Magnetar Capital
Encyclopedia
Magnetar Capital is a hedge fund
based in Evanston, Illinois
. Among its many activities, the firm was actively involved in the collateralized debt obligation
(CDO) market during the 2006–2007 period. In some articles critical of Magnetar Capital, the firm's arbitrage
strategy for CDOs is described as the Magnetar trade.
.
In 2006, Magnetar Capital began to buy large amounts of equity tranches in CDO deals. Partner David Snyderman (also formerly of Citadel LLC) told Derivatives Week at the time that Magnetar Capital was "excited about the opportunities in the mortgage derivatives market". From 2006-2007 Magnetar Capital sponsored (bought the equity tranche) of about $30 billion dollars worth of CDOs. Many of the CDOs were named after stars or constellations.
Around 2006, Magnetar Capital received marketing from Goldman Sachs
regarding "short bets" against the housing market via an Asset-backed securities index
(ABX).
In 2006, Andrew Sterge (formerly of Cooper Neff Group, BNP Paribas
) brought his team from AJ Sterge Investments to work for Magnetar Capital Magnetar also hired Michael Gross of Apollo Management.
In 2006, Magnetar Capital started a reinsurance
company called Pulsar Re.
In 2006, a team at Calyon
bank participated in multiple deals involving Magnetar Capital CDOs. The team, led by Alexander Rekeda, left Calyon for the Mizuho bank
in late 2006. In 2007, Mizuho did more CDO deals with Magnetar Capital.
In 2007, Magnetar participated in a series of CDO deals with GSC Partners and JP Morgan Chase. They would later become the center of an Securities and Exchange Commission case against JP Morgan.
In October 2007, Magnetar Capital set up a Credit Derivatives Product Company
(CDPC) named Quadrant Structured Credit Products, with Lehman Brothers
. Employees included Gene Park (formerly of AIG
), Martin Nance, and others. Fitch Ratings
rated it AAA in October 2007 and withdrew its rating in October 2008. In December 2008, Quadrant bought competitor Cournot. Moody's withdrew its rating in February 2009.
As of 2010, 23 of the CDOs sponsored by Magnetar Capital had become "nearly worthless".
says that she covered the strategy itself in her book of 2003, before Magnetar Capital was founded. In 2006 Derivatives Week did a story on the strategy. In 2008 Carrick Mollenkamp and Serena Ng of the Wall Street Journal reported on the large losses of CDOs linked to the fund. In mid 2010 two more indepth analyses appeared, one a joint effort between NPR
and ProPublica
, and another in the book EConned by Yves Smith, in connection with her website nakedcapitalism.com
Eisinger and Bernstein won the Pulitzer Prize of 2011 for their series on the CDO industry. It was the first Pulitzer for work published only on the web.
ProPublica
's written story came out on their website in April 2010, coinciding with the radio show. It alleged that the company's trades in the CDO market helped worsen the financial crisis of 2007–2010 by helping to structure CDOs it was planning to short (bet against).
The story essentially claimed that Magnetar Capital "sponsored" mortgage-backed collateralized debt obligation
s by agreeing to buy the worst tranche
(portion) of the CDO, the "equity tranche". Since very few wanted to invest in the risky Equity Tranche, those few that did were called "sponsors"; without them the CDO would never get created. The ProPublica stories claimed that Magnetar Capital then shorted (bet against) the better tranches of those (and similar) CDOs by buying credit default swap
s that insured them. When the middle tranches of the CDOs failed, Magnetar Capital made back many times its initial investment in the equity tranche by receiving the insurance payoff.
The report also claimed that Magnetar Capital tried to influence the managers of the CDOs it was instrumental in creating, to buy certain risky bonds that would increase the risk of those CDOs failing. It also claims that Magnetar Capital CDOs "defaulted" at a significantly higher rate than similar CDOs. (This may reflect Magnetar Capital's superior performance in identifying which of the "high-quality" tranches were most overpriced.) They also claim that the CDO market would have "cooled off" in late 2005 if Magnetar Capital had not entered the market, and that this would have resulted in the financial crisis being less severe.
Magnetar Capital stated to investors that it never sought to bet on the decline of the subprime-mortgage market. Rather, the firm states, it had no embedded view regarding the direction of housing prices, the rate of mortgage defaults, or the subprime mortgage market generally. Instead, Magnetar Capital claimed it sought to profit from arbitrage
: its perception that the riskiest, high-yield tranches of CDOs were underpriced relative to the less-risky low-yield tranches. The firm expected to make a profit when either the overpriced securities declined or when the underpriced securities appreciated. With the collapse of the subprime market, Magnetar Capital lost money on the risky tranches but made a net profit because the overpriced tranches declined even further. Magnetar Capital rejected the idea that it had picked securities purposely so that they would fail.
