Confidence Game - Christine Richard [107]
This was the trade Ackman had asked Warren Buffett about at the 2003 Berkshire Hathaway annual meeting, the transaction that Buffett had warned would bring out the brokers “with their fins showing.”
Then Chaplin touched on a topic that equity analysts watched very closely. MBIA had halted its buyback plan. “Going into a period of uncertainty, we think it’s critical for our balance-sheet strength to be unquestioned,” Chaplin explained. Within minutes, the stock swooned.
As the call drew to a close, the questions became more accusatory. “Are you saying that the mark-to-markets here are irrelevant because the markets are wrong?” one caller asked. “Because so far this year, the markets have been more than right, and the rating agencies have been totally wrong on virtually everything.”
The logic of the entire bond-insurance business was under fire. “Why would someone have wrapped these portions of the portfolios? The point of insurance is to protect yourself from losses. It seems that there is no instance that you could have a loss. That’s what MBIA seems to be telling us. So why do people buy your product?” a caller asked.
“What we are providing is protection against remote losses,” Chaplin replied. “That’s an important part of our business model, and there has been ongoing demand for protection against those remote losses at least going back over the 34-year history of our company.”
“Okay, if it’s based on remote losses and your model goes back 34 years, have you ever seen a housing market like this in the last 34 years?” the caller asked. “And what is your definition of remote? I mean, at which level is this a problem? At what point do you start to worry?”
If Chaplin knew where that level was, he didn’t appear eager to share it. “It is possible that as we see the housing market deteriorate that there will be pressure on transactions in our portfolio, and I think I said that pressure could be manifested as losses in the future,” Chaplin said. “We have not seen any to date. That doesn’t mean, given the potential for an unprecedented experience in the housing sector, that there will never be any losses, so it would be unfair to say that we expect that there never will be any loss no matter what happens.”
By the time the call ended, MBIA’s shares had dropped 21 percent. It was the single biggest drop in its share price since the stock market crash in 1987.
During the Gotham investigation four years earlier, the question of MBIA’s CDO losses had generated intense debate. Bill Ackman was asked to justify the dealer estimates he used in his report. To regulators, the gulf between Ackman’s and MBIA’s estimates for the bond insurer’s CDO losses suggested wild exaggeration on Ackman’s part.
“Why is their number $35.5 million and yours comes out to somewhere between $5 [billion] to $7 billion?” an attorney for the Securities and Exchange Commission (SEC) asked Ackman. “That is a big number.”
“Someone is wrong,” Ackman said. “That is the answer.”
Someone was clearly wrong in the fall of 2007. This time, however, it wasn’t so easy to say that MBIA’s critics—or those skeptical of Merrill Lynch’s or Citigroup’s numbers—were the ones exaggerating.
By October 30, credit-default-swap (CDS) premiums on MBIA Inc. were bid at 250 basis points, meaning it cost $250,000 to buy protection against default on $10 million of MBIA Inc. debt. The next day it cost $295,000; by November 1, it jumped to $345,000. “The problem now is that investors fear the relationship between the rating agencies and the guarantors is so incestuous that the rating agencies cannot issue downgrades without implicitly conceding that their proprietary capital models are flawed,” wrote Kathy Shanley, an analyst with the research firm Gimme Credit.
By November 2, CDS rates jumped to $470,000; one day later, the cost stood at $510,000. “As the credit market continues to weaken, our confidence that guarantors will survive