Your latest entry into the “hoocoodanode” files:
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 [1] helped revive the Wall Street money machine, spawning billions of dollars of securities ultimately backed by home mortgages.
***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 [2]. 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 [3], 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.
They knew.
Once again, can you imagine how devastating it would be for this country if these bastards would please just go Galt?
(via, who you should read for more info on this trade.)
BR
There was a computer science research paper from not long ago that I posted about at DKos.
The paper proved mathematically that certain types of CDOs could be designed so that it is impossible to detect bad assets. (It has to do with information asymmetry – the creator of the bundle knows where the bad assets are but the buyer computationally cannot.)
Just goes to show these things shouldn’t even exist.
SGEW
I have outrage fatigue. My arm’s gettin’ real tired from waving this damned pitchfork in the air.
scav
@SGEW:
don’t quit on us now but I know what you mean. I’m trying to perfect a menacing and piercing stare (vaguely rusty too, which you can just manage with hazel eyes) for those moments when my arm needs a rest.
Kat
Speaking of ‘Working as intended’ and ‘hoocoodanode’…
John posted earlier about the sheer hell of trying to figure out his surgery bills. This recent Denver Post article explains why that’s so difficult:
Fictions, frauds found to abound in medical bills
8 out of 10 bills from hospitals and health care providers contain errors.
The print version of the article also included this:
A few of the more obvious medical-bill red flags
* $212 per minute of operating room time.
* $23 for a half-inch-square alcohol swab.
* $500 for 44 tiny white cups used to hold pills, listed as ‘medicinal delivery system’.
* $5,000 for 97 pair of nonsterile latex gloves for a patient’s one-day stay.
* $150 for a teddy bear listed as a ‘cough support device’ and given to open-heart surgery patients to hold while coughing.
* $650 for two minutes of emergency room doctor’s time.
* $3,334 for a drug that costs $691 per dose. This was charged twice, though administered just once.
* $47,000 for a surgical procedure that normally costs $8,000.
* Charges for an individual’s surgery on three feet.
* Charges to draw blood, though that was already included in the fee to test it.
Sorry this comment is off-topic, but my email isn’t working, and I wanted to be sure John read this article.
Cat Lady
Working for a large law firm closing Merrill Lynch CRE securitizations through the peak of the bubble was an education in how little the average American can know about the so called rational market. The senior partner who’d been structuring sophisticated real estate transactions all of his professional life never understood what was really going on with these asset pools, and yet we’re told over and over by the teatards and their puppet masters in the media the government is the problem and to trust in the magic of the markets and retire like kings.
Everything’s been looted including sovereign funds, and the only thing left for Wall Street is cannibalism and ponzi schemes. No wonder the Goopers want to get back in power so much – looting the Treasury and rent seeking is their only path to riches.
Kat
Jeez… The bold in my comment above wasn’t my idea. Sorry.
scav
OK, this is the nearest available pure pitchfork thread for this OT but rhymes wonder.
(via Guardian)
Battling?! Battling?! Kiddo in the cute dress, I know this is probably your second or third language but that is more properly shuffling and hiding and dancing about sprinkling sanctity dust. Even bloody Latin must make some sort of distinction between those actions.
Derelict
Just to drag this thread back on topic, I’m going to propose an identical scheme to my brother-in-law.
He should buy a truck for his business. It’s a legitimate investment for him that will produce profits over the long term.
But he shouldn’t have to wait for the long term. Instead, he should take out insurance on the truck to cover both its replacement cost AND the contents (which will be valued at 50% of the truck’s replacement cost). Then, he can set the truck on fire, claim the losses against the insurance policy, and have an instant 50% profit on the deal.
I don’t want to hear about how this is somehow illegal or constitutes fraud against the insurance company. It’s not. This is simply doing what the Big Boys of investment do every day–it’s just on a slightly smaller scale.
Brian J
First, Felix Salmon is awesome. He’s known in a lot of circles as the King of Finance Bloggers. I like how, like Paul Krugman, he seems to make this stuff accessible to outsiders like me by being clear and cogent.
Anyway, as I try to figure this stuff out, I try to keep an open mind. I have a hard time understanding a lot of it, so when I hear someone like Bill Maher refer to what Goldman Sachs was doing–trying to have it both ways as far as investing outcomes with its clients–as being the sort of thing that would would make one neighbor “punch another neighbor in his fucking face,” I don’t immediately come to an opinion. Maybe I will one day soon, but not right now.
That said, I have a hard time reading something like this
and wondering how the hell it isn’t illegal, or at least regulated more heavily in some way. What value is there in letting companies do that?
Island in Alabama
Yves Smith’s ECONNED goes into detail on the Magnetar scam. This story is not new to readers of her book or (naked capitalism) blog. It is good to see this story get some play in the financial media. I’d like to see this get onto 60 Minutes, or maybe one or two of the Pravda MSM newscasts (not that I’d expect it to happen).
This is what we can expect in a world where government regulations are stripped, emasculated, or simply not enforced.
In ECONNED, Smith does a great job in debunking the Efficient Marets Hypothesis (wherein we are supposed to believe that everyone makes rational economic decisions and prices are based on full information). Magnetar is a classic example of the use of information asymetry and gaming the system.
Roger Moore
@Brian J:
It’s not illegal because the big finance companies have paid a lot of money in
bribescampaign contributions and lobbying fees to make sure that it stays legal. And the obvious value is that it lets companies book big profits and their officers and high up employees take home enormous bonuses. But I assume you knew that already and are just asking this as a rhetorical question.tc125231
Are you really this breatheless? Of course they knew.
Always follow the money. In net, did the financial elite make or lose money? Did they have to give it back?
Since the answers are, the financial elite made a LOT of money, and they got to keep it, you have to realize that they would have no motivation to do something else.
If the same circumstances occurred tomorrow, they would do exactly the same thing.
russell
The Magnetar story was featured on today’s (4/10/10) broadcast of “This American Life”, with full credit given to Pro Publica.
Maybe they charged too much for whatever it was they did, but it seems pretty clear to me that some kind of medical intervention was called for.
Brendan M
John –
Fixed it for you!
Nancy Irving
What I don’t get is why they bought these crap tranches at all. Couldn’t they simply take the short positions?