Original poated on ProPublica by Janet Tavakoli:
My 2003 book, “Collateralized Debt Obligations & Structured Finance,” includes the “Magnetar” structure as applied to corporate CDOs. I don’t know the first person to use that structure, but contrary to many finance articles and recent books, the “Magnetar” structure itself wasn’t new when it was applied to mortgage loans and other asset backed securities. For example, it wasn’t developed by any of the people in Greg Zuckerman’s book, The Greatest Trade Ever. Furthermore, there are a large variety of structured products and a huge network of players. Magnetar was a cog in the wheel, but the story is much bigger then just this one hedge fund.
One of the key people at Magnetar, David Snyderman, was in the structured products group at Citadel in August 2004. At that time, the group asked me to meet with them and asked if I would help them with this structure for the ABS market after reading about it in my CDO book (Wiley, 2003, Chapter 6 (especially Pp. 184-194, and this information is also in the 2008 updated edition). They said my book gave them the idea to apply the structure to the other loan markets. As I recall, Snyderman did not attend his group’s meeting on that day.
My CDO book was written as a caution to investors not a handbook for guys like this. I declined to get involved. In my opinion, the investment banks that got involved in these structures should have declined to do so, too. To the best of my knowledge, Citadel got rid of the entire group and they scattered to various shops.
The SEC should have shut down this kind of activity, but the SEC dropped seminal investigations into CDOs and failed to act on information in the public domain.
The Magnetar strategy story was already told by the Wall Street Journal, before Bear Stearns imploded (March 2008), and before Fannie, Freddie, Lehman, AIG, and TARP. This was before the meltdown, when it mattered most, but regulators and most of main stream media ignored the significance of these issues.
The following is a link to a December 2007 Wall Street Journal story explaining the creation and implosion of a CDO called “Norma” with which Magnetar was involved. It was written by Serena Ng and Carrick Mollenkamp. http://online.wsj.com/article/SB119871820846351717.html
The following is an excerpt of story the same reporters did for WSJ on Magnetar’s strategy on January 14, 2008 (link at bottom). (I am also quoted in this article.) The WSJ has to work within space limitations, but it got the word out on many of the key issues, and it did a good job.
There is obviously a lot more to this. I wrote about many of the structures and players in STRUCTURED FINANCE (Wiley, 2008) and in my book on the financial crisis and how to fix it, DEAR MR. BUFFETT (Wiley, 2009).
A Fund Behind Astronomical Losses
By SERENA NG and CARRICK MOLLENKAMP
January 14, 2008
The trading strategy of a little-known hedge fund run by an astronomy buff contributed to billions in losses on Wall Street, even as the fund itself profited from the subprime-mortgage crisis.
Its trading highlights the important role some hedge funds played in the great debt unwind that is now plaguing financial markets. Many hedge funds realized early on “that the loans and securities that went into CDOs were extremely toxic, and they designed structures to exploit that,” says Janet Tavakoli, a structured-finance consultant.