Goldman Sachs Executive Vice Officer David Viniar just explained to Senator Coburn that "without the shorts you wouldn't have the longs, and there would be a lot less credit out there". They seemed to agree that this would have been a bad thing, but this was exactly Yves Smith's point not long ago, that the structure of these shorts on the housing market were central to the ponzi finance scheme that kept inflating the bubble. The availability of triple shit rated mortgage debt would have dried up sooner and the housing bubble would have deflated sooner were it not for these butterfly trades, and the resulting crisis and damage to the economy that much smaller.
By buying the risky bottom slices of CDOs, Magnetar didn't just help create more CDOs it could bet against. Since it owned a small slice of the CDO, Magnetar also received regular payments as its investments threw off income.
With this, Magnetar solved a conundrum of those who bet against the market. An investor might be confident that things are heading south, but not know when. While the investor waits, it costs money to keep the bet going. Many a short seller has run out of cash at the gates of a big payday.
Magnetar could keep money flowing -- via its small investments in CDOs -- and could use that money to pay for its bets against CDOs.
Similar, commonly traded, assets appeared in multiple Magnetar CDOs. Experts say the benefit of that overlap to Magnetar was that when the hedge fund bet against non-Magnetar CDOs, the CDOs still had similar characteristics to the ones Magnetar had invested in.
Soon enough, bankers and CDO managers had a sense of how it worked. "Everyone knew," said one person who managed Magnetar CDOs. "They used the equity to fund the shorts."