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Magnetar Hedge Fund Sheds New Insight Into Wall Street’s Dark Side

An obscure hedge fund called Magnetar offers new details into the world of collateralized debt obligations (CDOs) and how the instruments cost investors billions while yielding a payday bonanza for Magnetar. And that’s the irony. What Magnetar did appears to be legal.

Magnetar and the toxic deals it created and then bet against are the subject of an investigative story by ProPublica and co-produced with Chicago Public Radio’s This American Life and NPR’s Planet Money.

The short version of Magnetar – which was started up by former Citadel trader Alec Litowitz – begins with the Chicago hedge fund buying up the riskiest portion of CDOs. At the same time, Magnetar placed bets that portions of its own deals would fail. Meanwhile, Magnetar ended up reaping a massive fortune.

Magnetar worked with most of Wall Street’s top banks in its deals – deals that ultimately produced $40 billion worth of extremely toxic, high-risk CDOs. Among the banks that helped sell those toxic assets to investors: Merrill Lynch, Lehman Brothers, Citigroup, UBS and JPMorgan Chase.

“Along the way, it did something to enhance the chances of that happening, according to several people with direct knowledge of the deals. They say Magnetar pressed to include riskier assets in their CDOs that would make the investments more vulnerable to failure. The hedge fund acknowledges it bet against its own deals but says the majority of its short positions, as they are known on Wall Street, involved similar CDOs that it did not own. Magnetar says it never selected the assets that went into its CDOs.”

ProPublica offers an excellent slideshow of how Magnetar orchestrated its CDO deals. Entitled The Anatomy of the Magnetar Trade, the slides provide a straightforward and simple account of the players involved in the CDO market and how when the instruments ultimately collapsed, Magnetar profited.

The complete (5,900 words) story on Magnetar is well worth the read. You can view the story in its entirety here.

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