Confidence Game - Christine Richard [117]
Zerbe’s recommendation was to avoid the bond insurers as a sector until it was possible to get a better understanding of the losses they would take on CDOs and other mortgage securities.
David Einhorn at Greenlight Capital spotted Zerbe’s report around midnight and passed it along to Ackman and others. The subject line read, “What is that under the rug?”
“We had originally questioned how Moody’s and S&P could have taken a more negative view of MBIA than Ambac, given our analysis suggested Ambac had a more risky portfolio,” the Morgan Stanley report continued. “Now we know. MBIA simply did not disclose arguably the riskiest parts of its CDO portfolio to investors: $8.1 billion of CDO squareds.”
Whitney Tilson, at T2 Partners, had received the report as well and messaged Ackman a little after 7 a.m. “Stop the presses! An analyst with a spine, holding a management team’s feet to the fire! I think this is a first!”
At 8:11 a.m., Erika Kreyssig on Pershing Square’s trading desk messaged Ackman to tell him that CDS contracts on MBIA Inc. had widened 105 basis points as word of the report got around. The contracts were now bid at 580 basis points, indicating that it cost $580,000 a year to protect $10 million of debt against default. “We bought $25 million at 570 basis points,” she wrote. “Really tough to get offers. Got lucky with that one.”
MBIA’s shares plunged. More than 50 million shares traded that day, by far the highest-volume day in the company’s history. After the market closed, MBIA released a statement saying that it hadn’t broken out the numbers before because these complex CDOs had less than 25 percent of their collateral in subprime mortgages.
Investors and analysts took little comfort in the statement. “Happy Holidays,” GimmeCredit analyst Kathy Shanley wrote later that day. MBIA “found one more present for investors tucked away in the back of its closet. Just what you always wanted and just your size too—$8.1 billion of CDO squareds.”
Wall Street’s clever packaging and repackaging of debt was now seen as a scam. “To keep the music playing required increasingly egregious excesses—ever greater quantities of increasingly risky loans, structures, and leveraging,” Doug Noland, a credit analyst with David W. Tice & Associates, wrote the day after MBIA disclosed its CDO-squared exposure. The bond insurers had both abetted the process and been duped by it. “The credit insurers destroyed themselves,” Noland concluded.
Chapter Twenty
The Panic Begins
When this story hits the newspaper, the headline is going to be “How Wall Street Ate Main Street.”
—ERIC DINALLO, NEW YORK STATE INSURANCE SUPERINTENDENT, JANUARY 2008
BY JANUARY 2008, the bond insurers were up against a tight deadline. They had less than a month to raise billions of dollars of capital to preserve their triple-A ratings. Yet the entire business model was being questioned. The companies’ share prices had collapsed. Credit-default-swap (CDS) contracts on MBIA and Ambac, the industry leaders, were priced at levels that suggested investors believed the companies faced a good chance of filing for bankruptcy. “The clock is ticking for all these companies,” Robert Haines, an analyst with CreditSights Incorporated, a bond-research firm in New York, said.
During the first week of January, Bill Ackman got an e-mail from a Harvard Business School classmate. Fiachra O’Driscoll, then the managing director of Synthetic CDO Trading at Credit Suisse. He had been watching the situation with the bond insurers with interest. “Was wondering if you would have 15 minutes for a chat about potential outcomes,” O’Driscoll wrote.
A few days later, O’Driscoll arrived at Pershing Square’s offices with a stack of printouts. The Credit Suisse group had come up with a model for predicting for how much MBIA and Ambac would lose on mortgage-backed securities and collateralized-debt