Journalism in the Public Interest

SEC Investigating Deal Between JPMorgan and Hedge Fund Magnetar

The SEC is investigating whether JPMorgan adequately disclosed to investors that the hedge fund Magnetar influenced a deal it was also betting against. 


The Securities and Exchange Commission is investigating whether JPMorgan Chase allowed a hedge fund to improperly select assets for a $1.1 billion deal backed by subprime mortgages, according to people familiar with the probe.

Called "Squared" and completed in May 2007, the deal was a collateralized debt obligation, or CDO, made up of pieces of other CDOs. The hedge fund, Magnetar Capital, based in Evanston, Ill., purchased the riskiest slice of Squared as part of a strategy to bet against the mortgage market.

As we reported in April, together with Chicago Public Radio’s This American Life and NPR's Planet Money, Magnetar often purchased the riskiest portion of CDOs, enabling the banks to complete the deals. Magnetar also frequently bet against those same CDOs, using side bets. Magnetar's purchases ultimately spawned at least $40 billion worth of risky CDOs in 2006 and 2007.

While Magnetar bought the riskiest slices, the CDOs were created and marketed by investment banks. In the case of Squared, the SEC is examining whether JPMorgan adequately disclosed to the investors it marketed Squared to that Magnetar had a role in picking the securities that went into the deal while also betting against segments of the deal. The 294-page Squared prospectus, which was created by JPMorgan, has generic language warning that some investors and the CDO manager might have investments that conflict with the interests of other holders of the CDO. (Read the prospectus.)

Magnetar has consistently maintained that its investment strategy was not based on a fundamental analysis of the housing market. The fund says it would have made money whether house prices rose or fell. And the fund has said that it didn't have final say over what assets went into its CDOs. The hedge fund did not comment on the investigation.

Having declined to comment on specific questions about Squared for our story in April, Magnetar now disputes the April ProPublica account of the Squared transaction. (Read their recent letter, and our response.) The fund says it invested in the transaction after it had been initiated by JPMorgan and GSC, a third-party independent manager, whose fiduciary duty was to pick the best assets for the CDO. GSC didn't respond to our requests for comment.

The investigation echoes the SEC's suit earlier this year against investment bank Goldman Sachs. In April, the SEC charged Goldman with misleading investors in the creation of a CDO called Abacus 2007-AC1. The bank did not disclose the role of a hedge fund, Paulson & Co., that helped put together the deal as part of its bet against housing. In June, Goldman paid a $550 million fine to settle the case. The agency didn't charge Paulson with any wrongdoing. In June, the Wall Street Journal reported that the agency had stepped up its probes of Magnetar's deals.

As we noted in our earlier story about Magnetar, Squared included a piece of a CDO from one of those Goldman Sachs deals, called Abacus 2006-17.

It is not clear how far the SEC's investigation has progressed. The SEC is actively looking at the entire CDO market, including multiple managers and investment banks. Since Magnetar made no legal representations to investors in any of its CDOs, it may not have violated any of the rules that govern the transactions. Another possible complication in the SEC's probe is that the biggest loser in the deal by far was JPMorgan itself.

According to a person familiar with how the deal came together, Magnetar committed to purchase $10 million worth of Squared's riskiest part, called the equity. Magnetar's purchase allowed JPMorgan to create and sell the CDO.

One participant in the deal told ProPublica that Magnetar pushed the bankers to select riskier bonds. "They really cared about it," this person said. "They wouldn't pull punches. It was always going to be crappier assets." The hedge fund requested that Squared include slices from other CDOs that Magnetar helped spawn, according to this person.

In response to questions for this story, Magnetar said that the fund "did not at any time require or expect any specific assets to be purchased into the Squared transaction." The fund said GSC, the CDO manager, "at all times exercised its own discretion and judgment regarding the characteristics and appropriateness of each of the assets selected for inclusion in Squared."

In its statement, the fund says that a number of assets were purchased for Squared "prior to Magnetar's agreeing to purchase equity in Squared."

E-mails that the SEC has obtained in the course of its investigation show Magnetar executives discussing specific assets with bankers from JPMorgan, according to the participant in the transaction. This person, who asked not to be named because of the investigation, reiterated that Magnetar requested that specific assets go into the deal.

