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A bipartisan report by the U.S. Senate’s Permanent Subcommittee on Investigations adds new detail on the activities of the hedge fund Magnetar and its role in helping to create more than $40 billion in mortgage-backed securities, most of which failed disastrously. ProPublica first wrote about Magnetar in April of last year and the story is cited several times in the Senate report.The report is the culmination of a two-year Senate investigation into the origins of the 2008 financial crisis. It largely takes a case study approach, focusing on mortgage lender Washington Mutual, its regulator, the Office of Thrift Supervision, two credit rating agencies (Moody’s and Standard & Poor’s), and two investment banks, Goldman Sachs and Deutsche Bank. The investment bank section focuses on the profitable business of collateralized debt obligations. Between 2004 and 2008, U.S. financial institutions issued $1.4 trillion worth of CDO securities. Deutsche and Goldman were notable in the business for aggressive bets against CDOs, as was Magnetar.
The Senate report quotes candid emails from a Deutsche Bank official, Greg Lippmann, discussing Magnetar’s strategy. “[T]hey [Magnetar] want to short the market and are willing to pay the freight,” Lippman wrote to a colleague in late September 2006.
In another email, Lippmann explains how Magnetar was willing to buy the risky and difficult-to-sell bottom part of collateralized debt obligations in order to bet against the parts higher up in the capital structure, describing its strategy as “a bit devious.”
In response to ProPublica’s earlier report, Magnetar has said that it did not have a bearish view of the market nor did it have a plan to short the housing market. A Magnetar spokesman declined to comment today on the Senate report.
The report focuses extensively on efforts by Goldman Sachs to short CDOs in 2007. Included in the Goldman section is an email from an employee at the bank, Deeb Salem, discussing the possibility of buying a 201Cbunch of the CDO protection201D from Magnetar.
In a January 2007 email concerning a CDO called Abacus, Goldman trader Fabrice Tourre details how much CDO managers generally earned on Magnetar deals as a benchmark. These fees could range from $2 million to $3 million, based on Tourre’s estimate. Banks could earn from $5 million to $10 million per transaction.
Goldman responded to the Senate report by posting a statement on its website pointing to an internal review the firm conducted on its business practices. “While we disagree with much of the report, we take seriously the issues explored by the Subcommittee,” the statement said.
The report shows how secretive and compartmentalized the CDO business became in 2006 and 2007. For example, the report cites a Goldman document describing how investors in Magnetar’s deals had few ways to figure out that the securities they were buying were created, in part, by a hedge fund so that it could bet against them.
The report also examines how investors in CDOs started to withdraw from the market toward the end of the boom. Rather than stop the business, the banks found ways to continue it. For instance, the ultimate buyers for key portions of CDOs became other CDOs, a practice described in another ProPublica story.
“Rampant conflicts of interest are the threads that run through every chapter of this sordid story,” said Subcommittee Chairman Senator Carl Levin.