Emails give glimpse into deals that fueled financial meltdown

Hedge fund Magnetar and Wall Street banks created $40 billion of CDO deals. The emails show how they did it

As ProPublica has been detailing for two years, Wall Street banks and the hedge fund Magnetar worked together to build mortgage-backed deals that the hedge fund also bet against. The more than $40 billion of deals helped fuel the crash of 2008.


Now, recently collected emails from bankers and a Magnetar executive involved in some of the deals appear to shed new light on how they did it.

Fiduciaries threatened with a loss of business if they didn't cooperate. Prime movers behind a billion-dollar deal suggesting they need to keep their actions hidden. It's all portrayed in the emails, which were included as part of a civil lawsuit against Magnetar filed in New York's Southern District Court in late June. (Our reporting is also cited in the complaint.)


The suit was brought by Italian bank Intesa San Paolo, which lost $180 million on an investment linked to a mortgage bond deal put together by Magnetar and French bank Calyon. The deal was "built to fail," in the words of the complaint.

Boston-based Putnam was the manager on the deal, called Pyxis 2006, which involved the creation of a $1 billion collateralized debt obligation. The managers in such deals were supposed to be independent and looking out for all investors' interests.

Intesa is suing all three players, Magnetar, Calyon and Putnam. Intesa, which is seeking unspecified damages, accuses Calyon and Putnam of misrepresenting the deal and Magnetar of acting in a conspiracy with Calyon and Putnam to aid and abet fraud. (Much of the information cited in the suit comes from an earlier case involving many of the same players that was settled.)


As with all partial document trails, the emails are open to a variety of interpretations. Magnetar says they have been selectively excerpted and that the more complete email chains don't show what the plaintiff alleges.

The firms involved in the deal — Magnetar, Putnam and Calyon —filed motions todismiss the suit last month.

A Putnam spokesman said, "The lawsuit is completely without merit and will be defended vigorously." A Calyon spokeswoman declined to comment.

Magnetar is reportedly under SEC investigation. The hedge fund says it has not received a formal notice of possible charges from the SEC and calls the lawsuit "meritless." The hedge fund reiterated that it "did not control" what went into the deals, known as collateralized debt obligations. (Read their full response.)

Here are some excerpts from the emails, with our captions: 

On June 14, 2006, an executive from Calyon wonders if Magnetar's participation should be hidden, that is, remain "behind the scenes and outside of the docs" in "exactly the same way we did" with another Magnetar CDO:

Banker asks if Magnetar wants to be "behind the scenes" (p. 12)



Magnetar's Jim Prusko responds: "No, not at all. What's your number?" Magnetar points to that response as exculpatory.

Yet a week later, Calyon, Magnetar and Deutsche Bank (which was also investing in the deal and playing a similar role as Magnetar), discussed creating a side agreement giving Deutsche Bank and Magnetar veto power over assets that were to go into the deal. Such side agreements were rare and would have left some investors unaware of important details of the deal.

The Side Letter, giving DB and Magnetar control (p. 7)


Ultimately, that side deal was never consummated, according to Magnetar. But Magnetar made sure it knew about the asset selection for the CDO, which Intesa charges is an example of its secret control. Neither Magnetar's influence in the deal nor the hedge fund's bet against it were clearly disclosed to investors:

Magnetar wants to know about all purchases (p. 23)


As the linchpin investor on the CDO, Magnetar needed to know what went into the investment, the hedge fund says. This does not indicate it ultimately controlled what went into the deal. Magnetar points out that Prusko, the Magnetar executive, wrote to the manager in an earlier email that the hedge fund will buy assets "of your choosing":

"We will buy... names of your choosing" (p. 24)


Though Calyon, which created and marketed the deal, told Intesa that it would select some better-quality, "prime" assets, none got in there, according to the complaint:

"Prime" assets didn't make it into the CDO (p. 39)


A key issue is who exactly knew whether Magnetar was betting against, or shorting, the deals in which it was investing. In one of the email exchanges, from September 2006, executives from Calyon and Putnam discuss who is shorting. The Putnam executive says: "It is definitely Magnetar." In other words, the manager who was supposedly looking out for investors' interests claimed to know that Magnetar was betting against the deal:

"definitely Magnetar" (p. 29)


Other emails refer to a CDO manager, the Dutch-owned NIBC, which was involved in another Magnetar deal. (As we reported in 2010, NIBC once pushed back against perceived pressure from Magnetar to make a deal riskier.)

