 PM on April 15, 2010 [1 favorite]

I know it's popular to hate on TAL these days, but I think they've been on a roll lately. The Barry Cooper segment of this last week's show, the Patrick Wall and hookworm stories from last week, the whole NUMMI show. They all could be good FPPs.
posted by kmz at 9:45 PM on April 15, 2010

You said Magnetar when I think you meant Magnetar. Interesting post, though.
posted by koeselitz at 9:46 PM on April 15, 2010

...and this is why people in the country of America are so very very angry. At President Obama and Health Care reform. Sheesh.
posted by Artw at 9:53 PM on April 15, 2010 [2 favorites]

Thanks for posting this. I really enjoyed hearing and reading it when it came in my feed reader.
posted by l33tpolicywonk at 10:26 PM on April 15, 2010

This is an excellent post and I wish straight would post more often. Also, I'm glad to see that even in this hard bitten economic climate, someone is still being paid to write showtunes.
posted by hermitosis at 10:30 PM on April 15, 2010

The Magnetar Trade
John Gapper on the Magnetar Trade
The Cover-Up
Doth Magnetar Speak With Forked Tongue?
Rahm Emanuel and Magnetar Capital: The Definition of Compromised
The Magnetar trade, part 2 - "Tavakoli and my other correspondent both believe that ProPublica and This American Life have the story wrong."
posted by kliuless at 10:32 PM on April 15, 2010

There is a certain way of thinking, a belief that companies, particularly financial companies, will always take profit, no matter how destructive, because it is their nature.

I am actually in favor of capitalism, albeit regulated, because it is so very, very powerful to use an evolutionary system of companies to optimize the symbolic manipulation of power*.

Let us not forget, though, that evolution is based on sex and death. Both of these elements are difficult to come to terms with, and can get quite out of hand.

I guess what I'm saying is that we should recognize that these are very hungry animals we are dealing with, and building stronger cages is in order.

*Money is the symbolic manipulation of power, and it is very difficult to accomplish things in a society without it.

I think my mixed metaphor got out of hand there.
posted by poe at 10:32 PM on April 15, 2010 [2 favorites]

Speaking of showtunes about the malefactors of the financial crisis
posted by delmoi at 10:43 PM on April 15, 2010

Anyway, I'm kind of annoyed by all the short seller hate out there. Jim Cramer hates the shorts. What does that tell you? Short sellers provide valuable information to the market, and it incentives people to explain the risks to everyone, for example James Chanos who's been spending a lot of time talking about the problems in the Chinese economy. Chanos is the one who discovered the problems with Enron.

Now, people who market assets to others while shorting on the backend is pretty shady. But pure short selling is a good thing.

(When Micheal Lewis was on the Daily Show, Jon Stewart asked why people couldn't just use "reality" to figure out how to invest. But, in my view, people don't really see reality when it goes against their interests. Sober minded people won aren't interested in gambling simply don't pay attention to the stock market. People who aren't excited by the buying and selling on the stock market are bored to tears by it.

Short selling allows people to monetize their cynicism. And frankly, given the amount of cynicism I've got, in my view that's a good thing.
posted by delmoi at 10:59 PM on April 15, 2010 [3 favorites]

I'm surprised at two things: a) The amount of anger in American politics, and b) that almost none of this anger is directed at anyone in finance.

Frankly, when the crisis really hit home, I expected bankers and traders to head for the hills, but nobody broke out the torches and pitchforks anyway. There was this one item in the media about Goldman Sachs employees arming themselves, but that turned out to be false. Where are the anti-finance militias? You had one guy who crashed his light aircraft into an IRS building, but nothing like that has happened on Wall Street.
posted by Harald74 at 11:17 PM on April 15, 2010 [3 favorites]

delmoi, the TAL radio/podcast story makes the same point about the importance of honest short selling.

Thanks for the additional links, Kliuless. Steve Hsu in his follow-up to your last link makes a pretty good case that Magnetar was not actually smart enough to have figured out which bonds were the crappiest in order to have purposely designed the CDOs to fail.

