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SEC Proposes Ban on Magnetar-Like Deals

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Photo by Alex Wong/Getty Images

The Securities and Exchange Commission yesterday unveiled proposed rules to ban hedge funds and banks from assembling risky securities, marketing them to investors and then immediately betting against their own creations, reaping profits when they fail. The rule would also ban firms from setting up risky securities for the benefit of an undisclosed third party.

As we detailed last year, exactly those kinds of questionable deals helped fuel the financial crisis and resulted in huge losses for investors.

Goldman Sachs and JPMorgan Chase have already paid millions of dollars—a relatively small sum for both banks—to settle SEC charges that they misled investors. Several other banks, including Citigroup and Mizuho of Japan, are being investigated by the SEC for similar deals.

“It was as if a car dealer sold a car with bad brakes, then bought insurance that paid off when the car crashed,” Sen. Carl Levin, chairman of a Senate committee that investigated such deals, said in a statement yesterday.

The SEC’s new rule is designed to target two potential conflicts of interest:

For instance, a firm might package an asset-backed security, sell that security to an investor and then short the security to potentially profit as the investor incurs a loss.

Or a firm might allow a third party to help assemble an asset-backed security in a way that creates an opportunity for the third party to short the security and reap a profit.

The rule would ban any party who participates in the creation of a security from betting against the security. The ban would remain in effect for one year and would also apply to the affiliates or subsidiaries of the participants.

As we reported last year, the hedge fund Magnetar often pushed for riskier assets to be included in deals and placed bets against many of the same investments. Its deals helped create more than $40 billion in the securities known as collateralized debt obligations, or CDOs, and pumped more hot air into the housing bubble. When the housing market finally collapsed, nearly all of those securities became worthless, but Magnetar’s bets against them reaped handsome profits.

Magnetar was involved in the Merrill Lynch and Mizuho deals that the SEC is now investigating, as well as the deal that cost JPMorgan Chase $154 million in a settlement with the SEC. (Magnetar has always maintained that it did not have a strategy to bet against the housing market. The hedge fund has not been accused of wrongdoing as part of the SEC probes.)

Anticipating criticism, including from one of its own commissioners, that its new rules could stifle the free flow of capital, the SEC noted in a press release that the rule “is not intended to prohibit traditional securitization practices.” SEC Chairman Mary Shapiro said the rule “would provide exceptions for risk-mitigating hedging activities, as well as activity consistent with liquidity commitments and bona fide market-making.”

The rule was created to fulfill the demands of the Dodd-Frank Reform Act and will be finalized after a 90-day period for public comment.

While it’s entertaining to watch the SEC play whack-a-mole with investors who are smarter than they are (probably intentionally so), it misses the point that these sorts of activities are fraudulent and, as such, are already illegal.  Banning them is like airing a public service advertisement that, “hey kids, murdering people isn’t cool.”

Prosecute it as fraud, then sue the stuffing out of them for malpractice.  If cases aren’t handled this way, then we can be pretty sure there intent isn’t to protect anybody but the perpetrators.  Big surprise.

bogglesthemind

Sep. 20, 2011, 1:13 p.m.

(Magnetar has always maintained that it did not have a strategy to bet against the housing market. The hedge fund has also not been accused of wrongdoing as part of the SEC’s probes.)

In other words; it was just scamming as usual that St. Magnetar was engaged in. I can see that.

Barry Schmittou

Sep. 20, 2011, 1:19 p.m.

The U.S. Government’s failure to prosecute is criminal and evil !!

The world’s economy and many lives have been destroyed because big businesses in America know they can commit crimes repeatedly and never face prosecution.

A related example is the failure to prosecute Wachovia for laundering $378 billion for Mexican drug cartels during the time there have been at least 22,000 drug related murders in Mexico proves corporations can even enable mass murder and no one will be prosecuted by the U.S. Government.

The $378 billion that Wachovia laundered is equal to three years of funding for the war in Afghanistan !! Wachovia allowed some of the most ruthless murderers in the world to make this huge amount of blood money readily available and appear legitimate, but no one was prosecuted !!

you mean the stories you wrote after the WSJ first highlighted this cdo sausage making factory right?

Stuart Davies

Sep. 20, 2011, 1:44 p.m.

