Confidence Game - Christine Richard [156]
“In the case of MBIA, I think it is very unlikely that they will actually default because it’s not in their interest to do that,” Thain replied. “I think they will simply go into a runoff mode, and they will simply keep collecting their payments and making their payments and they’ll live for years and years and years and years.”
That would be the best outcome—if they could outrun the reality and wait for the economy to turn and for people to start making their mortgage payments again. But the crisis was coming anyway—for MBIA, for Merrill Lynch and John Thain, and for everyone else.
Epilogue
The bond-insurance industry was destroyed from within.
—JACK BUTLER, MBIA FOUNDER, 2009
IN THE WEEKS AFTER ACA Capital tore up billions of credit-default-swap (CDS) contracts, the stock market traded sideways and analysts were quoted saying “the worst is behind us,” as disaster approached.
On September 7, Fannie Mae and Freddie Mac were placed into government conservatorship. Then during the second weekend in September, some of the largest financial institutions in the United States toppled like dominoes. On September 15, Bank of America bought Merrill Lynch & Company as confidence in the broker evaporated. Lehman Brothers, after a failed search for a white knight, filed for bankruptcy protection. The following day, the Federal Reserve Bank of New York announced it would lend $85 billion to American International Group (AIG).
AIG had been downgraded, triggering a requirement for its AIG Financial Products unit to post billions of dollars of collateral on credit-default swaps written on collateralized-debt obligations (CDOs). AIG Financial Products, like the bond insurers, was a business built on the belief that the company would always have a high rating.
The events ignited another backlash against short sellers. The Securities and Exchange Commission temporarily banned short sales of some 800 financial companies’ shares.
On January 22, 2009, Pershing Square held its annual dinner at the New York Public Library. Investors ascended the floodlit steps past the stone lions with a dusting of snow on their heads. Bill Ackman’s fund had been in business for five years, and 2008 had been its first down year. But the crowd was cheerful. Pershing’s main fund fell 11 percent, not bad given that the stock market was down 40 percent.
Losses in the main funds on retailers such as Target Corporation and Borders Group Incorporated were offset by gains on short positions in MBIA and FSA, Ackman explained. MBIA had been “the gift that keeps on giving,” but not any longer. Ackman told the group that he had closed out the MBIA position at the end of 2008 after nearly seven years. “It’s the end of an era,” Ackman said and moved on to the next slide.
Ackman’s short position on MBIA had been his highest-returning investment to date. Pershing Square investors made about $1.1 billion as faith in the bond insurer collapsed. As the managing partner with the largest stake in the fund, Ackman received the largest share of those gains, around $140 million. He didn’t actually pocket any of it, though. The gains offset losses elsewhere in the fund during 2008. Yet Ackman figures he owes the Pershing Square Foundation the full $140 million. He has given the foundation $50 million and expects over time to pay the $90 million balance as future profits cover 2008’s losses.
Gotham Credit Partners, the small fund set up exclusively to short MBIA in the credit-default-swap market back in 2002, was wound down at the end of 2008. Those who didn’t add to their investment over time lost most of their money as MBIA CDS contracts expired with no worth. Those who continued to bet with Ackman and kept putting more money into the fund made multiples of their investment.
As the dinner ended, guests dispersed into the evening. Lights from the party illuminated the facade of the library’s east wing and the words carved into it: “But Above All Things, Truth Beareth Away the Victory.” With the stock market falling, Wall Street in tatters,