Seems to me the biggest villains, as mentioned at the end of the This American Life story, are the people who should have been paying better attention to what they were buying. As summarized in your link titled "The Cover Up":

Because the banks made up-front fees for creating CDOs, the actual human beings making the decisions did not particularly care if the CDOs collapsed — they just wanted Magnetar’s money to make the CDOs possible.

(Oh, and koeselitz, I just like magnetars and wanted to point out where the hedge fund got it's name.)
posted by straight at 11:31 PM on April 15, 2010 [1 favorite]

So why don't we do the obvious thing and regulate CDS like insurance. Perhaps ban the sale of a CDS to someone who doesn't actually own the asset the CDS is protecting?

And yes, sometimes shorts are shitheads. Just because there are people who use short sales responsibly does not mean that everyone is doing so. If they were really that useful, they wouldn't get hammered when they're correct about the overvaluation, just wrong about the timing of the impending market correction. (see: SemGroup and the oil bubble)
posted by wierdo at 11:34 PM on April 15, 2010

Yeah, I (from my admittedly ignorant view of high finance) don't think it's short selling per se that's the problem, it's transparency.

The stuff with Magnetar is super difficult to prove because most of the details of the purchases are not public. My thought is that if high finance is going to play in the same pool as large chunks of public money, then they have to stop pretending that what goes on between companies is private and of no concern to the general public.

I'm surprised at two things: a) The amount of anger in American politics, and b) that almost none of this anger is directed at anyone in finance.

I'm taking it that you haven't noticed that the two groups often involve the same people.
posted by lumpenprole at 11:53 PM on April 15, 2010 [1 favorite]

I'm taking it that you haven't noticed that the two groups often involve the same people.

Do they really? (I'm not American, BTW, so if I appear tone deaf on this, that might be the cause. I'm going on what I can read on the Net about this.) The angriest of them all seem to be the militia movement, which as far as I can tell recruit members from the poorest strata of society. Their anger does not seem to focus at all on the financial sector (hell, it's not that well focused at all, as far as I can tell).

So from my point of view, if I was poor (or at the very least poorer) and was desperate and without prospects, my scapegoat would tend to be the "fat cats" who are still living large and sitting secure in their mansions. Apparently a totally different narrative is in the minds of the American public.
posted by Harald74 at 1:37 AM on April 16, 2010 [1 favorite]

Apparently a totally different narrative is in the minds of the American public.

I'm not American either, but I always got the impression that "The American Dream" tends to inspire those poor people to believe that they, too, will one day be rich...therefore taxes on the rich are bad, the rich are noble people who drive the economy, the market should be left to do it's work, tax on inheritance is bad etc. etc.

It's a pathetic state of affairs.
posted by Jimbob at 3:23 AM on April 16, 2010 [1 favorite]

I love the bit about "They were predators, when they came in the room we should have run away." One day I want to hear a WS advisor say something like "Have no business with them; they're too smart. " They'll destroy your economy for fun and you'll pay them for it.
posted by a robot made out of meat at 6:14 AM on April 16, 2010

So why don't we do the obvious thing and regulate CDS like insurance. Perhaps ban the sale of a CDS to someone who doesn't actually own the asset the CDS is protecting?

Tim Geithner testified in congress that determining who is doing "legitimate" hedging with CDSes is "To hard"
posted by delmoi at 6:14 AM on April 16, 2010

[comments removed - metatalk your option]
posted by jessamyn at 6:22 AM on April 16, 2010

Anyway, I'm kind of annoyed by all the short seller hate out there. Jim Cramer hates the shorts. What does that tell you? Short sellers provide valuable information to the market, and it incentives people to explain the risks to everyone, for example James Chanos who's been spending a lot of time talking about the problems in the Chinese economy. Chanos is the one who discovered the problems with Enron.

If you actually listened to the story, you'd know that this was discussed at some length. There is a very big difference between an honest short, which tends to keep bubbles from bursting because there is always some downward price pressure from skeptics-- and what was at play here, which is to actually create the toxic assets to bet against them via a CDS. And this created the exact opposite incentive to the one you are proposing-- Magnetar and their proxies in the investment banking community (arguably) deliberately covered up the risks in order to keep suckers buying in to supposedly AAA-rated securities. This is much more like fixing a sporting event than betting on the downside of a free market.
posted by norm at 7:55 AM on April 16, 2010

SEC just charged Goldman with fraud for structuing weak CDO's for Paulson and Co to write CDS against. Not exactly what Magnetar was doing, but related.

