Confidence Game - Christine Richard [127]
The credit-rating companies and bond insurers mistakenly assumed that even more diversification was created when mortgage-backed securities were pooled into CDOs. Yet the CDOs were backed by securities all created around the same time, containing mortgages that all originated around the same time. The CDOs perfectly captured the risk that had spread across the housing market of inflated home values and borrowers lying to get into mortgages they couldn’t afford. The risk only appeared to have been shattered by the securitization process. In fact, it was lethally concentrated.
AT 4:02 A.M. ON JANUARY 30, 2008, Ackman e-mailed more questions to O’Driscoll and his team at Credit Suisse who had been working all night to make sure the data were complete. Before the market opened that day, Ackman gave the model’s predictions to Charlie Gasparino, a reporter at CNBC, who announced them on air. Shortly after, Ackman issued a press release describing the model. “Up until this point in time, the market and the regulators have had to rely on the bond insurers and the rating agencies to calculate their own losses in what we deem a self-graded exam,” Ackman said in a statement. “Now the market will have the opportunity to do its own analysis.”
Ackman’s letter, also released to regulators, included a description of how to find the model on the Internet. “By focusing the discussion on a fundamental, data-driven approach, we expect that the dissemination of the Open Source Model will enable market participants and regulators to accurately estimate probable losses by relying on rigorous fundamental analysis of specific credit exposures, a departure from relying on the opaque, faith-based pronouncements that the bond-insurance industry has promulgated to the marketplace,” Ackman wrote.
Pershing Square’s description of the bond insurers’ CDO business made it sound like a veritable Russian doll of risk, with CDOs nested inside CDOs nested inside CDOs. “Users of the model can drill down multiple layers to identify and analyze individual credits of not just the outer CDOs but also those exposures of the CDOs owned by outer CDOs (that is, ‘inner CDOs’) and further to identify the specific exposures of the ‘inner-inner CDOs’ owned by those inner CDOs that are, in turn, owned by the outer CDOs that have been guaranteed by MBIA and Ambac.”
As traders, analysts, hedge fund managers, and reporters pulled up the model, it began crashing computers across Wall Street. “This model is quite large, approximately 110Mb. Each recalculation of this model on a typical workstation—3.4GHz Dual Core Pentium D with 3Gb of 800 MHz FSB DDR2 RAM—benchmarks at 25-30 minutes,” the Pershing Square letter warned in a footnote.
Ackman argued that regulators should stop the bond insurers from paying further dividends to their holding companies because management was underestimating expected claims and thus overstating statutory capital levels. “One would expect management to estimate losses at a level which allows the insurance subsidiary to pay holding-company dividends,” Ackman continued. “Rarely is a man willing to sign his own death warrant.”
DAN LOEB, THE FOUNDER of hedge fund Third Point LLC, who had watched the MBIA saga for years, logged on to Amazon.com and ordered a book for Ackman. Loeb is well known for penning his own sharply worded letters to the management of companies in which he has an investment interest. He is also an avid reader, particularly of stories about heroes, villains, and adventure—books such as Don Quixote and Alexandre Dumas’s The Count of Monte Cristo, the book he bought for Ackman.
The nineteenth-century French novel tells the story of a man known as Dant