The theory is that Magnetar Capital was essentially betting that the likelihood of multiple defaults on the underlying loans was more likely than was reflected in the price of the higher tranches. The high prices of the "high-quality" tranches reflected the assumption that any defaults would be localized and unrelated, so that it was unlikely that much of the portfolio would default at once. Magnetar Capital was betting that, in all likelihood, if the equity tranch lost its value, the rest of the CDO would lose value as well, because many defaults were likely to happen together. This is what, in fact, happened.
Magnetar Capital also disparaged the reporters, stating that "the questions we received from you [the ProPublica reporters] last week, and the assertions reflected in those questions, reflect significant inaccuracies or misunderstandings regarding aspects of Magnetar Capital’s investment strategy".
Later, Magnetar Capital wrote a letter to its investors, rebutting many of the claims in the ProPublica story. IE:
ProPublica continued to publish articles on Magnetar Capital throughout 2010 and 2011. Although arbitrage is recognized as leading to price convergence, ProPublica continues to insist the opposite in this case—that Magnetar Capital is responsible for price distortions in the CDO market.
Smith also wrote a book, EConned, which contains a detailed description of Magnetar Capital's activities. It cites anonymous sources affiliated with institutions that did business with Magnetar Capital. Her research was gathered in October 2009 and the book came out in March 2010. The book goes into detail surrounding the motives of the various parties and the numbers involved that made the deal profitable. It also describes the large size of Magnetar Capital's play in proportion to the subprime market as a whole. The book gives a larger context for the Magnetar Capital arbitrage, fitting into Smith's thesis of the modern science of economics being largely a failure.
Smith and the nakedcapitalism.com bloggers continued to post articles regarding Magnetar Capital throughout 2010. They also produced a spreadsheet analyzing the Magnetar Capital CDOs, similar to the one found at ProPublica.
". Their report went in depth into the activities of Greg Lippman, the head global CDO trader of Deutsche Bank
. He was a CDO expert, and worked at the heart of the Synthetic CDO market during the credit bubble. He also is featured in the book The Big Short
by Michael Lewis; it describes his attempts to sell "short positions" on the mortgage security market to hedge funds.
In the report transcript, Lippman describes Magnetar Capital's strategy of shorting one part of the CDO while buying the other; he also writes about what he thinks their view of the housing market is. When asked if they are "bearish on housing", he says that "yes…as they r buying equity and shorting the single names…a bit devious".
In another email, someone asks him how Magnetar Capital has distorted the market. In the report transcript, no explanation is provided; Lippman indicates only that he has an "easy, but lengthy answer".
Hedge fund
A hedge fund is a private pool of capital actively managed by an investment adviser. Hedge funds are only open for investment to a limited number of accredited or qualified investors who meet criteria set by regulators. These investors can be institutions, such as pension funds, university...
based in Evanston, Illinois
Evanston, Illinois
Evanston is a suburban municipality in Cook County, Illinois 12 miles north of downtown Chicago, bordering Chicago to the south, Skokie to the west, and Wilmette to the north, with an estimated population of 74,360 as of 2003. It is one of the North Shore communities that adjoin Lake Michigan...
. Among its many activities, the firm was actively involved in the collateralized debt obligation
Collateralized debt obligation
Collateralized debt obligations are a type of structured asset-backed security with multiple "tranches" that are issued by special purpose entities and collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand...
(CDO) market during the 2006–2007 period. In some articles critical of Magnetar Capital, the firm's arbitrage
Arbitrage
In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices...
strategy for CDOs is described as the Magnetar trade.
History
Magnetar Capital was founded in 2005 by Alec Litowitz (formerly of Citadel LLC) and Ross Laser (formerly of Glennwood Capital Partners). It is based in Evanston, IllinoisEvanston, Illinois
Evanston is a suburban municipality in Cook County, Illinois 12 miles north of downtown Chicago, bordering Chicago to the south, Skokie to the west, and Wilmette to the north, with an estimated population of 74,360 as of 2003. It is one of the North Shore communities that adjoin Lake Michigan...
.
In 2006, Magnetar Capital began to buy large amounts of equity tranches in CDO deals. Partner David Snyderman (also formerly of Citadel LLC) told Derivatives Week at the time that Magnetar Capital was "excited about the opportunities in the mortgage derivatives market". From 2006-2007 Magnetar Capital sponsored (bought the equity tranche) of about $30 billion dollars worth of CDOs. Many of the CDOs were named after stars or constellations.
