Confidence Game - Christine Richard [118]
The traders had looked at how a sample of 1,200 securities backed by the bond insurers would perform under various housing market scenarios. Then they used the performance of various types of securities to predict how thousands of other, similar securities that the bond insurers had exposure to would perform.
When Credit Suisse forecast a 10 percent decline in home prices in year one, a 10 percent drop in year two, and no change in prices in year three, the results for the bond insurers were devastating. And the problems weren’t just with subprime mortgage-backed securities or CDOs. Securities backed by adjustable-rate, Alt-A mortgages originated in the first half of 2007 were projected to be nearly wiped out. The lowest-rated double-B tranches were a 100 percent loss, and the triple-Bs were a 99.75 percent loss. Even the triple-As were expected to lose more than 40 percent.
The presentation gave Ackman an idea. If he could make the Credit Suisse model available to the public, investors could input their own forecasts and make their own decisions about the fate of bond insurers. O’Driscoll agreed to the idea.
ON JANUARY 9, 2008, MBIA said it would cut its dividend and sell $1 billion in so-called surplus notes through its insurance company, to raise capital and secure its triple-A rating. The company had to move quickly. Conditions had worsened. MBIA preannounced some of its numbers for the fourth quarter, setting aside nearly $800 million to pay claims on home-equity-loan-backed securities just one month after saying it didn’t expect to take any losses on home-loan-backed securities. The company also expected to pay about $200 million on CDOs. The mark-to-market losses on CDOs for the fourth quarter increased by another $3.3 billion.
As MBIA’s underwriters marketed the notes, it was clear investors were nervous. Early price talk on the bonds suggested investors wanted a yield of 12 percent to 15 percent, the type of return demanded from a distressed borrower.
Ackman wasn’t helping matters. On January 10, he appeared on Bloomberg Television to talk about MBIA and the surplus note offering. He warned that investors should think very carefully about buying MBIA’s surplus notes. The New York state insurance superintendent must approve every payment on the notes. Given the mounting losses at MBIA, Ackman didn’t believe a single payment should be allowed. “The superintendent will take the money in, but he’s not going to let money go out of the system,” Ackman said. Even with the Warburg Pincus investment in MBIA and the proceeds from the surplus note offering, “the amount of capital required here is vastly in excess of the capital MBIA is trying to raise,” Ackman said.
MBIA’s future was bleak, Ackman insisted: Neither MBIA nor Ambac would write another municipal bond policy in the future, he predicted. Furthermore, unless it raised additional cash, MBIA Inc., the holding company of the insurer, would be out of cash by the end of the year. “We have a bigger short position than we did two weeks ago,” he told viewers. “Almost every week, we’ve increased our position here.”
MBIA sold the notes the next day, January 11, with a 14 percent yield. A month later, Warren Buffett commented on the transaction: “When a company issues a 14 percent bond when U.S. Treasuries are below 4 percent and it’s rated triple-A, we’ve now seen the cow jumping over the moon.” Among those snapping up the high-yielding securities was Marty Whitman of Third Avenue Management LLC, who had recently disclosed that his fund owned 10 percent of MBIA’s common stock.
Nearly everyone—with the exception of the short sellers—was happy to see MBIA pull off the deal. “It’s good news for the company, good news for the bond-insurance sector, and good news for the credit markets,” Kevin Murphy, a fixed-income portfolio manager at Putnam Investments in Boston, told Bloomberg News.
LESS THAN A WEEK LATER, on January 16, Ambac announced its plans to fend off a credit-rating downgrade. It also preannounced disastrous