Confidence Game - Christine Richard [105]
For years, Wall Street had been expanding this market, using it to finance all types of loans—including high-risk subprime mortgages. The key had been to diversify the risk, to elevate the ratings to the highest-possible level and wipe away any perception of risk. But investors now feared the $1.5 trillion market was contaminated. Subprime and CDOs had turned the ABCP market into a field strewn with land mines. Investors tiptoed toward the fringes, hoping their commercial paper matured without a problem. Once they were out, they stayed out, leaving no one to provide funding for more than a trillion dollars of mortgages, credit card balances, and auto loans.
Some market commentators later pointed to August 9 as the official beginning of the credit crisis, the point at which isolated problems turned into systemic failure. The next day, central banks around the world coordinated a massive intervention for the first time since the September 11, 2001, terrorist attacks. The U.S. Federal Reserve System added $43 billion to the banking system, the European Central Bank flooded the interbank market with $215 billion, and the Bank of Japan added $8.4 billion.
On August 14, 17 Canadian ABCP sellers couldn’t roll over their commercial paper. It appeared the banks had an “out” for providing liquidity support in the event of a market disruption. They decided that what was happening qualified as a market disruption. Simon Adamson, an analyst with CreditSights in London, told Bloomberg News that the situation was developing “a frightening momentum.”
Ackman wrote to Pershing Square investors the same day: “In 2006, our short position in MBIA’s stock and our investment in credit-default swaps were a source of significant mark-to-market losses,” Ackman said. “We have more than recouped our previous mark-to-market losses on this investment.” Investors seeking to protect $10 million of MBIA debt against default for five years would have agreed to pay $16,000 a year in premiums on the day MBIA announced its settlement with regulators in January. That same insurance now cost $250,000 a year. “We believe that we are still in the early innings,” Ackman wrote.
As the summer drew to a close, Ackman attended the U.S. Open as a guest of JP Morgan. He made his way through the crowd at the Arthur Ashe Stadium in Flushing Meadows to the bank’s court-side suite. Inside, JP Morgan CEO Jamie Dimon and his wife chatted with guests. Dimon shook Ackman’s hand and mentioned that he’d seen the “Who’s Holding the Bag?” presentation. “Very interesting,” he told Ackman.
Guests milled around the open bar and dug into a buffet of filet mignon and Caesar salad. Several people gathered in front of the plate glass window to watch the action below. The event, a favorite entertainment venue for Wall Street clients, was packed. For all the problems in the credit markets, stocks were still on the way up and wouldn’t peak until October 9, 2007, when the Dow Jones Industrial Average would hit an all-time high of 14,164.
By the end of August 2007, the collapse of Wall Street was nevertheless well under way. The financial system was breaking down in places unfamiliar even to those who worked on Wall Street: the asset-backed commercial paper market and the world of off-balance-sheet entities like SIVs. It deteriorated as investors struggled with how to price billions of dollars of super-senior CDOs and as investors came to realize that sometimes it isn’t good enough to be 99.99 percent certain about the future.
“Make sure you don’t have any bond-insurer exposure,” Ackman told Dimon as the matches played on.
Chapter Eighteen
Parting the Curtain
As the credit market continues to weaken, our confidence that guarantors will survive the credit meltdown is waning.
—KEN ZERBE, MORGAN STANLEY ANALYST, NOVEMBER 2007
IF ONE WERE to pinpoint the day when faith in the bond insurers was irreparably undermined, it would probably be October 25, 2007. That was the day MBIA reported the second quarterly loss in its history. It had taken