Hmmmm, what did the cat drag in today?

U.S. regulators notified a former JPMorgan Chase & Co. (JPM) executive whose unit packaged mortgage- linked investments that he may be sued for his role in selling the securities as the housing crisis worsened in 2007.

Oops.

The issue apparently revolves around the 2007 "Squared" CDO, which (amusingly similar to the previous Goldman case) allegedly had Magnetar helping select assets for the deal.

Magnetar, of course, is accused of possibly being short parts of the transaction (the presumption is that they were net short, but the story does not say - it says they may have bought some of the most-junior pieces, which one would presume would be the equity tranche.)

Squared was sold in April 2007, with GSC Group serving as the CDO’s manager and JPMorgan underwriting the deal, according to data compiled by Bloomberg. Its collateral consisted partly of other CDOs tied to bonds backed by assets such as mortgages, with the initial holdings including credit-default swaps referencing $968 million of those CDOs, according to an offering document. CDOs backed by other CDOs were commonly referred to as “CDOs squared.” Squared went into default the following January.

You have to love these deals.  Leverage upon leverage, all synthetic.  There's nothing "real" about any part of them - someone is going to get hosed, because the guy who's short is responsible to pay the coupon, and the guy who's long gets the coupon (less the bank's profit from skimming in the middle, of course.)

The problem with these sorts of deals is that due to their leverage very small differences in performance turn into huge changes in the outcome.  This, in turn, makes fair and full disclosure of how assets were selected, who did the selecting and what their interest in the deal was from the outset critical in trying to analyze whether such a thing is an "investment" (really a gambling construct) you want to get involved in.

Evanston, Illinois-based Magnetar told investors in an April 2010 letter that it didn’t help banks create CDOs that were “built to fail” on a bet that homeowners with bad credit would default on their loans. The firm offered limited input on the creation of CDOs, and made bets that would pay off if they soured as part of a “market neutral” portfolio designed to profit no matter what happened, Magnetar said in the letter.

Oh that's clever.  A no-lose scenario?  Hmmmm... ok, who got the "had to lose" end of that stick, and did they know they were getting it?  Derivatives are like that - if someone wins, someone else loses.

I guess we'll find out in the fullness of time.