Around 2006, Magnetar Capital received marketing from Goldman Sachs
Goldman Sachs
The Goldman Sachs Group, Inc. is an American multinational bulge bracket investment banking and securities firm that engages in global investment banking, securities, investment management, and other financial services primarily with institutional clients...
regarding "short bets" against the housing market via an Asset-backed securities index
Asset-backed securities index
The ABX is a credit derivative swap contract that pools lists of exposures to mortgage backed securities.In January 2006, CDS Indexco and Markit launched ABX.HE, a subprime mortgage backed credit derivative index, with plans to extend the index to underlying asset types other than home equity loans...
(ABX).
In 2006, Andrew Sterge (formerly of Cooper Neff Group, BNP Paribas
BNP Paribas
BNP Paribas S.A. is a global banking group, headquartered in Paris, with its second global headquarters in London. In October 2010 BNP Paribas was ranked by Bloomberg and Forbes as the largest bank and largest company in the world by assets with over $3.1 trillion. It was formed through the merger...
) brought his team from AJ Sterge Investments to work for Magnetar Capital Magnetar also hired Michael Gross of Apollo Management.
In 2006, Magnetar Capital started a reinsurance
Reinsurance
Reinsurance is insurance that is purchased by an insurance company from another insurance company as a means of risk management...
company called Pulsar Re.
In 2006, a team at Calyon
Calyon
Crédit Agricole Corporate and Investment Bank is Crédit Agricole's corporate and investment banking entity. With a staff of 13,000 employees in 58 countries, Crédit Agricole CIB is active in a broad range of capital markets, investment banking and financing activities...
bank participated in multiple deals involving Magnetar Capital CDOs. The team, led by Alexander Rekeda, left Calyon for the Mizuho bank
Mizuho Financial Group
, abbreviated as MHFG, or simply called Mizuho is a banking holding company headquartered in the Ōtemachi district of Chiyoda, Tokyo, Japan...
in late 2006. In 2007, Mizuho did more CDO deals with Magnetar Capital.
In 2007, Magnetar participated in a series of CDO deals with GSC Partners and JP Morgan Chase. They would later become the center of an Securities and Exchange Commission case against JP Morgan.
In October 2007, Magnetar Capital set up a Credit Derivatives Product Company
Credit Derivatives Product Company
Credit Derivatives Product Companies, or CDPC, are a business almost solely focused on selling credit default swaps contracts. IE, they basically sell 'insurance' against someone failing to pay back a loan...
(CDPC) named Quadrant Structured Credit Products, with Lehman Brothers
Lehman Brothers
Lehman Brothers Holdings Inc. was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth largest investment bank in the USA , doing business in investment banking, equity and fixed-income sales and trading Lehman Brothers Holdings Inc. (former NYSE ticker...
. Employees included Gene Park (formerly of AIG
AIG
AIG is American International Group, a major American insurance corporation.AIG may also refer to:* And-inverter graph, a concept in computer theory* Answers in Genesis, a creationist organization in the U.S.* Arta Industrial Group in Iran...
), Martin Nance, and others. Fitch Ratings
Fitch Ratings
The Fitch Group is a majority-owned subsidiary of FIMALAC, headquartered in Paris. Fitch Ratings, Fitch Solutions and Algorithmics, are part of the Fitch Group....
rated it AAA in October 2007 and withdrew its rating in October 2008. In December 2008, Quadrant bought competitor Cournot. Moody's withdrew its rating in February 2009.
As of 2010, 23 of the CDOs sponsored by Magnetar Capital had become "nearly worthless".
In the press
Several journalists and writers have reported on the Magnetar Capital CDO program. Janet TavakoliJanet Tavakoli
Janet Tavakoli is an American author and structured finance expert based in Chicago. She has had three books published on credit derivatives, structured finance, and the 2008 global financial crisis.-Education and background:...
says that she covered the strategy itself in her book of 2003, before Magnetar Capital was founded. In 2006 Derivatives Week did a story on the strategy. In 2008 Carrick Mollenkamp and Serena Ng of the Wall Street Journal reported on the large losses of CDOs linked to the fund. In mid 2010 two more indepth analyses appeared, one a joint effort between NPR
NPR
NPR, formerly National Public Radio, is a privately and publicly funded non-profit membership media organization that serves as a national syndicator to a network of 900 public radio stations in the United States. NPR was created in 1970, following congressional passage of the Public Broadcasting...
and ProPublica
ProPublica
ProPublica is a non-profit corporation based in New York City. It describes itself as an independent non-profit newsroom that produces investigative journalism in the public interest. In 2010 it became the first online news source to win a Pulitzer Prize, for a piece written by one of its...
