CEPR - Center for Economic and Policy Research

Multimedia

En Español

Em Português

Other Languages

Home Publications Blogs Beat the Press Magnetar Did Not Give Us the Great Recession

Magnetar Did Not Give Us the Great Recession

Print
Friday, 23 April 2010 12:03

ProPublica has a good piece on the dealings of Magnetar, one of the hedge funds that shorted the housing market, while at the same time taking a long position that it used to finance its short position. While the piece involves solid investigative reporting, it is more than a little oversold. The piece begins:

"In late 2005, the booming U.S. housing market seemed to be slowing. The Federal Reserve had begun raising interest rates. Subprime mortgage company shares were falling. Investors began to balk at buying complex mortgage securities. The housing bubble, which had propelled a historic growth in home prices, seemed poised to deflate. And if it had, the great financial crisis of 2008, which produced the Great Recession of 2008-09, might have come sooner and been less severe."

According to the article, Magnetar raised a total of $40 billion. This is equal to roughly 0.2 percent of the $20 trillion value of the housing market at the time. Did Magnetar's long investments help to prop up the market? Probably a bit, but it's hard to see it going too far. Furthermore, by last 2005 the bubble was already pretty close to its peak (that came in the summer of 2006), so it's unlikely that they could have pushed prices much higher than they would have otherwise gone, although it may have slowed the process of the air leaving the bubble. (Actually, a full assessment of its impact would have to factor in its short positions, which would have gone the other way.)

As a purely practical matter, business reporters like to focus on the financial crisis and blame it for the severity of the current downturn, but this really makes little sense. The financial crisis clearly sped things along, but is there any reason to believe that house prices would be higher today in the absence of the crisis. (I'm betting they will fall another 15-20 percent in real terms.) If house prices would be at current levels, is there any reason to believe that consumers would be spending more absent the crisis, that businesses would be investing more, that builders would be putting up more homes or malls? I see zero evidence on any of these fronts, hence I don't attribute the severity of the downturn to the financial crisis. But, I'm open to persuasion.

 

 

Comments (12)Add Comment
...
written by paul, April 23, 2010 3:11
I think you're slightly misreading their argument, which (I think) is not that Magnetar alone prolonged the bubble, but rather that they provided the financial and psychological lubrication that helped others prolong it, and that they did so in a particularly pernicious way. That is, by the combination of equity tranche and CDS.

Would the economy be in better shape if we hadn't had the extra year or two of excess spending and a bigger crash than necessary? That's a hard one to figure out. I'm imagining the need for a half-trillion-dollar stimulus arising sometime in the middle of Bush's second term...
...
written by izzatzo, April 23, 2010 3:39
The rain in Spain,
Falls mainly on the plain,
Especially when it bubbles,
With no financial pain.

No ceteris paribus needed,
Empirical proof is there,
The US diagnosis,
Bubblia not Finosus.

Unstable capitalism,
Animal spiritualism,
Driven at its core,
By herd mentality scores.

Lots of corollary factors,
But none the protagonist actor,
The elephant in the room,
Buyer-seller benefactors.

Of their own creation,
Closed loops of speculation,
No matter what they pay,
It's less than what they sell.

Cause is effect,
And effect is cause,
Cause the cause of bubbles,
Causes effects that cause.

Markets never clear,
Seeking equilibrium,
Prices chase prices,
Fed by self-fiblibriums.

Even Nanny Baker,
Couldn't put a stop to it,
Every time he brought it up,
They said he was full of it.
...
written by zinc, April 23, 2010 11:24

Dean:

It has become apparent to me that you do not understand the market and have fallen victim to bad statistics: "Magnetar raised a total of $40 billion. This is equal to roughly 0.2 percent of the $20 trillion value of the housing market at the time." What is the relative value to the stimulus package and, combined with the other profiteers, what was the total value of their "investment" to progress the other tranches ?

