Confidence Game - Christine Richard [123]
But for the banks, canceling the policies would be a disaster. Some hadn’t made the first premium payment, yet they were counting on the insurance to shield them from massive mark-to-market losses.
If the banks could figure out a way to raise $15 billion for the bond insurers, then the companies might be able to hold on to their triple-A credit ratings, Dinallo told them. That would shield the banks from having to raise more capital, and a trillion dollars of municipal bonds would retain their triple-A ratings.
Dinallo had another card to play with the banks. Was it possible that these bankers had bought insurance after they knew the extent of the coming damage? If so, how was that different from the fraud committed by a man who buys life insurance after the doctor tells him he has only months to live? There was a question of culpability, Dinallo explains. If banks saw the crisis coming and constructed and insured securities to offload the damage, then that would be insurance fraud.
As early as late 2006, it was clear to many people that the housing market was set up for a huge fall. At the same time, financial firms such as Citigroup and Merrill Lynch went on a CDO-creating spree.
Hedge fund manager John Paulson, who made billions of dollars for his investors by shorting the ABX Index, a measure of the performance of mortgage securities, told investors in his Paulson Credit Opportunities Fund in early 2008 that as soon as home prices stopped rising, many securities were doomed. “The value of the CDO securities is simply nothing more than the value of the underlying collateral. If the BBB collateral is worthless then the CDO is worthless,” Paulson wrote his investors.
To those knowledgeable about the structured finance market, it would have been clear in early 2007 that BBB-rated securities were in trouble. “The hypocrisy of the CDOs was that mezzanine CDOs, consisting exclusively of BBB collateral, somehow had 70 percent of their capital structure rated AAA,” Paulson wrote. “It is the AAA CDO securities that are causing so much turmoil in the markets as their holders (Merrill Lynch, Morgan Stanley, Citibank, UBS, Wachovia) or their guarantors (Ambac, MBIA, ACA) are forced to write down.”
Now the banks were threatening to consume decades of municipal bond premiums to offset their losses on toxic securities that they had created in a rush to remove subprime mortgages and other risky assets from their balance sheets. “You people created this mess,” Dinallo told the executives. They had to be part of the solution. “When this story hits the newspaper,” he said, “the headline is going to be ‘How Wall Street Ate Main Street.’”
AT PERSHING SQUARE, Shane Dinneen, the most recent hire on the investment team, was assigned the task of spot-checking the Credit Suisse model, which Ackman had dubbed “the Open Source Model,” and put it on the Internet where it would be open to input from users. When Dinneen opened the Excel program which ran the model, the first thing he noticed was that instead of seeing the standard three tabs—one for each linkable spreadsheet—this file had 600.
Dinneen had joined Pershing Square several months earlier after completing a two-year training program with Blackstone Group. He had been “a number cruncher” with the private-equity firm, building spreadsheets to predict postleveraged buyout profit-and-loss statements, balance sheets, and cash flow statements.
Ackman described Dinneen, a graduate of Harvard College, in a letter to investors as “our tall, red-headed