

The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going - yanw
http://www.propublica.org/feature/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going

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johnl
Magnetar says it was "market neutral," meaning it would make money whether
housing rose or fell.

Sounds like they were acting as market makers to me. Taking up risky long
positions and hedging with short positions to protect the downside. Sounds
like whoever took the risk of the short position misjudged the cost of that
risk.

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mwerty
All I got out of the article was that a hedge fund was hedging.

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chris11
This wasn't a normal hedge. They were actually creating the products that they
were betting against.

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dtby
In what way do you think that makes it an abnormal hedge?

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jordanb
It eliminates the legitimate justification for a hedge.

The argument behind hedging is that it's like taking out insurance: it allows
you to take a position that you'd like to be in (invest in a home, for
instance) but that you would otherwise find too risky.

What they were doing, essentially, was buying a house and insisting that it be
built on an unstable foundation, in a tornado zone, with substandard wiring
and a garage piled with oily rags, in the hope that it'll get destroyed and
they can collect the insurance.

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byrneseyeview
A hedge fund isn't supposed to hedge away all returns. The hedged part means
that they buy and sell similar assets whose prices reveal discrepancies. In
this case, there was a discrepancy between the return of the equity slice of
CDOs (very high, implying a high default risk) and the cost of insuring the
debt portions of CDOs (very low, implying a low default risk).

Magnetar basically said "Okay, the risk is probably not as high as the equity
guys think. And not as low as the debt guys think. Why don't we buy from the
equity-holding pessimists, sell to the debt-holding optimists, and pocket the
difference?" And they bought, sold, and pocketed.

If you're going to be outraged, pick one:

Did they profit from the misery of others by selling short? Then they had to
be net sellers, which decreased prices and made the bubble smaller. Or did
they needlessly fuel a speculative bubble? In that case, they had to be net
buyers, which would make them net losers.

Since Magnetar was long volatility (returns will either be way better or way
worse than investors expect), this complicates things. But they basically made
money from being right, while their counterparties lost money for being wrong.
As long as everyone goes into these transactions with the same information,
that's the only way fools and their money are parted.

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jordanb
The article asserts that Magnetar was net short on the CDOs, although the This
American Life episode makes that more clear than the linked article does.

They can't prove that Magnetar was net short, because that information isn't
pubically available. But their evidence was that Magentar was pressuring the
banks who were creating the CDOs into building them out of unusually risky
assets. They have emails from a deal that fell apart because the bank refused
to bundle in the assets that Magnetar wanted.

> Did they profit from the misery of others by selling short? Then they had to
> be net sellers, which decreased prices and made the bubble smaller. Or did
> they needlessly fuel a speculative bubble? In that case, they had to be net
> buyers, which would make them net losers.

The thing is, Magnetar was _only_ buying the equity position of the CDO. They
were then buying insurance against the higher tranches failing.

They were sponsoring billion-dollar CDOs with a few million dollar investments
in the lowest tranche. They were then buying insurance against the failure of
the much larger upper tranches. Without them buying the equity, the CDO
wouldn't have been created.

The argument is that without Magenatar, the CDOs wouldn't have come into
existence (because they wouldn't have had a sponsor willing to buy the equity
tranche). Magnetar wanted the CDO to fail as evidenced by its pressure of the
banks to include rotten assets. So my analogy stands, they insisted on the
construction of a dangerous house so they could collect the insurance.

