Hedge fund operators bet housing bubble would burst

Pulitzer prize story tells how and why taxpayers lost billions

A magnetar is a dying star that has imploded upon itself, causing a super magnetic field – a black hole.

Retired at 38, former Citadel Fund manager Alec Litowitz capitalized his new fund by that name and had t-shirts printed for his employees that said “Very bright; very magnetic.”

According to Pulitzer Prize winning radio reporters Jesse Eisinger and Jake Bernstein, the new hires privately joked about working for something named after a black hole.

Had the housing bubble burst more quickly, according to their Pro Publica Kindle Single Edition of “The Wall Street Money Machine,” the investors, the banks and ultimately the taxpayers wouldn't have gotten hurt quite as badly as they were by the $40 billion lost in worthless investments brought into the world by bankers who sometimes actually worked to cause the collapse of their own institutions.

A short and to the point piece of investigative journalism, the book is part of a series of titles published by the on-line purveyor at the modest price of $.99, and it's not much longer than a take-out in a serious and slick, traditional magazine.

It's a good in-flight laptop or smart phone read.

As the first few pages unfold, one is at first amazed, then outraged to learn that, though Magnetar did nothing illegal, played by all the rules in place at the time, and certainly did not cause the housing bubble or the subsequent collapse of the market, the traders did something sneaky that assured their realization of hundreds of millions in profits – the same way a side bettor in a crap game makes his money, whether he's controlling the bones, or not.

Here's how the scam worked.

Banks bundled as much as a billion dollars at a time in mortgage debts into securities called “Collateralized debt obligations” and traded them on the market. Fund managers bought the riskiest part of the securities – the equity, which can pay as much as 20%, and is paid only after the first two “tranches,” the first and mezzanine levels, take their profits each month, as homeowners make their payments.

By making sure they had enough government-backed insurance on their equity contributions, they realized hundreds of millions in their pay envelopes without taking much of a risk. After all, they only gave people a chance to get some money down on the come line; they didn't cause the fade to take place.

It just worked out that way. It could have happened to anybody.

Professional traders and investment bankers are very skeptical, according to the authors. Although Magnetar's honchos say they did not select the riskiest of the risky equity contributions in their trades, they certainly insisted on having securities of the type in the mix.

Perhaps somewhat tongue in cheek, Messrs. Bernstein and Eisinger say that “They understood the Magnetar Trade as a bet against the subprime securities market. Why else, they ask, would a hedge fund sponsor tens of billions of dollars of new CDO's at a time of rising uncertainty about housing?”

At 99 cents, delivered to your laptop or smart phone through Kindle's “whisper” technology at the speed of light, you can't go wrong. Not a bad deal for a kibbitzer with nothing to lose, no?