Link here (its a PDF)

I have mixed feelings about this - but if the SEC is going after anyone, going after the banks who structured these things and sold them on for the fee income on both sides are the guys they should be going after.

Also despite this scamminess, Magnetar had a down year in '08 and had to gate a bunch of their funds. Couldn't happen to a nicer bunch of guys from persobal experience.
posted by JPD at 8:02 AM on April 16, 2010

here is the press release for the PDF-phobes out there
posted by JPD at 8:03 AM on April 16, 2010

“More and more leverage in the system, The whole building is about to collapse anytime now…Only potential survivor, the fabulous Fab[rice Tourre]…standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!” Similarly, an email on February 11, 2007 to Tourre from the head of the GS&Co structured product correlation trading desk stated in part, “the cdo biz is dead we don’t have a lot of time left.”

damning emails from the credit salesguy at goldman responsible for selling this stuff on.
posted by JPD at 8:13 AM on April 16, 2010

Let us not forget, though, that evolution is based on sex and death.

Unfortunately, while corporations are allowed to hook up with one another, there is no corporate death penalty. Without death, there is no evolution.
posted by five fresh fish at 9:05 AM on April 16, 2010

Or, I should say, no evolution toward the "best fit" niche. Instead, one ends up with sociopathic corporations that do immense damage to society, instead of corporations that work with and for the benefit of society.

We really, really need to start killing companies that hurt our society.
posted by five fresh fish at 9:07 AM on April 16, 2010 [1 favorite]

Got an E-mail from Obama calling it the "Wall Street Reform." Love the rebrand. Now, as all 41 GOP senators move to oppose, Obama declares he will veto any bill that doesn't regulate derivatives, which the Credit Default Swaps were. Looks like classic GOP overreach.

Can't wait to see Wall Street 2 from Oliver Stone.
posted by Ironmouth at 11:54 AM on April 16, 2010 [1 favorite]

delmoi wrote: "Tim Geithner testified in congress that determining who is doing "legitimate" hedging with CDSes is "To hard""

That's why I think a bright line rule of "you must own an asset that can be protected by a CDS to bu a CDS on it" is a good idea. Not that it helps the write side on its own, but it's insurance, and we have plenty of experience regulating insurance companies.
posted by wierdo at 11:57 AM on April 16, 2010

Do they really? (I'm not American, BTW, so if I appear tone deaf on this, that might be the cause.

Sure, but you're talking about people and the media, not actual politics. What I meant is that most of the people at the Fed were at one times heads or very high up in the banks that they're being asked to regulate. I'm not saying that there's any underhanded dealings or quid pro quo, but only that they're not working terribly hard to make it clear that there wasn't.

I listened to the TAL piece again this morning and was struck by the transparency issue again. Essentially, it's hard to prove malfeasance because we can't compare the buy sheet vs the default swap sheet. We can't prove that they were making intentionally risky investment, then hedging the crap out of it because we don't know what they bought.

The thing is, I think there's very little chance for real reform in this area because so many of the people involved come from that world. And to them, the damage that it would do the business of hedge funds is worse than the possible long term stability that we might gain out of it.

I'm not sure how to convince them otherwise.
posted by lumpenprole at 1:36 PM on April 16, 2010

Can't wait to see Wall Street 2 from Oliver Stone.

That's going to be awesome.
posted by delmoi at 5:55 PM on April 16, 2010

hookworm stories

To be fair: the hookworm segment that TAL ran was originally a story on Radiolab. Although the coda that TAL added -- that the hookworm fellow had been shut down by the FDA and fled the country after the story was first broadcast -- did add a whole new layer of strangeness.

And yes, the show on NUMMI was fascinating.
posted by We had a deal, Kyle at 3:35 PM on April 17, 2010