I think your current position, a defender of the fraud, is untenable.
...
written by tom , April 24, 2010 1:25
hello-
the $40 billion you mentioned was the balance of the CDOs. The CDOs were made up of slivers of MBS transactions which were otherwise hard to sell. these slivers were about 2-3% of the MBS deals. $40 billion divided by 3% is $1.3 trillion. Thus, the Magnetar deals were based on MBS transactions that had, in the aggregate, a principal balance of about $1.3 trillion. Also, the Magnetar deals were based on the new loans being written in 2006 and 2007, not on all of the loans outstanding (and previously written).
Total subprime MBS issuance was probably about $1.2 trillion in 2006-07. Deals appeared multiple times in the various Magnetar transactions, so the referenced issuance of the deals could actually exceed total subprime issuance.
As a result, you can see the numbers you referenced are barking up the wrong tree. Hopefully, this will help clarify for you the significance of the Magnetar transactions.
Financing the Bubble?
written by ellen1910, April 24, 2010 3:13
From The Big Short via [http://www.nakedcapitalism.com/2010/03/debunking-michael-lewis-subprime-short-hagiography.html]Yves Smith[/http://www.nakedcapitalism.com/2010/03/debunking-michael-lewis-subprime-short-hagiography.html]:

“Then he said something that blew my mind,” Eisman tells me. “He says, ‘I love guys like you who short my market. Without you, I don’t have anything to buy.’ ”

Say that again.

“He says to me, ‘The more excited that you get that you are right, the more trades you’ll do, and the more trades you do, the more product for me.”
Fraud
written by Ron Alley, April 24, 2010 7:21
Dean,

Zinc and Tom have it about right. Fraud is fraud. Greed is good, but fraud is not. Hidden transactions in the CDO and the CDS markets made fraud difficult to detect. Changes in the securities law have made it harder for investors to recover money lost in fraudulent transactions. The volume of money available, the lack and oversight and the profits available through opaque transactions that invited fraud all injected oxygen into the fire of the housing market. The result was a housing bubble.

You have it all wrong when you conclude that the housing bubble caused the money supply to rise and and the failure of financial market regulation to fade away. The housing bubble, as we know it, could not have occurred independently of those factors.
...
written by bobbyp, April 24, 2010 12:19
zinc: Dean is not 'defending' fraud in any sense.

tom: So fill us in on how a leveraged bet on $40b of underlying financial instruments caused the collapse of the housing bubble? Dean merely points out that the housing bubble and its collapse had real economic impacts on real economic output of real goods and services.

Ron: Dean has never asserted that the housing bubble 'caused' the money supply to increase, and the rest of your last paragraph is incoherent.
It's the debt not the prices.
written by Amileoj, April 24, 2010 6:48
If house prices would be at current levels, is there any reason to believe that consumers would be spending more absent the crisis, that businesses would be investing more...?


Sure, that's easy: They (business and consumers both actually) would be a lot less in debt than they are now.

The financial crisis was simply a bank run. As such, it was driven (as they always are) by the sudden collective dawning of the fact that the banks were awash in bad debt. To have avoided the this crisis would have been (would have required) avoiding the building up of that mountain of bad debt--there is no other way.

The key to understanding the depth and duration of our current economic woes is not where house prices are now--for instance, the mere disappearance of the housing "wealth effect" and its effect on demand. Wealth effects come and wealth effects go, but their going does not always leave behind 10% unemployment for years on end.

The key is where asset prices are now relative to where they were at the height of the credit bubble.

Had asset prices not climed and collapsed so much, and so rapidly, they would not have left the huge overhang of unsustainable debt in their wake. The issue is not (just) that homeowners are much less rich than they thought a couple of years ago; the issue is that they are a lot more in debt.

I think it's clear that the last few years of the bubble were only possible because the shadow banking system continued to move ultra-risky debt securities at AAA prices.

Without those leverage-fueled excesses, there would be a reduced preference for liquidity now, the sudden explosion of which was the driving force of the recession, and lingering effects of which are the main thing slowly (and possibly stalling) the recovery.