, and another in the book EConned by Yves Smith, in connection with her website nakedcapitalism.com
ProPublica / NPR / This American Life report
In 2010 This American Life, of Chicago Public Radio, broadcast a radio show on Magnetar Capital's CDO strategy. The report was by Alex Blumberg, of the NPR Planet Money project. The report consisted largely of Blumberg's interviews with Jesse Eisinger and Jake Bernstein, of ProPublica, whom Blumberg had commissioned to research possible financial misdeeds related to the subprime housing bubble. Eisinger and Bernstein interviewed dozens of people who had worked in the industry and many who were directly involved in Magnetar Capital deals.Eisinger and Bernstein won the Pulitzer Prize of 2011 for their series on the CDO industry. It was the first Pulitzer for work published only on the web.
ProPublica
ProPublica
ProPublica is a non-profit corporation based in New York City. It describes itself as an independent non-profit newsroom that produces investigative journalism in the public interest. In 2010 it became the first online news source to win a Pulitzer Prize, for a piece written by one of its...
's written story came out on their website in April 2010, coinciding with the radio show. It alleged that the company's trades in the CDO market helped worsen the financial crisis of 2007–2010 by helping to structure CDOs it was planning to short (bet against).
The story essentially claimed that Magnetar Capital "sponsored" mortgage-backed collateralized debt obligation
Collateralized debt obligation
Collateralized debt obligations are a type of structured asset-backed security with multiple "tranches" that are issued by special purpose entities and collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand...
s by agreeing to buy the worst tranche
Tranche
In structured finance, a tranche is one of a number of related securities offered as part of the same transaction. The word tranche is French for slice, section, series, or portion, and is cognate to English trench . In the financial sense of the word, each bond is a different slice of the deal's...
(portion) of the CDO, the "equity tranche". Since very few wanted to invest in the risky Equity Tranche, those few that did were called "sponsors"; without them the CDO would never get created. The ProPublica stories claimed that Magnetar Capital then shorted (bet against) the better tranches of those (and similar) CDOs by buying credit default swap
Credit default swap
A credit default swap is similar to a traditional insurance policy, in as much as it obliges the seller of the CDS to compensate the buyer in the event of loan default...
s that insured them. When the middle tranches of the CDOs failed, Magnetar Capital made back many times its initial investment in the equity tranche by receiving the insurance payoff.
The report also claimed that Magnetar Capital tried to influence the managers of the CDOs it was instrumental in creating, to buy certain risky bonds that would increase the risk of those CDOs failing. It also claims that Magnetar Capital CDOs "defaulted" at a significantly higher rate than similar CDOs. (This may reflect Magnetar Capital's superior performance in identifying which of the "high-quality" tranches were most overpriced.) They also claim that the CDO market would have "cooled off" in late 2005 if Magnetar Capital had not entered the market, and that this would have resulted in the financial crisis being less severe.
Magnetar Capital's Response
Magnetar Capital disputed the story. Many of its responses were explained in ProPublica's story and in a detailed letter Magnetar Capital sent to ProPublica, posted on ProPublica's website. Magnetar Capital said, among other things, that it was not betting, it was hedging, that most of its hedges were against non-Magnetar-Capital CDOs, and that it was not making CDOs that were "built to fail" on purpose. It also claimed that its strategy was not based on a downturn in the housing market (that is, it did not bet that mortgage-backed CDOs would default). It detailed many of its objections in a letter and list of responses to ProPublica, which are linked to on ProPublica's website.Magnetar Capital stated to investors that it never sought to bet on the decline of the subprime-mortgage market. Rather, the firm states, it had no embedded view regarding the direction of housing prices, the rate of mortgage defaults, or the subprime mortgage market generally. Instead, Magnetar Capital claimed it sought to profit from arbitrage
Arbitrage
In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices...
: its perception that the riskiest, high-yield tranches of CDOs were underpriced relative to the less-risky low-yield tranches. The firm expected to make a profit when either the overpriced securities declined or when the underpriced securities appreciated. With the collapse of the subprime market, Magnetar Capital lost money on the risky tranches but made a net profit because the overpriced tranches declined even further. Magnetar Capital rejected the idea that it had picked securities purposely so that they would fail.
The theory is that Magnetar Capital was essentially betting that the likelihood of multiple defaults on the underlying loans was more likely than was reflected in the price of the higher tranches. The high prices of the "high-quality" tranches reflected the assumption that any defaults would be localized and unrelated, so that it was unlikely that much of the portfolio would default at once. Magnetar Capital was betting that, in all likelihood, if the equity tranch lost its value, the rest of the CDO would lose value as well, because many defaults were likely to happen together. This is what, in fact, happened.