Regarding another Magnetar deal, Calyon's Alex Rekeda writes in November 2006 that NIBC is concerned that it is ceding too much power to Magnetar and Deutsche, which was again partnering with Magnetar on the deal. He also relays another concern: "They feel very strongly that the older vintage bonds that they have in the portfolio have by far superior credit characteristics compared to the bonds they can pick up in the market now." Translated: NIBC was feeling pressure to buy riskier bonds and didn't think doing so would benefit investors.

(Last month, the Securities and Exchange Commission settled securities law charges against one of the players, the former Calyon banker Rekeda, accused of violating securities laws in conjunction with another Magnetar CDO. Rekeda did not admit or deny wrongdoing.)

"They feel very strongly" (p. 37)


Deutsche's Michael Henriques replies that the original investors — which include Magnetar and Deutsche Bank — are taking "execution, credit and manager risk." That suggests Magnetar and Deutsche viewed themselves as the real managers of the CDO, not the supposedly independent NIBC. Henriques, who later went to work for Magnetar, also complains that NIBC is treating Deutsche Bank and Magnetar poorly, lacking "a spirit of partnership."

"Manager risk" (p. 37)



That same day, Deutsche's Henriques threatens to withdraw a lucrative line of business from NIBC:

"Go back to the regular style" (p. 38)


In another deal from a few months earlier, Magnetar's Prusko had also threatened to withhold business from the manager, Putnam, if it did not "play ball":

"Take it or leave it." (p. 18)


Magnetar says Prusko's email solely refers to the fees on the deal, and not about controlling asset selection or any other issue.

In a statement, Magnetar said: "Intesa's decision to amend this complaint appears to be little more than a transparent effort to sensationalize a baseless case in which each defendant has already moved for dismissal.

"As the Plaintiff is well aware from the motion to dismiss we filed some time ago, no Magnetar entity was a party to the credit default swap at issue in the case, and we were not even aware of that transaction until this complaint was filed.

"We continue to believe that Intesa's accusations are meritless, and that the case should be dismissed.

"And, as we have stated numerous times in the past: Magnetar did not control the asset-selection process and our Mortgage CDO investment strategy was designed and implemented to maintain a market-neutral portfolio."



IRDA proposes greater investment freedom to insurers

The draft guidelines of IRDA pertain to participation of insurers in repo and reverse-repo operations in government securities and corporate debts

New Delhi: The Insurance Regulatory and Development Authority (IRDA) has came out with three draft guidelines with a view to giving greater freedom to life and non-life insurance companies to participate in money market operations, reports PTI.
The draft guidelines pertain to participation of insurers in repo (borrowing) and reverse-repo (lending) operations in government securities and corporate debts, Corporate Default Swaps (CDS) and Securities Lending and Borrowing (SLB) Schemes.
IRDA has invited comments of stakeholder within 15 days on these guidelines, which are expected to help insurers earn money from treasury operations.
These draft guidelines require the insurers to put in place risk management mechanism and formulate policies for undertaking such investments.
As per the draft norms pertaining to repo and reverse operations, IRDA said the exposure of a life insurance company in the reverse-repo (lending) in corporate debt securities should be restricted to 10% of the controlled funds.
In case of non-life insurance companies the limit in reverse and reverse-repo operations has been pegged at 10% of investment assets.
The tenure of repo transactions, it added, will be for a period of 180 days, with the prior approval of the investment committee of the insurance company.
The IRDA further said that insurance companies would be allowed to undertake repo and reverse operations only in AAA- rated corporate debt securities.
As a matter of caution, the IRDA has clarified that insurers will not be permitted to undertake such operations in debts of promoter group companies.
The boards of insurers, it added, would be required to incorporate necessary guidelines in their Investment Policies.
These should pertain to credit rating, exposure and tenor of collaterals.
As regards participation of insurers in the SLB operations, the draft norms said insurers would be permitted to "lend only up to 10% of their total equity holdings" in such operations.
"Equities lent in SLB would not be treated as if the insurer owned such equities and all benefits arising on such equities shall be available to the insurer i.e. the beneficial rights of the insurer shall continue," it said.
The board, the draft added, would have to amend its Investment Policy and put in place adequate Risk Management framework on SLBs.
IRDA also proposed that insurers could participate in CDS on Corporate Bonds market as "users" (protection buyers).
"The CDS would be permitted as a 'hedge' to manage Credit Risk... mandatory rating for both the issuing company and the Referenced Entity shall be prescribed by the board of the insurers," it said.
It added that no CDS transaction could take place between entities of the same promoter group.
Besides, it directed that "All CDS transactions shall be reported to the Investment Committee, Audit Committee and to the Board on a Quarterly periodicity".


