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Magnetar Capital

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Magnetar Capital
Company typePrivate company
IndustryInvestment management
Founded2005
HeadquartersEvanston, Illinois[1]
Key people
ProductsHedge fund
AUM$13.5 billion[2]
Number of employees
260[1]
Websitewww.magnetar.com

Magnetar Capital is a hedge fund based in Evanston, Illinois. The firm was founded in 2005 and invests in fixed income, energy, quantitative and event-driven strategies.[1] 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".[3]

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, Illinois.[4]

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".[4] From 2006-2007, Magnetar Capital bought the equity tranche of about $30 billion worth of CDOs.[5] Many of the CDOs were named after stars or constellations.

Around 2006, Magnetar Capital benefited from marketing from Goldman Sachs regarding "short bets" against the housing market via an Asset-backed securities index (ABX).[6] That year, Andrew Sterge (formerly of Cooper Neff Group, BNP Paribas) brought his team from AJ Sterge Investments to work for Magnetar Capital.[7] Magnetar Capital also hired Michael Gross of Apollo Management[8] and started a reinsurance company called Pulsar Re.[7] Also in the same year, 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.[9][10][11][12]

In 2007, Magnetar Capital 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.[13][14] In October of that year, 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.[15][16][17][18][19][20]

As of 2010, 23 of the CDOs that Magnetar Capital had bought the equity tranche of had become "nearly worthless".[21][22]

The 2010 Ig Nobel Prize in Economics was awarded to executives and directors of Magnetar Capital, among others, "for creating and promoting new ways to invest money—ways that maximize financial gain and minimize financial risk for the world economy, or for a portion thereof."

In 2012 Intesa Sanpaolo sued Magnetar Capital (and others) for alleged fraud related to Pyxis ABS CDO 2006-1.[23]

The US Federal Securities and Exchange Commission had been investigating deals involving Magnetar Capital for years, for example the JP Morgan settlement regarding Squared CDO 2007-1. ProPublica published a summary of these activities in 2012. In 2012, The Wall Street Journal reported that the SEC was directly investigating Magnetar Capital.[24]

In 2015, Institutional Investor/Alpha magazine gave Magnetar an A grade and the #4 ranking among hedge funds worldwide.[25]

List of Notable Magnetar Capital CDOs

Each CDO is considered a separate company entity,[26] which is why they have the suffixes "LLC", Ltd, etc.

  • Pyxis ABS CDO 2006-1 LLC[23]
  • Squared CDO 2007-1 LLC
  • Delphinus CDO 2007-1 Ltd[27][28]

In the press

Several journalists and writers have reported on the Magnetar Capital CDO program. In 2008, the Wall Street Journal published "A Fund Behind Astronomical Losses".[5] In mid‑2010, two in-depth analyses appeared, one a joint effort between NPR and ProPublica, and another in the 2010 book ECONned by Yves Smith.

Tavakoli

Janet Tavakoli, a financial industry expert and consultant, had been writing about structured finance in a series of books starting in 1998. In her 2008 book, "Structured Finance and Collateralized Debt Obligations" (2nd ed.), she specifically mentioned Magnetar Capital's Constellation CDOs in the chapter on "The Credit Crunch and CDOs". She described the deals as "classic long equity, short mezzanine", a type of deal whose moral hazards she explored elsewhere in the book. She wrote that "Constellation CDOs seemed designed to fail".[29].

In her explanation of the deal capital structure, she noted that monoline insurers were major investors. She correctly inferred that these bond insurers would be subject to major losses related to CDO investments.[30] She also noted that "Excess interest is sometimes paid to the equity investor, creating a conflict of interest".[29]

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.[3] Eisinger and Bernstein won the Pulitzer Prize of 2011 for their series on CDOs as a financial instrument. It alleged that Magnetar's activities in the CDO market helped worsen the financial crisis of 2007–2010 by helping to structure CDOs it was planning to arbitrage (buy underpriced part and sell overpriced part).[3][31]

The story essentially claimed that Magnetar Capital "sponsored" mortgage-backed collateralized debt obligations by agreeing to buy the worst tranche (portion) of the CDO, the "equity tranche". Without equity tranche buyers, 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 swaps that insured them. When the equity and better tranches of the CDOs all failed during the mortgage crisis, Magnetar Capital made back many times its initial investment in the equity tranche because of the insurance it owned on the better tranches.[21][32]

The report claimed 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.[21][33][34]

Magnetar Capital's response

Magnetar Capital disputed the story. Magnetar responded directly to Pro-Publica's story in a detailed letter. 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).[35]

Magnetar Capital stated to investors that it never sought to bet on the decline of the subprime-mortgage market.[36] 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.[5][21][32][35][37][38]

Magnetar Capital believed 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 believed that, in all likelihood, if the equity tranche 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.[39]

Magnetar Capital also further stated 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".[37]

Later, Magnetar Capital wrote a letter to its investors to rebut many of the claims in the ProPublica story,

"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."[40]

Despite the ProPublica claims that these trades lead to price distortions, it is generally acknowledged that arbitrage leads to price stability and convergence.

