UPDATE! Rahm Emanuel and Magnetar Capital: The Definition of Compromised!

[KoKo]

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Tuesday, April 13, 2010
Rahm Emanuel and Magnetar Capital: The Definition of Compromised

Magnetar- Yves Smith

1) A neutron star with an intense magnetic field, capable of emitting toxic radiation across galaxies
2) A hedge fund, the single market player most responsible for the severity of the 2008 financial crisis, through the toxic instruments it created

Rahm Emanuel

1) White House Chief of Staff
2) Politician selected by Magnetar’s CEO to be sole recipient of his political donations, 2006-2008

Strange as it may seem, nearly three years after the onset of the global financial crisis, its greatest, most destructive, and most profitable “it ought to have been a crime” has gone almost entirely unnoticed.

Most people believe that they understand the broad outlines of the financial crisis, and that a central element was an explosion in mortgages made to people who could not afford them.

But how did such destructive behavior occur on such a large scale? The conventional view is that the subprime mortgage blowup resulted from bank
executives being short-sighted, greedy, or both.

But that simple story deters inquiry into how and why this disaster came to pass. Some recognize that the appetite for subprime mortgages seemed to come from investors. In fact, it resulted in a large degree from the way traders at certain large banks used subprime mortgages in a strategy to make their profits seem much larger than they actually were. The effect of this “negative basis trade” strategy was to overpay employees of those banks and consequently eviscerate the banks’ abilities to withstand future economic uncertainty.

The appetite for subprime mortgages was also inflated by people who were betting that the housing market would fail.

Moreover, the devastation wrought by this strategy remains virtually a secret. The fact that it has been almost invisible and appears to have been entirely legal, demonstrates a set of vexing problems. First, that investigations of the crisis have not delved deeply enough, and second, that the deregulation so keenly sought by the financial services industry has made activities legal that by any common-sense standard should be criminal.

But the sponsors of this toxic trade did bother to make sure they had a powerful friend. The head of the firm in question gave substantial amounts of money by political contribution standards to Rahm Emanuel’s PACs, and only his PACs, over the period when these transactions were in play.

The moving force behind a brilliant and devastating subprime short strategy was a heretofore unknown Chicago hedge fund, Magnetar, headed by Alec Litowitz, formerly of the hedge fund behemoth Citadel. Our studies indicate that Magnetar alone accounted for between 35% and 60% of demand for subprime mortgages in the year 2006.

This is how their strategy worked in detail.

The ruse at the heart of their transactions was creating subprime (so called “mezz” or mezzanine) collateralized debt obligations by investing in the riskiest layer, the so-called equity tranche. This kind of CDO consisted almost entirely of not just any subprime risk, but that of the dodgiest layer that could be sold short, the BBB tranches, via a combination of actual bonds and credit default swaps.

But Magnetar’s true objective was not to invest in this toxic waste, which its role as funder of the CDO would lead most to believe. While Magnetar paid roughly 5% of the total deal value for its equity stake, it took a much bigger short position by acting as a protection buyer on some of the credit default swaps created by these same CDOs. This insurance in turn was artificially cheap because over 80% of the deal was rated AAA. Most investors did not understand what Magnetar recognized: this concentrated exposure to the very riskiest type of bond associated with risky mortgage borrowers, each of these CDOs was a binary bet. It would either work out (in which case Magnetar would still show a thin profit) or it would fail completely, giving Magnetar an enormous profit and wiping out even the AAA investors who mistakenly believed they were protected by having other investors sit below them and take losses first. Thus the AAA investors were only earning AAA returns for BBB risk.

Much More of THIS at......
http://www.nakedcapitalism.com/2010/04/rahm-emanuel-and-magnetar-capital-the-definition-of-compromised.html

[tinrobot]

1. Magnetar was just covered on NPR

It was the subject of "This American Life"

http://www.mybanktracker.com/bank-news/2010/04/12/the-magnetar-trade-examined-by-this-american-life-musical-segment/

Brilliant reporting, and the show made light of it by comparing it to Mel Brook's "The Producers" where the lead characters intentionally make a flop to make more money.

Magnetar did the same thing with their derivatives that Nathan Lane/Zero Mostel did with a crappy musical. They made their derivatives so horrible that they were guaranteed to fail, then bet against them. When the derivatives failed, Wall Street failed as well and Magnetar's bets paid off quite handsomely.

The show wrote a clever song that explains it all:

http://dealbreaker.com/2010/04/the-magnetar-song/

[Usrename]

2. We need a deterent for these criminals.

Heads on pikes!

[yurbud]

3. Vlad the impaler had a better idea...

whole person on pike without capital punishment first.

[truedelphi]

4. This should be front page news. And it also expalins why

Obama failed to keep his promise of October 2008 - "During my first year in office, I will carefully keep tabs on the financial firms and the bankers, and should their policies prove risky to the public, whose money has been used for the Bailout, I will immediately see to it that there are stipulations and regulations put in place... Blah Blah Blah." (I am paraphrasing, but Obama was completely aware of how the Bailout monies had no stipulations or requirements, and that the same derivatives that had caused the mess had been kept in place.

Obama then came up with some nonsensical rhetoric, circa late March 2009 - "I have never had any understanding of economic matters, but leave them in the capable hands of those I have appointed. I was too busy focusing on Iraq and Afghanistan when I was running for office to gain any understanding of the American market place." And blah Blah Blah.

One does wonder if he is so totally clueless, why he took it into his head to run for office. So the public is left wondering - "Mr. President, are you inept?"

Or "Mr. President, are you fully aware of all these economic matters, but beholden to those whose CorpoRATe backing brought you to the Presidential dance?"