Confidence Game - Christine Richard [12]
“In our market, $5 [million] to $10 million is a typical trade, and he was expressing interest in multiple hundreds of millions,” Neumann told the attorneys. “It wasn’t unheard of, but it was unusual. It was our first request for MBIA in that size.”
As Ackman continued to buy, the price rose. At the beginning of 2002, it cost around $35,000 per annum to buy protection on $10 million of MBIA debt. By late summer, the price topped $200,000 a year.
Then, in August, Neumann tapped into a substantial seller. The mystery seller allowed Gotham to increase its position to hundreds of millions of dollars of contracts. This newfound supply of credit-default protection on MBIA also caused the price of buying CDSs on MBIA to fall to around $100,000 per annum and sent a reassuring message to the market about MBIA’s financial health. Ackman suspected that the counterparty on the other side of many of his trades was MBIA. The company later confirmed that it sold CDS contracts on itself.
“Frankly, it’s a very crazy thing to do,” Ackman told attorneys at the Securities and Exchange Commission after the SEC launched an investigation of Gotham several months later.
After all, MBIA was selling protection against its own bankruptcy filing. Who would buy an insurance policy that by definition required the policyholder to collect from a bankrupt company? Wall Street brokers would have agreed to arrange such a transaction only if MBIA put up collateral to make sure that it could pay out in the event of a default.
The real reason MBIA was selling protection on itself, Ackman suggested to regulators, was to drive down the price of its CDS contracts and create an impression of stability. Conversely, the SEC would question whether Gotham was trying to undermine confidence in the company by bidding up the contracts.
“Every once in a while, spreads would go out, and we would step out of the market because we didn’t want to pay these high prices,” Ackman explained to the SEC. “Those are the times we believe they would step in to sell it, so it would come back down, and then we would start nibbling again.”
AMONG THE FIRST PEOPLE Ackman talked to after his meeting with MBIA executives in August was Henny Sender, a reporter at the Wall Street Journal. Ackman spent several months talking to Sender about MBIA’s expansion beyond municipal finance, its off-balance-sheet debt, and the guarantees on CDOs it was writing by the billions. But when Sender’s article appeared in early November 2002, it was as much about Ackman as it was about MBIA.
The market for credit-default swaps could be extremely thin, sources told the Journal, and an investor taking even a small position in a company could easily push the premiums one way or the other. The Journal estimated that Ackman’s $1 billion position against MBIA might have cost as little as $15 million.
“This is a company built on faith,” Ackman told the Journal. “[MBIA] depends on the markets believing that it has the resources to back all its claims.” MBIA’s president, Gary Dunton, along with analysts from Fitch Ratings and Standard & Poor’s, said the credit-default-swap market—and, by extension, Gotham—had it wrong. The company was as secure as it had ever been. The shares fell in response to the article but rebounded the next day.
Disappointed in the Wall Street Journal article, Ackman began to write a research report that would lay out all of his concerns about MBIA. In preparing the report, Ackman approached the New York State Insurance Department (NYSID). His first tip that MBIA’s regulators might have been in over their heads came when he called to set up a meeting with the official responsible for overseeing the financial-guarantee companies. “Auto,” said the person answering the phone. MBIA, with credit-market exposure nearly the size of Citigroup, was overseen out of the same division that regulates insurers that cover fender benders and stolen cars.
Ackman and David