Magnetar also said that the Squared transaction was initiated by GSC and JPMorgan "independently of Magnetar and well before Magnetar agreed to invest in the equity tranche of Squared."

The Squared deal was completed nearly a year after housing prices had peaked. Within eight months of the transaction, Squared dropped to a fraction of its initial value.

JPMorgan earned $20 million in creating Squared, according to the person involved in the deal.

JPMorgan's sales force sold parts of the CDO to 17 institutional investors, according to a person familiar with the transaction. These investors included Thrivent Financial for Lutherans, a Minnesota-based not-for-profit fraternal organization, whose $10 million investment was wiped out. Thrivent didn't respond to requests to comment. Small pieces of Squared also ended up in mutual funds run by Morgan Keegan, a regional investment bank based in Memphis, Tenn. Morgan Keegan was sued by individual investors who claimed they were misled about the risks of their investments. Among the investors was former Chicago Bulls player Horace Grant, who was awarded $1.4 million in arbitration. Morgan Keegan did not respond to requests for comment.

JPMorgan Chase, which kept the large, supposedly safe top slices of Squared on its books, without hedging itself, lost about $880 million on the deal. Banks often kept such slices since they were widely believed to be nearly risk-free.

Magnetar came out a winner. The fund earned about $290 million on its bet against Squared, according to a person familiar with the deal.

Barry Ritholtz

Nov. 1, 2010, 4:03 p.m.

The new & improved SEC seems to be pretty busy lately . . .

Matt Greenfield

Nov. 1, 2010, 4:48 p.m.

Good reporting.  I agree with Barry—lately there are moments when one could almost think that the SEC was charged with regulating banks rather than with protecting them against the consequences of their crimes.

True, gotta have time for SEC employees to watch porn.  I mean, really.  Why bother with regulating the financial industry and all that?

Why bother reading prospectuses that would enable the securitization of home loans and maybe realize I dunno maybe bringing the US economy to its knees via the total collapse thanks to the SEC for allowing such crap to be securitized?

Just a thought.

We will fight.  We will gain strength and the majority of the middle class of this country will return the power of the country where it belongs.  the majority.

At some point these CDO managers had to know that they were an instrument of plausible deniability in the scheme of things.  Perhaps more careful scrutinization of the contracts that shifted almost all of the blame away from the key players to smaller third-parties would have tipped them off.

The ability to shift blame based on terms of a contract needs to change.  Stories like this are proof positive of that.  We’ll never know who was truly to blame or who profited until all of the banks dealings are put on the balance sheets where they belong.  Truth in accounting isn’t big government its responsible mangement.  Didn’t we learn anything about false profits from the S&L disaster?  Not likely as many of the failsafes of that mess have been changed to allow for more of the same.

America may not have a deep history like Europe but those in charge sure have a heck of a time learning from it.  I didn’t have to look back too far to see a trend in greed, neither should anyone else.

I find this on the net. very interesting. Part I.

In fact, it is my theory that during the period of time roughly covering 2002 – 2007, originating lenders (as well as everyone else in the chain of the securitization process) bet against the borrower to be able to fulfill their obligation. The strategy can be compared to a situation whereby the lender deposited a single dollar bill into a slot machine, the dollar bill would be gone forever, but the slot machine was guaranteed to payoff every single time and return 2, 3 or even 5 dollars . The mechanism for this process was what is known as “credit default swaps” Credit default swaps were (and amazingly still are allowed) a way for entities to bet against (or for) borrowers of home mortgages to be able to continue making payments on loans that were rigged to fail. This fact means that as a result of these “bets”, your loan has already been paid off.

Additionally, investors in these securitized trusts that are mortgage backed securities, or collateral debt obligations, were covered by monoline, multiline, or other form of “pool insurance” or mortgage guarantee insurance, which has already indeminfied the securitized trust for a borrower’s default. Moreover, these trusts also “overcollateralized” and/or “cross collateralized” certain “tranches” within these securitized trusts that subrogated losses from borrower defaults to other tranches (thus different investors than the ones trying to foreclose on your home), and therefore the investor on your loan may have in fact already been indemnified for any loss from default on your loan.