Naked Capitalism / EConned

Yves Smith of the website, nakedcapitalism.com, analyzed Magnetar Capital's CDO program. Smith also wrote a book, ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism, in 2010 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.[41][42] The book goes into detail surrounding the motives of the various parties and the numbers involved that made the deals 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.[43]

Smith and the nakedcapitalism.com bloggers produced a spreadsheet analyzing the Magnetar Capital CDOs, similar to the one found at ProPublica.[44][45]

Moe Tkacik, formerly of the Wall Street Journal, worked with individuals from nakedcapitalism.com on an article about the relationship (and large number of campaign donations) between Barack Obama's chief of staff Rahm Emanuel and Magnetar Capital CEO Alec Litowitz. Tkacik's article was "de-published" from DailyFinance, but Yves Smith published another version of the story on Huffington Post.[46]

Senate Report of 2011

File:Lippman.magnetar.email.png
Lippman describes Magnetar Capital's arbitrage as "buying equity and shorting the single names…a bit devious"
File:Lippman.magnetar.email2.png
Lippman offers to explain how Magnetar Capital distorted the market

In April, 2011, the United States Senate released the Levin-Coburn report on "Wall Street and the Financial Crisis". 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 are buying equity and shorting the single names…a bit devious".

SEC decision not to prosecute

In August 2013, U.S. Securities and Exchange enforcement officials announced their decision not to file criminal or civil charges against Magnetar for its activities in creating CDOs and mortgage-backed securities that resulted in billions dollars of losses during the 2008 financial crisis.[39]

Huber Heights, Ohio

In January 2013, the firm became the largest homeowner in Huber Heights, Ohio by buying almost 2,000 homes from the family of the town's original developer. It rents these homes as part of its investment strategy.[47]