Yes, the sudden disappearance of housing wealth (and, more directly, of MEW) contributed, and continues to contribute, to our real-economy problems. But this is not fundamental -- the economy is awash in desired savings that are not being put to productive use. Just because housing is obviously not that use, does not tell us why other uses, truly productive ones, are not being found.
Magnetar really did extend the subprime mania
written by hhill51, April 25, 2010 4:11
Dean -

What you're missing is the fact that they sponsored deals built out of BBB bonds, typically the lowest-rated tranche in a subprime MBS. Those are only 5% of a typical deal, with roughly 80% AAA and 5% AA and 5% A rated bonds above the BBB's.

Their demand for BBB's drove demand for $800 billion in subprime mortgages to be securitized. That is more than the $600 billion created in the peak year of production, and roughly two thirds of the peak of total outstanding subprime mortgages (around $1.2 trillion).

They accepted a much lower yield (paid a higher price) than those bonds traded at in 2004 or 2005, essentially assuring that hundreds of billions of financing would be looking for borrowers, with enormous profits of 4% or so for the mortgage brokers who could produce those mortgages. On an average $200K to $300K loan, that was a big payday to dangle in front of thousands of independent brokers, and they responded by shoving as many loans into the pipeline as they could.

I explain a lot of this on my blog, if you're interested. Check out the posts on the roots of the meltdown, invisible leverage, and this topic as well, with a post called "Magnetar Redux"....

Howard Hill
mindonmoney.wordpress.com

Magnetar: "We Were Long the Housing Market"
written by C W, April 25, 2010 12:57
ProPublica is dissembling.

In a letter to ProPublica dated 6 April (and available on ProPublica's website, though none of the commenters on NPR.org seem to have read it), Magnetar wrote:

http://www.propublica.org/documents/item/magnetars-letter-in-response#document/p2

"Magnetar would earn materially more money if these CDOs in aggregate performed well than if these CDOs performed poorly."

On 20 April, ProPublica said that it heard through Bloomberg News about another letter Magnetar wrote, this time to investors. That letter calls ProPublica's report "blatantly false."

Further, they refer to their letter of 6 April thusly:
Despite our best efforts to
educate ProPublica’s reporters about the specifics of Magnetar’s Mortgage CDO investment
strategy as well as the general process and market circumstances regarding the structuring
and issuance of CDOs, ProPublica simply got the story wrong.


Somebody is lying here. I hope readers of this blog will read both sides of the story rather than just listen to the showtune. (It is a damn good showtune though.)

PS: I posted this criticism on NPR's Planet Money blog on 21 April and haven't yet received a response (25 April).
...
written by Brian, April 25, 2010 2:54
I agree that the housing bubble was the problem, but this was a debt-driven bubble in an environment that a previous commenter best described as 'lubricated' which ultimately led to a lot of poor investment, fraud and ponzi financing schemes. I think you have to look at the main cause of the bubble, an endogenous credit cycle in an unregulated environment.
Full assesment of Magnetars position..
written by Nick B from DC, April 26, 2010 1:26
In the article you mentioned taking into account their short positions, which runs opposite their long, so that would lessen the impact of "lubricating" the subprime CDO stuff. But wasn't part of the Magnetar story that Goldman et al were pushing these CDO's without disclosing Magnetar's pushing the lower tranches to be as risky as possible, and only investing in those tranches while shorting the top tier? So wouldn't that lack of transparency hide the effect of their shorting the cdo? Also, maybe this is just due to bankers greed/ stupidity or just human irrationality in general, but even the bankers who knew about Magnetar were also investing in the top tranches of these CDO's, but not even hedging their bets. I'm no economist, but from This American Life's piece on all of this, sounds like Magnetar was definitely able to help effect the bubble. Also as they point out, they were not the only ones doing this. Anyway, it's really interesting piecing together all the broken aspects of the financial/credit/banking system that all helped this crisis become such a doozy!

Write comment

(Only one link allowed per comment)

This content has been locked. You can no longer post any comments.

busy
 

CEPR.net
Support this blog, donate
Combined Federal Campaign #79613

About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

Archives