I find this on the net Part   II.

Even in light of the above, the servicer, and other parties that engineered the securitization that includes your mortgage, seek to collect yet again, by foreclosing on your home. I have credible evidence that suggests that mortgage servicers may be auctioning these homes and not turning the proceeds over to the securitized trust and its investors. Thus the mortgage servicer is keeping the proceeds of these foreclosure auction sales as a financial windfall (another reason why your servicer has absolutely no incentive to work with you on a loan modification).

This issue is now surfacing when homeowners who are attempting to be approved by their mortgage servicer for President Obama’s Home Affordable Mortgage Program (“HAMP”). Some applicants are being told that, while technically their loan meets the qualifying criteria of the program, they are being denied because their loan is covered by “pool insurance”. Additionally,borrowers generally get the runaround when trying to get their mortgage payments modified. This is so for a number of reasons, but mainly because the mortgage serivcer receives more money for keeping you in foreclosure. Default servicing pays more money. The trust has an escrow account to pay litigation fees to servicers, and the servicer gets to keep all late fees and junk fees paid by the homeowner. This means the servicer is incentivized to default a home loan and its motivation is at odds with its client, the securitized trust. The largest default servicer in the country is based in Jacksonville – Fidelity National Default Solutions (now known as LPS Default Title and Closing). This is
Federal Securities Law


If your mortgage was securitized, it is subject to the securities and exchange commission and its rules and regulations as well federal laws governing securities (acts of 1933 and 1934).

One of the main requirements under federal securities law is that a prospectus be provided to investors in mortgage backed securites. If your mortgage has been securitized, theoretically your mortgage loan ended up in a securitized trust as part of the securities sold to large institutional investors. Under federal securities law the prospectus determines the roles of all of the parties to the transaction, and sets forth the requirments enabling the trust to qualify as a federally regulated security.

Another source of authority is the “pooling and servicing agreement”, which is the contract

Theoretically these trusts were set up to be “bankruptcy remote”. So what generally happens is that a financial institution creates many sub-corporations in order to create a chain of “absolute sales” of the trust assets, leading to the final transfer into the securitized trust. Generally these are the requirements and parties involved in the process:

Cut Off Date – The date that all of the mortgaage loans must be identified, which will be forming the asset pool of the securitized trust.

This radio show will tell the truth. It’s worth to listen.

The first 4 minutes I don’t care, but after that, you will find out all about the banking fraud and corruption of the current mortgage crisis.
Want to KNOW CDO,s Bail out Fraud, Foreclosure,?

How Wall Street r a p e d the American people?

All those incompetants who could not find a real job and who eventually persuaded the gov’t to hire them are truly showing why they could not get a job in private industry, as they are the very bottom of the talent barrel and thus have no clue and care little about doing a competant job. “What you don’t get done today you can do next year while you dream about your fat pension and paid time off!”

That’s just how the SEC operates, when the staff even shows up for work. with all their paid time off on taxpayer money.

One can only hope that the new congress, whichever party is in the majority, does not bow more to Wall Street and muzzle needed investigations such as this.

This collection of bankers simply collected money from various sources to finance the individual monies lent to homeowners.  At no point did they make the money brighter, faster, stronger, more environmentally friendly, they simply traded.  They do not engineer or create; they are pariahs to a world that needs creativity to solve real problems.  At what point in a normal day can any citizen of the developed world thank the heavens for the advent of investment bankers.  Contrarily, thanks to a legion of dedicated and intelligent people, I am capable to use this computer integrated to the internet: Politics aside, we need to return to a value system that values creativity - not trading, capital pooling, etcetera.

Like anything unethical done Jamie Dimon, comes as a shock to anyone?  Really.

My question is in regards to this revealing detail:

“The fund says it would have made money whether house prices rose or fell.”

What magical leprechaun fund is it that makes money regardless of market conditions? Being that this is a tertiary, imaginary product to begin with it really is not a stretch to assume that this entire ‘collateralized debt obligation’ was part of a scheme to defraud the market and its investors from the start… yet again…


Nov. 2, 2010, 2:37 p.m.