NPS throws great opportunity for insurers: PFRDA

According to the NPS provisions, an investor can withdraw 60% of his total corpus, which he has saved during his working life and the rest will go to an annuity plan of a life insurer

Mumbai: Despite the National Pension System (NPS) throwing up a large opportunity to life insurers, there are not enough players in the system to take advantage of this, the Pension Fund Regulatory and Development Authority (PFRDA) said, reports PTI.
"The minimum 40% contribution under the NPS towards annuity is a great opportunity for life insurance players, as they can get captive customers from this system. But we don't have enough players in this arena," PFRDA Chairman Yogesh Agarwal said while addressing a CII summit on insurance.
"While 85% of the total market in annuity plan are with Life Insurance Corp of India (LIC), around 10% are with SBI Life Insurance and the remaining are shared among the rest of the players," he said, adding despite the huge opportunity, life insurers are not entering this segment.
The new NPS provisions make its mandatory contribution of 40% of the total corpus towards annuity schemes of life insurers, which gives a large captive customer base to these companies, the regulator said.
According to the NPS provisions, an investor can withdraw 60% of his total corpus, which he has saved during his working life and the rest will go to an annuity plan of a life insurer.
Talking about the revised NPS guidelines, he said the endeavour is to popularise the scheme among private employees and the general public.
Total corpus of NPS is around Rs18,000 crore, majority of which is contributed by the public sector employees. To make it popular among private investors, the NPS has come up with revised guidelines, he said.
The new NPS guidelines allow the PFRDA to increase the number of fund managers from the present six to an unrestricted number with any financial institution that fits the eligibility criteria to be a fund manager.
It also lets the regulator allow fund managers to increase their commission from the present dismal 0.0009% per Rs 10 lakh to an amount which is yet to be finalised by the regulator.
"Though there will be some rise in charges for fund managers, it will still be very minimal in comparison to what insurers and mutual funds charge," he said.




5 years ago

Kerala Government has announced introduction of New Pension Scheme (Rechristened as ‘Participatory Pension Scheme’) for its employees joining service from April 1, 2013. CM is lamenting that this will put additional burden on the state exchequer to the extent of 13% of the wage bill in respect of new recruits and savings, if any, will start accruing when they start retiring! For the new recruits, it will be a straight 13% cut on their remuneration package, which, any serving employee will tell, is a little more than what a normal wage revision factors in as rise in total wages. Media has been keeping a learned silence on the issue. NPS was kept outside the purview of VI Pay Commission, although the scheme was under implementation and already there were several central government employees affected by NPS whose wage structure the Commission was reviewing. Some links are missing. Will anyone come out with the real compelling concerns that weighed with GOI and state governments to introduce NPS which in reality is ‘No Pension’ Scheme, even before it has gained legislative legitimacy with appropriate systems for implementation in place?
M G Warrier

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