“It was as if a car dealer sold a car with bad brakes, then bought insurance that paid off when the car crashed”. This analogy is getting close, but it would be more accurate to say that it was as if a car dealer SABOTAGED the brakes, sold the car to an unsuspecting client after paying off a third party to certify its safety, then bought insurance that paid off when the car crashed.
  I am still waiting for the US attorney general, or more likely one of the State attorney generals to connect the legal dots that tie this segment of the Great Chain of Financial Fraud (GCOFF) with another key segment that came earlier in the process… the entire sub-prime loan origination scam.
  There has been a lots of reporting on the robo signing, backdating, and outright forgery of documents that has been occurring on the foreclosure end of this mess, but the fact that loan originators forged documents as well has been largely lost in the in the media din.
  The big banks and their proxy loan originators used a whole grab bag of tricks as part of their deliberate sub-prime policy, from enticing people to take out loans with poison hidden in the fine print, to tricking people into signing loan applications that they were unaware they were signing, to forging “proof of income” documents, etc. It is also quite clear that this practice was disproportionately employed in minority neighborhoods of all economic brackets.
  So why is this significant? Because CDO’s such as magnetar were filled with sub-prime mortgages that were actually cherry picked with those deemed most likely to fail. This, combined with the loads of evidence that the banks or their proxy loan originators employed countless acts of fraud in implementing their sub-prime policy indicates that the criminal conspiracy was much larger than these individual deals.
  The banker boys needed these sub-prime loans to fail in order to collect the side bets they placed on the failure of the CDO’s that were based on those very CDO’s. I have a sneaking suspicion that even this was not the primary aim motive of these vermin - it is becoming increasingly evident that there are huge payoffs to be reaped by certain interests from the global economic implosion. Consider the “austerity measures” and further rounds of privatization of state assets that have resulted from this crisis… the tide of privatization appears to be headed for a storm surge. Cui bono?

The SEC has proven itself to be little more than a dating agency for corrupt lawyers and Wall Street investment houses.

What about repealing the provisions of the Commodities Futures Modernization Act that re-legalized these 19th century bucket shops?

http://en.wikipedia.org/wiki/Bucket_shop_(stock_market)

Stuart, regarding officials connecting dots, you might consider this guy:

http://www.washingtonpost.com/wp-dyn/content/article/2008/02/13/AR2008021302783.html

And that might give you some idea of why the dots continue on unconnected.

Barry Schmittou

Sep. 20, 2011, 3:06 p.m.

The tremendous and intricate complexities of this world wide fraud has caused me to believe we must be dealing with a spiritual form of evil known as the devil.

I just don’t see any other way that such complex worldwide finance frauds and other crimes the world leaders are committing could be occurring.

A good friend of mine told me about Ephesians 6:12 when my health benefits were stolen by MetLife in 2001 while the government watched numerous frauds committed repeatedly.

Ephesians mentions powers and principalities and to me that describes the world leaders perfectly.

“Wickedness in high places” does too.

I respect everyone who may not think this is Biblical. I am often challenged because my intellect and ego do not want to accept that we were created by a supernatural being and I need his help, but if things keep getting worse and worse and you ever reach a point where you have no where else to turn, I pray you will consider asking God for help. Of course it’s much better to ask before you reach near rock bottom like I did.

I greatly appreciate many who comment on ProPublica. Our country might have a chance if people like some of you ever become in charge.

I will close by greatly agreeing with what you have all said, including Stuart’s quotes :

“it is becoming increasingly evident that there are huge payoffs to be reaped by certain interests from the global economic implosion”

“loads of evidence that the banks or their proxy loan originators employed countless acts of fraud in implementing their sub-prime policy indicates that the criminal conspiracy was much larger than these individual deals.”

Stuart Davies

Sep. 20, 2011, 6:36 p.m.

John, great link. I don’t remember catching that little prime tidbit of information about OCC actively running interference for the banks on state efforts to regulate the predatory sub-prime scam. Yeah, Spitzer was a good one - and look what they did to him.  Let’s hope that Schneiderman or Nevada Attorney General Catherine Masto will hold these vermin’s feet to the fire….

To fill everybody else in who might have been ignoring the gossip news while the economy was about to collapse—I don’t know how widespread the news was—Spitzer was caught in a whirlwind prostitution scandal and forced to resign on March 12th, 2008, less than a month after that article went to press.  The charges were later dropped for lack of evidence.

(And we got saddled with David Paterson as governor, who…gah, what an idiot!)

Barry, I don’t begrudge you the feeling and can see why you might feel that helpless, but I wouldn’t be particularly impressed with a great spiritual evil that bothered with fancy accounting.  These are run of the mill bullies, and the most effective way of stopping bullies is to deprive them of attention.

I don’t mean to ignore them, in this case, but rather do what it takes to keep as much money away from the big banks and Wall Street as possible.  Not that it’s easy, but imagine how quickly the rats would leave the sinking ship if everybody just left the stock market.

Barry Schmittou

Sep. 21, 2011, 5:01 p.m.

Thanks for your kind expression John,

I actually feel help and hope in God, and the complexity of all the world wide crimes goes much further than the financial crimes you mentioned.

For instance :

I have just learned Obama’s ATF allowed thousands of large guns to be taken into Mexico in the 2010 Gun Walking Scandal.

ATF agents were begging their supervisors to stop this but they refused.

Here’s a quote from C B S :

One e-mail noted, “958 killed in March 2010 ... most violent month since 2005.” The same e-mail notes: “Our subjects purchased 359 firearms during March alone,” including “numerous Barrett .50 caliber rifles.”

The ATF says there plan was to video the gun runners and then arrest them later, but that rarely happened !!

