Magnetar Hedge Fund. A Case Study On How To Fleece The Innocent.
As we’ve explained before, a lot of money that flowed into building a housing bubble came from derivative securities.
These derivatives included several layers, or ‘tranches.’ The topmost tranche was rated very safe, AAA. As you went down the tranches the ratings fell until you got to the smallest and riskiest tranche, the ‘equity’ tranche which normally amounted to about 5% of the derivative’s value. The problem for investment banks who constructed and then sold these derivatives–normally valued at $100 million in total–was that pesky equity tranche. It was hard to sell because of its risk. But if it wasn’t sold to someone, the entire derivative fell through.
So along comes Magnetar, a hedge fund. They basically bought the equity slices and thus made the derivative securities possible for sale. Why would they do this? Because they shorted the derivatives they made possible. In fact they were often allowed to pick the underlying securities that went into the derivative, thus making it more likely the whole caboodle would collapse if housing prices fell. And the Magnetar guys were smart. They could see that this was a bubble and it was headed for a crash. In fact, a lot of Wall Street saw it coming and did the same thing. Magnetar wasn’t alone, it was just among the largest.
What about the investment bank? It was making hefty commissions all along the way and Magnetar’s equity purchases increased those commissions. But didn’t the investment bank have a whiff that this stuff was toxic, or ‘nuclear’ as was a common descriptor? Of course they did. Like Magnetar they were shorting their own product even as they were selling it to supposedly sophisticated clients. The investment bank’s problem wasn’t that they didn’t realize the crash was coming, what they didn’t realize was they would get caught with hundreds of millions, even billions of dollars, worth of unsold nuclear derivatives. When the turn came, the investment banks found out the market for this security toxic waste was very thin. That’s known as an ‘illiquid’ market.
So Magnetar made billions of dollars shorting that which they made possible. And the investment banks, en masse, became insolvent almost overnight, in the end to be bailed out by taxpayers. Socialism for the rich.
And that dear reader is how you loot an economy.
Beezer here. In any sane world this is considered fraud and subject to criminal prosecution. So now we’re supposed to believe further de-regulation is going to help?