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The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going

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  • Bernstein, Jake
  • Eisinger, Jesse
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    Abstract

    In late 2005, the booming U.S. housing market seemed to be slowing. The Federal Reserve had begun raising interest rates. Subprime mortgage company shares were falling. Investors began to balk at buying complex mortgage securities. The housing bubble, which had propelled a historic growth in home prices, seemed poised to deflate. And if it had, the great financial crisis of 2008, which produced the Great Recession of 2008-09, might have come sooner and been less severe. At just that moment, a few savvy financial engineers at a suburban Chicago hedge fund helped revive the Wall Street money machine, spawning billions of dollars of securities ultimately backed by home mortgages. When the crash came, nearly all of these securities became worthless, a loss of an estimated $40 billion paid by investors, the investment banks who helped bring them into the world, and, eventually, American taxpayers. Yet the hedge fund, named Magnetar for the super-magnetic field created by the last moments of a dying star, earned outsized returns in the year the financial crisis began. How Magnetar pulled this off is one of the untold stories of the meltdown. Only a small group of Wall Street insiders was privy to what became known as the Magnetar Trade. Nearly all of those approached by ProPublica declined to talk on the record, fearing their careers would be hurt if they spoke publicly. But interviews with participants, e-mails, thousands of pages of documents and details about the securities that until now have not been publicly disclosed shed light on an arcane, secretive corner of Wall Street.

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    Bibliographic Info

    Paper provided by Regulation2point0 in its series Working paper with number 569.

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    Date of creation: Apr 2010
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    Handle: RePEc:reg:wpaper:569

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    Cited by:
    1. Jan Kregel, 2011. "Will restricting proprietary trading and stricter derivatives regulation make the US financial system more stable?," PSL Quarterly Review, Economia civile, vol. 64(258), pages 227-247.
    2. Levitin, Adam & Wachter, Susan, 2012. "Explaining the Housing Bubble," MPRA Paper 41920, University Library of Munich, Germany.
    3. Mählmann, Thomas, 2013. "Hedge funds, CDOs and the financial crisis: An empirical investigation of the “Magnetar trade”," Journal of Banking & Finance, Elsevier, vol. 37(2), pages 537-548.

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