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Concerns About ‘Reputational Risks’

Magnetar partnered with Lehman Brothers on the CDO named after the constellation Libra, which closed in October 2006. A banker who worked on the CDO remembers that 'there was a back-and-forth fight about' assets between Lehman and Magnetar, with the hedge fund pushing for riskier assets. (Chris Hondros/Getty Images)As part of the big business Magnetar was doing in the fall of 2006, the hedge fund put together a CDO with Lehman Brothers named for the constellation Libra. John Mawe, a banker who worked on Libra, remembers that "there was a back-and-forth fight" about the assets between the bank's CDO manager and Magnetar, with the hedge fund pushing for riskier assets.

Mawe says Lehman's CDO in-house-management arm, which handled the deal, never put assets into Libra that it thought were bad investments.

Among the other banks that Magnetar approached during that time was Deutsche Bank, with whom it had teamed up to do its first deal months earlier. Deutsche Bank was anxious for business in order to maintain its standing as one of the top CDO banks, according to one of its bankers. Deutsche recommended CDO manager State Street Global Advisors.

The State Street managers were "highly skeptical" of doing a deal with Magnetar, according to one participant. "State Street wanted their deals to do well," said the participant, and with Magnetar, there was "a lot of reputational risk to be concerned about."

Hoping to close the deal, Magnetar's master salesman Jim Prusko drove up from his home in the New York suburbs to State Street's headquarters in Boston, to mollify executives in the management team. After the meeting, the deal went forward. As one banker explained, "there were other managers who were dying to do this deal" and get the millions in fees.

After subprime losses, State Street closed the business that managed its CDOs in late 2007. Frank Gianatasio, who worked in State Street's CDO business says, "We were comfortable with every transaction we put into our CDOs."

Deutsche, Magnetar and State Street called the $1.6 billion CDO they created Carina, a constellation whose name in Latin means a ship's keel. In November 2007, Carina had the distinction of being the first subprime CDO of its kind to be forced into liquidation.

State Street and Magnetar declined to comment on their negotiations over Carina.

This article is part of an ongoing investigation:
The Wall Street Money Machine

The Wall Street Money Machine

Enticed by profits and bonuses, Wall Street took advantage of complicated mortgage-based instruments to reap billions, only to exacerbate the eventual crash.

The Story So Far

As the housing market started to fade, bankers and hedge funds scrambled for ways to maintain the lavish bonuses and profits they had become so accustomed to, repackaging mortgages in complex securities called collateralized debt obligations. The booming CDO market masked how weak the housing market was, and exacerbated its collapse.

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