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Emails Give Glimpse Into Deals That Fueled Financial Meltdown

Jesse Eisinger
Propublica / News Report
Published: Tuesday 7 August 2012
Recently collected emails from bankers and a Magnetar executive involved in some of the deals appear to shed new light on how they helped fuel the crash of 2008.
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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."

How can it be legal to sell a

How can it be legal to sell a product falsely labled as AAA, then bet against the product knowing it will fail?

It's pretty clear to us. But,

It's pretty clear to us. But, as I said, the masses are unaware of what actually transpired.

The President, congress and the media continue to act as if the banks are perfectly respectable.

For some reason, our society,

For some reason, our society, our government has decided that white collar crime doesn't warrant the same level of punishment as smoking a joint.

Where is the shame? Why aren't these guys prosecuted and put in jail? Or at least held in disrepute by their friends and colleagues and fined so severely that their assets are forfit?

We need to stop tolerating criminal activity amongst the affluent as those it is a different circumstance. Actually, it is. Robbing a convenience store is tramatic for the people directly involved. Fraud and collapse of the entire financial system affects hundreds of thousands of people. The punishment should be proportional.

(And why, if Journalists can find these emails, cannot the government use them to stop these practices?)

The DOJ and the SEC know all

The DOJ and the SEC know all about these e-mails. Where is the shame? Most people don't even know about the outrageous behavior that caused the worldwide economic crash.

The media makes certain the masses don't know about it. That is now job one for the media. Step out of line and your job is over.

The media frames every discussion to favor the corporate (Wall Street) message. They are still pushing the meme that irresponsible borrowers are to blame. Obama himself even partially bolsters this meme, that there is "blame on both sides".

But there isn't blame on both sides. This was criminality on the part of the banks, pure and simple.

Those responsible should

Those responsible should spend time in prison. Real prison. And they should have their assets seized. Assets like exotic sports cars and palatial summer homes. Things that working people don't even dream of as they work themselves to exhaustion and early death.

Are you with me, people?

To hold Obama responsible is

To hold Obama responsible is ludicrous, after watching 8 years of Bush mismanagement and lying! With only the first two years of his term supported by a Congress and the last two years fighting the Republicans stand of " NO's" to everything from Obama or Democrats, this is especially true. So, where were the Republicans on this issue and why were THEY not going after prosecution? Perhaps it is because of the ties so many on Congress-but especially the Republicans-who have been 'bought' by these same corporations with campaign donations.

However, it is still the responsibility of CONGRESS-regardless of who controls it, to investigate with government agencies, bring charges against the parties responsible and send those charges when upheld, to correct authorities for prosecution. Yes, the RICO ACT should be enforced. It is NOT the job of the president, regardless of who it is.

And it is up to the public to DEMAND this if it is NOT taken up by Congress. So where is the public outcry here, except among the Occupy Wall Street Movement? Haven't heard it from the Tea Party.....their anger has been turned, instead (by rush, Rove, Norquist and Fox) toward the government!

Dear Anniemo, Stop excusing

Dear Anniemo,

Stop excusing Obama on this issue. He is just as bad if not even worse than Bush. he promised to protect the whistle blowers, instead he prosecuted more of them than any president.

It does not take a PhD in psychology or criminology to know that if a criminal knows they can commit crimes with impunity, they will keep committing them. Our economy will not heal until fraud is prosecuted.

During the Savings and Loan crisis, there were thousands of successful felony convictions for those involved in the fraud and it was only 1/70 the size of the 2008 crash. . Instead the Obama administration has prosecuted no top Wall St official. Why is this? Because they own him!

So in this [so called] election we have a choice between Romney who is Wall St, or Obama who is a tool of Wall Street. Some choice. Sounds a lot like the old Soviet Union to me where you had your choice of any candidate as long as they approved by the Politburo, only our Politburo is the ruling class. As long as we keep voting for the lesser of 2 evils, the evil will remain.

Personally I am taking serious looks at the 3rd party candidates. I would rather vote for something I want and not get it, rather than vote for something I don't want and to get it.

Dear end the illusion, I

Dear end the illusion,
I too am voting for 3rd party candidate Rocky Anderson. The Obama voting record is more Repub. than Dem. Both choices are disgusting. I won't stoop that low for my own piece of mind that I am not contributing to this horrible choice of so called "leaders".

What a shame - actually I

What a shame - actually I think its criminal - that a foreign bank has to sue some of the US banks ( or international banks that operated here) that bankrupted this nation and nearly the world, yet the government of this country does not have the balls to bring charges against them.

Sliced and diced fraudulent

Sliced and diced fraudulent AAA-rated subprime morgage backed collaterized debt obligations referred to as "Shitty Product" in Goldman Sachs' internal e-mail which were sold as investment grade treasure when they were knowingly worthless trash constitutes the crimes of megafraud, deceptive business practices, theft by deception, racketeering, criminal conspiracy, etc.

Ill-gotten gains should be seized under RICO forfeiture laws and the thieves should be imprisoned for the rest of their lives.

Obama's "Savvy Businessmen" buddies are actually thieves, conmen, scam artists, and common criminals. He refuses to look back and criminally prosecute. He and Holder must go for aiding and abetting this megafraud and racketeeting after the fact.

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