See also

References

  1. ^ a b c d Copeland, Rob (24 May 2017). "This Old School Hedge Fund is Going Quant". The Wall Street Journal. Retrieved 2 April 2018.
  2. ^ Levy, Rachael (17 March 2017). "'I think it benefits everybody': Hedge fund managers are cheering Trump". Business Insider. Retrieved 2 April 2018.
  3. ^ a b c The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going, by Jesse Eisinger and Jake Bernstein, ProPublica, April 9, 2010
  4. ^ a b Abigail Moses (2006-08-14). "Reach for the Stars: Ill. Fund Swallows Big Chunk of Synthetic ABS" (pdf). Derivatives Week. Retrieved 2010-05-01.
  5. ^ a b c "A Fund Behind Astronomical Losses" Carrick Mollenkamp and Serena Ng, 2008 2 13, The Australian (reprint of an article that had appeared in the Wall Street Journal)
  6. ^ Banks Bundled Bad Debt, Bet Against It and Won by Gretchen Morgenson and Louise Story, 23 December 2009, New York Times
  7. ^ a b Magnetar adds Sterge for reinsurance, efinancialnews.com, Jennifer McCandless, 2006 7 25, accessed 2010 5 1
  8. ^ Apollo’s Gross joins Magnetar as co-chairman, Jennifer McCandless, 2006 7 27 , accessed 2010 5 1
  9. ^ ProPublica's Timeline of Magnetar deals, 9 April 2010, Jake Bernstein, Jesse Eisinger and Krista Kjellman Schmidt. accessed 2010 5 7
  10. ^ Mizuho $7 Billion Loss Turned on Toxic Aardvark Made in America, By Finbarr Flynn, Oct 28, 2008, Bloomberg, accessed 2010 5 7
  11. ^ Rekeda Joins Guggenheim as CDO Head By ASR Staff March 3, 2008 structuredfinancenews.com, accessed 2010 5 7
  12. ^ Article: Mizuho Nabs Calyon CDO Staffers, Bank Loan Report, Dec 18, 2006, Pyburn, Allison, via highbeam.com. accessed 2010 5 7
  13. ^ https://www.sec.gov/litigation/complaints/2011/comp-pr2011-131-jpmorgan.pdf SEC.gov]
  14. ^ Blogs.wsj.com
  15. ^ Derivatives Week, Oct 22 2007, Quadrant CDPC Plots Wide Remit
  16. ^ Fitch Rates Quadrant Structured Credit Products LLC 'AAA', Business Wire , 2007 10 12, accessed 2010 5 3
  17. ^ Fitch Withdraws CDPC RatingsArchived 2012-03-28 at the Wayback Machine Business Wire 2008, accessed 2010 5 3
  18. ^ Moody's withdraws ratings on Quadrant Structured Credit Products LLC, Moody's Global Credit Research, Feb 02, 2009 , accessed abstract of article, 2010 5 3, via alacrastore.com
  19. ^ SCI Bulletin: CDPC acquired by competitor, Structured Credit Investor. 4 December 2008, accessed abstract via google search, 2010 5 3
  20. ^ About ARIS, Martin J. Nance, aris-corporation.com, accessed 2010 5 3
  21. ^ a b c d "The Inside Job. Act One: Eat My Shorts" (Episode 405), This American Life. (2010-04-09), Alex Blumberg, Jake Bernstein, Jesse Eisinger
  22. ^ The "nearly worthless" comment is at 36:40 into the This American Life "Inside Job" audio story
  23. ^ a b Mirabile Dictu! The SEC Finally Investigates Magnetar, Thursday, May 17, 2012, Yves Smith, Nakedcapitalism.com
  24. ^ The Magnetar Fallout: Who’s Been Charged, Has Settled, or is Now Being Investigated? by Cora Currier, ProPublica, July 19, 2012
  25. ^ Taub, Stephen. "The Hedge Fund Report Card" (PDF). Institutional Investor's Alpha. Retrieved 4 March 2016.
  26. ^ See Janet Tavakoli's books on CDOs
  27. ^ Eaglesham, Jean (11 October 2012). "Behind the Fall of a Crisis-Era Whiz". Wall Street Journal. Retrieved 27 June 2018. A $1.6 billion CDO called Delphinus CDO 2007-01, was sold to investors in mid-2007 just as the housing market started to crack. Delphinus soon imploded, and Mizuho suffered a multibillion-dollar loss on investments
  28. ^ "ADMINISTRATIVE PROCEEDING File No. 3-14953" (pdf). sec.gov. U.S. Securities & Exchange Commissiom. 18 July 2012. Retrieved 27 June 2018. The Delphinus transaction closed by mid-afternoon on July 19, 2007, with the S&P ratings that were obtained by the use of dummy assets, rather than the actual closing date portfolio. At closing, Mizuho sold securities based upon those ratings, which in turn misled investors to believe that the Delphinus notes were of higher credit quality. Investors were not aware that the actual portfolio at closing would have failed certain of S&P's quantitative tests.
  29. ^ a b Structured Finance and Collateralized Debt Obligations, Second Edition, Janet Tavakoli, publisher John Wiley & Sons, Inc., 2008, Constellation CDOs: pgs 413-415, Monolines: pgs 417-427
  30. ^ MBIA Posts Loss; Ambac Net Slides, Nov 9, 2010, Wall Street Journal online, by Alistair Barr and Joan E. Solsman
  31. ^ "The 2011 Pulitzer Prize in National Reporting: Jesse Eisinger and Jake Bernstein of ProPublica". www.pulitzer.org. Retrieved 9 July 2018.
  32. ^ a b The Anatomy of the Magnetar Trade, ProPublica. Graphic by Irwin Chen, Redub LLC
  33. ^ They hired PF2 Securities Evaluations to analyze the CDOs. A link is in their story
  34. ^ The "cool off" claim is at 36:15 into the This American Life "Inside Job" audio story.
  35. ^ a b Magnetar's Letter in Response, ProPublica.org, April 6, 2010.
  36. ^ Patrick, Margot (2010-04-20). "Magnetar Says It Didn't Help Create CDOs "Built To Fail"". The Wall Street Journal.
  37. ^ a b Magnetar's response to our questions, ProPublica.org, April 6, 2010.
  38. ^ Mollenkamp, Carrick; Serena Ng (December 7, 2007). "Wall Street Wizardry Amplified Credit Crisis: A CDO Called Norma Left "Hairball of Risk"; Tailored by Merrill Lynch". The Wall Street Journal.
  39. ^ a b Eaglesham, Jean (7 August 2013). "SEC's Hunt for Crisis-Era Wrongdoing Loses Steam". Wall Street Journal. Retrieved 9 July 2018.
  40. ^ Magnetar Denies Creating Faulty C.D.O.’s Michael J. de la Merced, 2010 4 20, New York Times (Dealbook blog), accessed 2010 4 22. Magnetar Capital's letter to investors is linked off of this article.
  41. ^ Amazon.com
  42. ^ Nakedcapitalism.com
  43. ^ See ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism, by Yves Smith, published by Palgrave MacMillan, 2010
  44. ^ Doth Magnetar Speak with Forked Tongue? By Tom Adams, Andrew Dittmer, Richard Smith, and Yves Smith, nakedcapitalism.com, 2010 4 15
  45. ^ Magnetar, Goldman Press Flurry Still Misses the Biggest Point of All by Andrew Dittmer
  46. ^ Rahm Emanuel and Magnetar Capital: The Definition of Compromised, Yves Smith, Huffington Post, April 13, 2010
  47. ^ Magnetar Goes Long Ohio Town While Shorting Its Tax Base, by Heather Perlberg & John Gittelsohn, 21 October 2013, Bloomberg.com


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