Magnetar Speaks, Defends Itself Preemptively

John Gapper at the FT has uncovered the investor letter Magnetar has sent to its clients, defending itself from ProPublica "allegations" but certainly prompted by the recent SEC-Goldman developments in deals precisely comparable to those Magnetar executed with Merrill in 2005-2007. The Citadel 'spin-off' discloses that its portfolio was essentially statistically predicated with a discontinuity of returns based on CDO loss percentages as seen on the chart below:

As Credit Suisse pointed out yesterday, Merrill Lynch is the most likely bank after Goldman to be investigated for shady CDO issuance practices, and as Magnetar was named not only in the Goldman Wells Notice response, but has traditionally been the biggest ML partner on these types of transactions, the Magentar letter below discloses what the fund's legal position will be once the probable SEC allegations come flying, especially if Goldman is any indication of the SEC's current state of mind.

What is most curious is the Magentar explanation for purchasing an equity tranche in their deals:

As has been discussed with many of you in the past, the "triggerless" equity structure that Magnetar preferred for its long investments required a significantly larger initial equity tranche investment, increasing the required long investment by at least 50 percent for a given CDO portfolio. If Magnetar had a fundamental short view, with an expectation that the equity would be written off, it would have been irrational to purchase equity in a triggerless CDO instead of taking the extra 50 percent investment and using it to buy additional credit protection. Even the argument suggested by ProPublica and others, that our longs were funding our shorts, would not require us to acquire (and risk) anywhere near the amount of CDO equity that our portfolio held relative to its hedges.

If you will pardon our language, but this is bullshit. Just as in Goldman's case, Magnetar realized full well that it was all about perceptions, and certainly it would have appeared irrational to other investors (especially if Magnetar, like Paulson, determined portfolio composition with the CDO agent) for them to do this without a bearish bias. Which is precisely why they did it - what better way to get the other side of the trade to be misled?

Full letter, courtesy of the FT:

magnetar-investor-letter-2010-04-19

Comments

[Cursive]

Why didn't they just say, "We engaged in financial engineering, a hoax that was foisted on the world by the global financial crime syndicate.  Any income that is generated by financial engineering is actually robbed from real productivity.  That's just how it was, so don't be a hater."

[GS]

the best part about this is how JPM managed to lose $880m on Magnetar trades

[Joe Davola]

I can't hear you with all the noise this money I'm rolling around in makes.

[nucleararms]

The funniest part of this to me is that it made it onto this American Life. That should help the Reps when they're trying to stave off financial reform. lolz not rly.

[chet]

Yeah, I find that interesting too.  Radio journalists from public radio (of all places) can smell the bullshit and explain it clearly to the layman, but the SEC, and every Attorney General in the country, and Congress are apparently just befuddled.