Magnetar Capital also disparaged the reporters, stating that "the questions we received from you [the ProPublica reporters] last week, and the assertions reflected in those questions, reflect significant inaccuracies or misunderstandings regarding aspects of Magnetar Capital’s investment strategy".
Later, Magnetar Capital wrote a letter to its investors, rebutting many of the claims in the ProPublica story. IE:
"we wanted to address the recent publicity regarding our Mortgage CDO investment strategy. At the center of these stories is a blatantly false and misleading story written by ProPublica, an online news outlet, regarding our Mortgage CDO investment strategy that was active from 2006 through 2007. Despite our best efforts to educate ProPublica’s reporters about the specifics of Magnetar Capital’s Mortgage CDO investment
strategy as well as the general process and market circumstances regarding the structuring and issuance of CDOs, ProPublica simply got the story wrong."
Counter Response
ProPublica's editor-in-chief, Paul Steiger, responded to Magnetar Capital's letter and wrote:
"Magnetar’s letter doesn’t deny that it purchased collateralized debt obligation (CDO) equity, that it bet against many of those CDOs, or that it exercised influence over the construction of the portfolios. In particular, it doesn't deny and in one case admits that it pushed for higher returns and hence greater risk in the portfolios...In short, we see nothing in our story to correct."
ProPublica continued to publish articles on Magnetar Capital throughout 2010 and 2011. Although arbitrage is recognized as leading to price convergence, ProPublica continues to insist the opposite in this case—that Magnetar Capital is responsible for price distortions in the CDO market.
Naked Capitalism / EConned
Yves Smith of the nakedcapitalism.com, along with other bloggers at that site, also worked on describing and analyzing Magnetar Capital's CDO program.Smith also wrote a book, EConned, which contains a detailed description of Magnetar Capital's activities. It cites anonymous sources affiliated with institutions that did business with Magnetar Capital. Her research was gathered in October 2009 and the book came out in March 2010. The book goes into detail surrounding the motives of the various parties and the numbers involved that made the deal profitable. It also describes the large size of Magnetar Capital's play in proportion to the subprime market as a whole. The book gives a larger context for the Magnetar Capital arbitrage, fitting into Smith's thesis of the modern science of economics being largely a failure.
Smith and the nakedcapitalism.com bloggers continued to post articles regarding Magnetar Capital throughout 2010. They also produced a spreadsheet analyzing the Magnetar Capital CDOs, similar to the one found at ProPublica.
Senate Report of 2011
In April, 2011, the United States Senate released the Levin-Coburn report on "Wall Street and the Financial CrisisWall Street and the Financial Crisis: Anatomy of a Financial Collapse
Wall Street and the Financial Crisis: Anatomy of a Financial Collapse is a report issued on April 13, 2011 by the United States Senate Permanent Subcommittee on Investigations. The 639 page report was issued under the chairmanship of Senators Carl Levin and Tom Coburn, and is colloquially known as...
". Their report went in depth into the activities of Greg Lippman, the head global CDO trader of Deutsche Bank
Deutsche Bank
Deutsche Bank AG is a global financial service company with its headquarters in Frankfurt, Germany. It employs more than 100,000 people in over 70 countries, and has a large presence in Europe, the Americas, Asia Pacific and the emerging markets...
. He was a CDO expert, and worked at the heart of the Synthetic CDO market during the credit bubble. He also is featured in the book The Big Short
The Big Short
The Big Short: Inside the Doomsday Machine is a 2010 non-fiction book by Michael Lewis about the build-up of the housing and credit bubble during the 2000s...
by Michael Lewis; it describes his attempts to sell "short positions" on the mortgage security market to hedge funds.
In the report transcript, Lippman describes Magnetar Capital's strategy of shorting one part of the CDO while buying the other; he also writes about what he thinks their view of the housing market is. When asked if they are "bearish on housing", he says that "yes…as they r buying equity and shorting the single names…a bit devious".
In another email, someone asks him how Magnetar Capital has distorted the market. In the report transcript, no explanation is provided; Lippman indicates only that he has an "easy, but lengthy answer".
See also
- List of CDO managers
- Goldman Sachs: Abacus mortgage-backed CDOs
- Merrill Lynch: CDO controversies
- Subprime mortgage crisisSubprime mortgage crisisThe U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
- Tricadia CapitalTricadia Capital-History:Tracadia Capital was formed in 2003 by Michael Barnes and Arif Inayatullah "to establish a CDO management business and pursue credit arbitrage strategies". As of 2003, Tricadia was owned by Mariner Capital, a fund of funds bond investor with $2.5 billion under management...