Confidence Game - Christine Richard [115]
Without Ackman present, Mick McGuire and Scott Ferguson, analysts on Pershing’s investment team, answered questions from the board. There was no doubt Pershing’s current investment thesis on MBIA was working, and no one at the firm saw the Warburg investment as an indication that Ackman’s analysis was wrong. Still, unexpected things had begun to happen, and that worried the group. “It didn’t make sense that smart investors would do the work of analyzing MBIA and then invest,” said McGuire. “If one smart investor could make a mistake, others might, too.”
The MBIA position had taken Ackman years to build, buying $10 million blocks of protection day after day. The lowest price he agreed to pay in premiums was 13 basis points, or $13,000 a year, and the highest was 700 basis points, or $700,000 a year. Most of the position was bought for less than 60 basis points. With MBIA 5-year credit-default swaps trading at around 450 basis points, there was a strong argument for taking profits.
In very round numbers, an investor buying protection on $4 billion of MBIA debt on the day the company announced its regulatory investigation in January 2007 would have agreed to pay $6.4 million a year for the protection. By the middle of December 2007, the same protection would cost $180 million a year. The value of the investment had increased by nearly 30 times. Of course, if MBIA filed for bankruptcy, the holder of those contracts stood to receive as much as $4 billion, or 600 times the annual cost of the insurance.
Might MBIA still blow up? Sure. But that was only part of the picture. “There is a real risk in using an outcome to validate a decision process,” McGuire said. For Ackman to insist on staying with the position, satisfied with nothing less than seeing the company file for bankruptcy, would be a mistake.
“The staff was impatient with Bill. They wanted him to get out of the position even when it seemed he was winning,” Peretz remembers. It wasn’t said directly, but you could sense their thinking: “You’ve proved your point; get out while you can.”
Of course, Ackman hadn’t yet proved his point because MBIA was still in business.
Pershing’s position—largely in credit-default swaps—created its own issues. The CDS market can be very illiquid and tends to get one-sided very easily, McGuire explained. On a day when there’s bad news about a company, everyone wants to buy protection, and when the news is good, everyone’s looking to sell. The market gaps hugely at such times and creates a real psychological barrier to closing out a position, McGuire said. It forces one to sell the position into bad news, even though that’s when the investment thesis is proving itself out.
When prices were swinging that wildly, it was hard not to have regrets. The investment team would steel itself at those moments when the market moved dramatically against it. The frustration boiled over if someone mentioned it.
“We should have sold there.”
“No shit.”
“It was better just not to talk about it,” says McGuire, remembering the tension.
Peretz sensed the investment team’s frustration. “You could see their exhaustion with it, almost a visceral discontent.” He suspected what they were thinking: “This is Bill’s mishigas,” the Yiddish word for craziness.
When Ackman met with the advisory board to give his views on the MBIA position, he repeated what he’d been telling investors for years. Despite the 30-fold rise in the value of MBIA CDS contracts, he remained convinced that Pershing Square should continue to hold its short position: “I have never seen such a good risk-reward opportunity in my entire career.”
MEANWHILE, DOWNGRADES of subprime-mortgage securities continued to cascade through the structured finance market. By the middle of December, Standard & Poor’s (S&P) had downgraded or placed under review $57 billion of CDOs. Moody’s had cut the