Garbor,  Great explanation on Part I, II, and III, I also usually explain it this way:
Imagine a sell you a beautiful car (your home) then I rigged it under the hood (Mortgage is been designed to default in the future) so this way the car will crash later on, ( will go in to in to default) then i go and I buy Insurance 2, 3, 4, to 1 (sometimes even 30 to 1) that that car will crashed ( will foreclose) and when it does i collect that insurance (when home goes in to foreclosure) that is why there is this other incentive to foreclose and not work with the homeowner to get a Modification or the HAMP

Yves Smith gave a great explanation of the Magnatar deal in her book ECOnned..  This is old stuff.  Go to the Naked Capitalism blog if you truly want to be informed.
Ehat’s taken the SEC so long, and why aren’t the CEO’s of these banks in jail?

acmodspecialists, You’ve got it. If you listen to the radio show I posted

in the first 15 min the attorney explain it very well.

I wonder why Timothy Geithner Herbert Allison,
Ben Bernake, Phyllis Caldvell, Shaun Donovan and our President with the rest of the goonies don’t get it???

I Would personally fire every single one of them for
1. Incompitency.
2.They are not qualified for the job.
3.Lying to the American people

And I would haul in Henry Paulson and freeze all his asset, untill he admits he purposly and willfuly misled the American public so Wall Street can gain billions. Inluding his buddy Blankfein from Goldman SUCK who received $67.5 million from the bail out, and freeze his asset also under financial terrorism.
Then start to go down the list.
And when all the moneys collected I would divided between troubled mortgages and those who lost their homes. I would leave enough money for them to get an Apartment and some expenses so they would not become homeless and hungry. Which makes me a lot better person then them because they don’t care about you or me.

The Economy would bounce back less then a New York Second.

Gabor- My friend I second your propositions!

JPMorgan also AKA WaMa gave me a loan Prime around 500K plus Subprime over 115K on 2005 with a shady loan.
Then modification done around 45K on 2007 and ended by subprime followed by prime or 1st loan foreclused on 2008.
They as DauchBank trustee took our home which we owned since 1992.

OK, Millions of people start to lose their jobs and become unemployed, thus leaving them to not be able to make their mortgage payments. Banks “Too Big To FAIL” also begin to go bankrupt, and fail all over the country. The unemployed tax payers give billions of dollars to what ever banks are still in operation to bail them out of bankruptcy, so they in turn can work with distressed homeowners to try and keep their homes. All the while knowing they are not going to be helping anybody, pocket the bailout money the taxpayers gave them, and still steal their homes.

Gabor - it is my theory that no money was really used at all in this whole endeavor.  It was like those old scam commercials from the 70s where you could buy wind up with a handful of houses for an initial investment of something ludicrous like 5$.

Money passed around so quickly that I really think the same initial 700,000 somehow was used to buy nearly every over-appraised and over-valued property in America in some sort of bizarre, massive-scale, national shell game.

When I read about ‘wirehouses’ I was convinced of this.  The money that came from a large bank on a loan was immediately paid back to them from investors, so did they really truly have skin in the game - or where they in the business of short-term loans where they borrowed the same 700k from another source and just moved it around back and forth, racking up fees along the way and selling the sh*t back to themselves?

If I borrow $ from Joe to give to Sally and Bill gives me the same amount of money within a week or a few days, where is any trace of my own skin???

Barry - you are a brilliant guy - what do you say?


Nov. 4, 2010, 1:07 a.m.

Garborr and Carol great explanations : )
I will also add that on top all of these now there is MERS, Banksters Lawyers and their Fraudclosures it keeps going and going and going, every day we hear new ways of how the Banksters keep stilling and committing frauds against the American People

I became unemployed and my house value fell by $50K (per the town)....after asking for a mod. for a year, Bank of America finally relented (once I contacted my US Senator) and gave me a mod. (I failed HAMP) which reduced my monthly payment by a whopping $100.oo, from $1900 to 1800….they also added on the payments I missed with fees, so my new mortgage is greater than the first.  They ignored the fact that my house value fell (their fault) and they also lowered my interest rate by .035 percent.  Thanks.  For not much.

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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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