Confidence Game - Christine Richard [33]
The company that MBIA used for pricing its CDOs hired a new data vendor, and suddenly the CDO prices were much lower, CEO Jay Brown explained. “We couldn’t make heads or tails of it,” he added.
MBIA had made some other changes in the wake of the Gotham report, such as providing a more detailed earnings release. “That is not because there’s a lot of new news,” Brown said. “It’s mainly because beginning exactly 90 days ago, when we appeared in the Wall Street Journal with a lot of questions, we’ve had more contact with our investor base and various analysts than we’ve had probably over the past two or three years.”
During the call’s question-and-answer session, analysts had more questions about the mark-to-market losses. “What are you really doing when you mark to market the portfolio?” asked Robert Hottensen from Goldman Sachs. “I’m still a little confused as to the linkage between actual credit losses and the change.”
Brown explained that the company backed certain CDOs using credit-default-swap contracts, a derivative that is required under accounting pronouncement FASB 133 to be marked to market. It is “confusing,” Brown reassured Hottensen. In fact, it’s really quite counterintuitive. The company has to take a loss as the price of CDOs declines and the value of MBIA’s guarantee on those securities consequently increases. The rule ignores the benefit to MBIA, which is able to charge more for its new CDO business, he explained. Meanwhile, the existing book of business is no riskier. “They’re still triple-A and super triple-A,” Brown said.
Not everyone bought that logic. Marco Kheirallah, an investor in Gotham Credit Partners and head of International Equities at Banco USB Pactual in Rio de Janeiro, frequently spoke with Ackman about MBIA. The company’s tendency to muffle any hint of volatility or uncertainty was a warning, he believed.
“Financial schemes are like magic tricks,” Kheirallah says. “They are about making people see what they’re not really seeing.”
IN EARLY 2003, in addition to preparing for upcoming testimony at the attorney general’s office and at the Securities and Exchange Commission, Ackman was working to liquidate Gotham’s holdings. He negotiated the sale of Gotham’s stake in Hallwood Realty Partners to renowned shareholder activist and corporate raider Carl Icahn for $80 a share. As part of the agreement, Ackman and Icahn worked out a “schmuck insurance” arrangement under which Ackman would get half of the profits if Icahn sold his Hallwood stake within 18 months.
When Icahn asked Ackman if he had any other interesting investment ideas, Ackman launched into his argument for shorting MBIA and gave Icahn a copy of the Gotham report Is MBIA Triple-A? Ackman thought Icahn seemed interested.
Even with the investigation hanging over his head, Ackman kept trying to interest people in his MBIA research. “I never did get your thoughts on our report on MBIA,” Ackman wrote to John Rutherfurd at Moody’s. It had been more than a month since Ackman first e-mailed him. “If you remember, you suggested that you would read at least the executive summary.”
Rutherfurd’s response was brief: “Noted,” he wrote. “As mentioned to you, I am not involved in the rating of individual companies, nor will I comment on them.”
Ackman appealed to Rutherfurd to reconsider. This is a “CEO-level issue for Moody’s,” he insisted.
It was a phrase he repeated when he wrote Stephen Joynt, the head of Fitch Ratings, a 15-page letter in March 2003. “MBIA is a CEO-level issue.”
“Clearly, I am not writing to you as simply an unbiased good citizen,” Ackman told Joynt. “Rather, I am writing after having done extensive research and having made investments on which we will profit if my analysis is correct.”
The issues he’d spotted at MBIA needed high-level scrutiny, Ackman insisted. “CDOs are a particular concern, and the confusion and controversy over MBIA accounting for losses on these securities should be a red flag.”
Quoting Warren Buffett, Ackman wrote: “Errors will usually be honest, reflecting only the human tendency to take