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All I got out of the article was that a hedge fund was hedging.

by mwerty 17y ago

chris11 17y ago
This wasn't a normal hedge. They were actually creating the products that they were betting against.
- dtby 17y ago
  In what way do you think that makes it an abnormal hedge?
  - jordanb 17y ago
    It eliminates the legitimate justification for a hedge. The argument behind hedging is that it's like taking out insurance: it allows you to take a position that you'd like to be in (invest in a home, for instance) but that you would otherwise find too risky. What they were doing, essentially, was buying a house and insisting that it be built on an unstable foundation, in a tornado zone, with substandard wiring and a garage piled with oily rags, in the hope that it'll get destroyed and they can collect the insurance.
    - byrneseyeview 17y ago
      A hedge fund isn't supposed to hedge away all returns. The hedged part means that they buy and sell similar assets whose prices reveal discrepancies. In this case, there was a discrepancy between the return of the equity slice of CDOs (very high, implying a high default risk) and the cost of insuring the debt portions of CDOs (very low, implying a low default risk). Magnetar basically said "Okay, the risk is probably not as high as the equity guys think. And not as low as the debt guys think. Why don't we buy from the equity-holding pessimists, sell to the debt-holding optimists, and pocket the difference?" And they bought, sold, and pocketed. If you're going to be outraged, pick one: Did they profit from the misery of others by selling short? Then they had to be net sellers, which decreased prices and made the bubble smaller. Or did they needlessly fuel a speculative bubble? In that case, they had to be net buyers, which would make them net losers. Since Magnetar was long volatility (returns will either be way better or way worse than investors expect), this complicates things. But they basically made money from being right, while their counterparties lost money for being wrong. As long as everyone goes into these transactions with the same information, that's the only way fools and their money are parted.
      - jordanb 17y ago
        The article asserts that Magnetar was net short on the CDOs, although the This American Life episode makes that more clear than the linked article does. They can't prove that Magnetar was net short, because that information isn't pubically available. But their evidence was that Magentar was pressuring the banks who were creating the CDOs into building them out of unusually risky assets. They have emails from a deal that fell apart because the bank refused to bundle in the assets that Magnetar wanted. > Did they profit from the misery of others by selling short? Then they had to be net sellers, which decreased prices and made the bubble smaller. Or did they needlessly fuel a speculative bubble? In that case, they had to be net buyers, which would make them net losers. The thing is, Magnetar was only buying the equity position of the CDO. They were then buying insurance against the higher tranches failing. They were sponsoring billion-dollar CDOs with a few million dollar investments in the lowest tranche. They were then buying insurance against the failure of the much larger upper tranches. Without them buying the equity, the CDO wouldn't have been created. The argument is that without Magenatar, the CDOs wouldn't have come into existence (because they wouldn't have had a sponsor willing to buy the equity tranche). Magnetar wanted the CDO to fail as evidenced by its pressure of the banks to include rotten assets. So my analogy stands, they insisted on the construction of a dangerous house so they could collect the insurance.
    - dtby 17y ago
      It eliminates the legitimate justification for a hedge. Not as described by the parent. His problem was that they were creating the financial instruments and the hedges. This is exceedingly common. I'll leave the moral outrage portion of your post alone with hopes that you already know how you vastly oversimplified simply by ignoring counterparties.

All I got out of the article was that a hedge fund was hedging.

by mwerty 17y ago

All I got out of the article was that a hedge fund was hedging.

chris11 17y ago

This wasn't a normal hedge. They were actually creating the products that they were betting against.

dtby 17y ago
In what way do you think that makes it an abnormal hedge?
- jordanb 17y ago
  It eliminates the legitimate justification for a hedge. The argument behind hedging is that it's like taking out insurance: it allows you to take a position that you'd like to be in (invest in a home, for instance) but that you would otherwise find too risky. What they were doing, essentially, was buying a house and insisting that it be built on an unstable foundation, in a tornado zone, with substandard wiring and a garage piled with oily rags, in the hope that it'll get destroyed and they can collect the insurance.
  - byrneseyeview 17y ago
    A hedge fund isn't supposed to hedge away all returns. The hedged part means that they buy and sell similar assets whose prices reveal discrepancies. In this case, there was a discrepancy between the return of the equity slice of CDOs (very high, implying a high default risk) and the cost of insuring the debt portions of CDOs (very low, implying a low default risk). Magnetar basically said "Okay, the risk is probably not as high as the equity guys think. And not as low as the debt guys think. Why don't we buy from the equity-holding pessimists, sell to the debt-holding optimists, and pocket the difference?" And they bought, sold, and pocketed. If you're going to be outraged, pick one: Did they profit from the misery of others by selling short? Then they had to be net sellers, which decreased prices and made the bubble smaller. Or did they needlessly fuel a speculative bubble? In that case, they had to be net buyers, which would make them net losers. Since Magnetar was long volatility (returns will either be way better or way worse than investors expect), this complicates things. But they basically made money from being right, while their counterparties lost money for being wrong. As long as everyone goes into these transactions with the same information, that's the only way fools and their money are parted.
    - jordanb 17y ago
      The article asserts that Magnetar was net short on the CDOs, although the This American Life episode makes that more clear than the linked article does. They can't prove that Magnetar was net short, because that information isn't pubically available. But their evidence was that Magentar was pressuring the banks who were creating the CDOs into building them out of unusually risky assets. They have emails from a deal that fell apart because the bank refused to bundle in the assets that Magnetar wanted. > Did they profit from the misery of others by selling short? Then they had to be net sellers, which decreased prices and made the bubble smaller. Or did they needlessly fuel a speculative bubble? In that case, they had to be net buyers, which would make them net losers. The thing is, Magnetar was only buying the equity position of the CDO. They were then buying insurance against the higher tranches failing. They were sponsoring billion-dollar CDOs with a few million dollar investments in the lowest tranche. They were then buying insurance against the failure of the much larger upper tranches. Without them buying the equity, the CDO wouldn't have been created. The argument is that without Magenatar, the CDOs wouldn't have come into existence (because they wouldn't have had a sponsor willing to buy the equity tranche). Magnetar wanted the CDO to fail as evidenced by its pressure of the banks to include rotten assets. So my analogy stands, they insisted on the construction of a dangerous house so they could collect the insurance.
  - dtby 17y ago
    It eliminates the legitimate justification for a hedge. Not as described by the parent. His problem was that they were creating the financial instruments and the hedges. This is exceedingly common. I'll leave the moral outrage portion of your post alone with hopes that you already know how you vastly oversimplified simply by ignoring counterparties.