Confidence Game - Christine Richard [135]
FOR DECADES, BOND INSURANCE had eased the sale of municipal bonds. Now it had turned toxic.
In the early 1990s, James Angel, a finance professor at Georgetown University, had set out to determine exactly what it was that bond insurers provided to the municipal bond market. On the surface, the business didn’t make any sense, Angel posited in his paper titled “The Municipal Bond Insurance Riddle.”
Angel determined that insurers weren’t being paid for enhancing the credit quality of the bond, which was strong to begin with. Instead, investors were paying for what banker Mark Northcross termed the “Good Housekeeping Seal of Approval.” That seal turned bonds issued by large cities and small towns into a commodity. Investors didn’t need to look beyond the rating and try to decipher the credit quality of a Mississippi sewer authority or a Michigan school district. The bond was simply a triple-A-rated municipal bond, an anonymous security for which a broker could instantaneously find a buyer.
Yet bond insurers never promised to provide liquidity. They were protecting investors against default and that’s something very different. The liquidity support provided by bond insurers turned out to be a house of mirrors. As long as the securities were rated triple-A and insured, investors would buy them. As long as investors bought the securities, the banks could claim they stood ready to back the market. But when confidence in the triple-A ratings of the bond insurers crumbled, demand for the securities disappeared. The banks could have supported individual issues, but they couldn’t make up for a loss of demand across the entire market.
“Reports of five more failed auctions at Piper Jaffray,” a trader at UBS e-mailed colleagues during the first week of February. Later, someone else at UBS passed along this piece of news: “Just heard . . . Goldman Sachs let a Sallie Mae deal fail.” On February 13, the day before Congress took up the question of what to do with bond insurers, the auction-rate market collapsed.
CONGRESS COULD NOT HAVE selected a more ironic date—Valentine’s Day—to bring together Bill Ackman, the top executives of MBIA and Ambac, and the credit-rating analyst. MBIA executives were furious about Ackman’s inclusion in the hearings as an “industry expert.”
“Mr. Ackman is in fact not involved in the industry in any capacity except that of a short-seller, and accordingly, MBIA questions the characterization of Mr. Ackman’s expertise,” MBIA’s chief financial officer Chuck Chaplin said in his prepared testimony.
The hearings fueled additional controversy. Shortly after midnight, as Valentine’s Day began, Eliot Spitzer left room 871 at the Mayflower Hotel. He had come to Washington to testify about the crisis in the bond-insurance business and about how the state of New York planned to intervene. But the trip would be remembered instead for the disgraceful episode that would end his public career. The arrangements for his rendezvous with a high-priced call girl had been captured by an FBI wiretap.
A thin layer of snow swirled through the streets of Washington, DC, as the start of the 11 a.m. hearing approached. Auctions continued to fail across the market, including a $74 million offering for the District of Columbia’s water and sewer authority, which was insured by Ambac.
Spitzer was first to testify and made clear that the banks had little time to act. “The clock is ticking, and as we move forward, we are seeing real harm not only to investors and governments but to the capital markets, and therefore it is time for