Hedge funds profit from subprime mess

Posted Jan 14th 2008 2:06PM by Zack Miller
Filed under: Scandals, Housing

As we read of writedowns, impending bankruptcies, and the faltering U.S. consumer, it's interesting to get a glimpse at the players behind this whole snafu.

The Wall Street Journal published an article today about Magnetar Capital, a fund started by a star trader from Citadel Investment Group. Magnetar was a key player in the structuring of CDOs, or collateralized debt obligations. Magnetar acted as a "lynch-pin investor" in over $30 billion of these syndicated bundles of subprime mortgages and derivatives, according to the article.

In spite of the losses being racked up on Wall Street, the fund, with about $9 billion in assets, made about 25% returns last year.

According to the article, "Magnetar swooped in on securities that it believed could become troubled but were paying big returns. CDOs are sliced based on risk, with the riskiest pieces having the highest yield but the greatest chance of losing value." Magnetar concentrated its trading on these riskiest pieces.

While the article positions Magnetar as a scapegoat, the authors do admit that "on average, the [Magnetar] deals are performing better than most other similar CDOs in the broader market, and many are still paying out interest."

This is a huge mess, with toxic financial instruments being passed from one institution to another with ramifications these firms are just beginning to understand. It's going to take a lot to unravel this mess and Magnetar is just one of many firms with a hand (arm?) in the debacle.

Zack Miller is the Managing Editor of IsraelNewsletter.com and a former equity analyst for a leading multinational hedge fund.

Tags: CDO, citadel, housing, Magnetar Capital, MagnetarCapital, mortgages, subprime