That evidence is in addition to $378 billion Wachovia laundered for the murderous Drug Cartels that have killed 35,000 in Mexico since 2006. Zero Wachovia employees were prosecuted for the laundering !!

Right below is another of the many examples of evil that is so complex I believe the Devil must be involved. While I file official complaints and try to stop injustice as the Bible tells us to do I believe we are watching the U.S/Global leaders cause great suffering and destruction as the Bible says they will do.

Here’s a summary of Non prosecution agreements I filed in Federal Court asking for a Special Prosecutor, and as expected the Court just denied my request saying there are no legal grounds :

(1) AIG received a Non Prosecution agreement for rigging huge bids to increase sales of Workers Comp;

(2) AIG received a Second Non Prosecution agreement for Aiding & Abetting Securities Fraud;

(3) AIG and Prudential received a Non Prosecution agreement for accounting frauds;

(4) Prudential was also fined $600 Million in Securities Fraud Fines

(5) Prudential, Unum Insurance, and MetLife also committed similar bid rigging violations regarding health care plans and have received multiple Non Prosecution agreements from multiple government agencies;

(6) Metlife still endangers patients lives by ignoring life threatening medical conditions when patients file claims on the policies that MetLife committed frauds to sell;

(7) JP Morgan received a non prosecution agreement for bid rigging in 32 States !!

(8) Wachovia Bank laundered $378 billion of Mexican drug money, no one was prosecuted !!

There were 32 Non Prosecution agreements in 2010. Many of the crimes are health care or financial fraud and kickbacks !!

That’s just a small portion of the complex worldwide corruption that makes me believe we are dealing with the powers and principalities and wickedness in high places mentioned in Ephesians 6:12

Powers and principalities is a perfect description of how the elite act at all the expensive elegant dinners and galas the lobbyists buy for our politicians !

AND the murders in Mexico and associated murders in the U.S. continue, while Obama’s DOJ prosecuted no one for laundering $378 billion of Mexican cartel drug money !!

I feel certain Bush’s DOJ would not have prosecuted anyone either !

Thank you again for your comment John. In my opinion you are one of many commenters on ProPublica who are working in your own way to stop injustice and make our nation and world the best they can be for all living beings !

Thanks, Barry.  We just need a billionaires funding us, and it’ll be all set, right?

(And yeah, I was trying to ignore the ATF story.  That’s over the top, even for me!  Those very guns, unsurprisingly, are starting to show up on American streets, by the way.  Geniuses…)

Something had better “stifle the free flow of capital” because it’s all going to the top.  Biggest craps table in the world.  Does anyone know who gets the money when SEC or the government slaps these robbers on the hand and fines them?

Some years ago I read an article about the mafia changing their image by sending their young people to ivy league schools to learn business and finance so they could run “legitimate” businesses.  Given the unscrupulous behavior of Wall Street and banks it’s highly likely the mafia has taken over the system.  They have never had any regard for laws.  Or maybe Wall Street traders and banks are simply using the mafia model?  Whatever is going on it’s criminal.

Cathy Timmons

Sep. 24, 2011, 5:34 p.m.

Senator Levin’s analogy is not apt: “It was as if a car dealer sold a car with bad brakes, then bought insurance that paid off when the car crashed.”

Presumably, Levin construes the car dealer =  Wall Street banks; the bad brakes = shoddily constructed CDOs.

But the analogy fails. The banks (JPM, ML, Citi, LEH) not only manufactured toxic products, they themselves also bought them, thinking they were great products.

So, it was akin to GM or Chrysler manufacturing & retaining ownership of a poorly built car, and then betting that it would perform like aces.

Luckily for the American economic system as a whole, Magnetar (not the rating agencies) correctly perceived the worthless longterm value of those shoddily-constructed products and thereby ended (sooner rather than later) the subprime-credit-lending madness.

If Magnetar had not shorted the subprime bond market, the housing price bubble would have inflated even higher, leaving even greater destruction when it eventually popped.

Of course, the real perpetrator of subprime credit lending fraud were the subprime loan originators, firms like World Savings bank.

If only some intrepid investigative reporters would investigate the criminal operation of World Savings Bank—and the use to which its owners then put their fraudulently acquired gains.

http://www.nytimes.com/2009/05/15/business/economy/15norris.html

Barry Schmittou

Sep. 29, 2011, 1:03 p.m.

Hey John,

I was off the computer for a week.

I would like to mention that I appreciate you writing that the ATF story is :

“over the top, even for me!”

To see you write that is a real attention getter because I know how dedicated you are in working for a better world.

I am still shocked by the failure to prosecute anyone for laundering $378 billion for the murderous drug cartels.

I am certain the danger to every living being on earth is exponentially increased because the people committing the financial crimes, health care crimes, and insurance company crimes are all related to a criminal corporate culture, and the U.S. Government will not prosecute them !!

Thanks again for your comment John, I know when you mention that somethings over the top for you we have tremendous evidence that must be remembered and resolved.

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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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