Confidence Game - Christine Richard [37]
During his final year of law school, Mitchell worked as a clerk for the New York law firm Caldwell and Raymond, where he was assigned to look into a federal plan to encourage the financing of affordable housing. Mitchell figured investors would balk at buying bonds to finance the construction of affordable housing if those bonds relied on the program’s loans to high-risk homeowners for repayment. But surely those investors would buy the debt if they believed the government stood behind the bonds. Mitchell suggested that federal housing authorities, though not bound to buy the program’s defaulted housing loans, pledge their intention to do so.
Mitchell later applied this concept to all types of debt, advising local governments on how to set up a bond-issuing authority that, in turn, secured a pledge from the government that it “intended” to help pay off the authority’s debt if necessary. The issuance of these bonds didn’t require a vote by local payers because the municipality was not pledging its full faith and credit to the repayment of the bonds.
The securities were dubbed “moral-obligation bonds,” and they made Mitchell a wealthy man by the time he was 30. Municipalities seeking to raise debt beat a path to his door, turning Mitchell into the best-known public-finance lawyer in the country. Mitchell’s innovation changed the public finance markets radically, making it possible for municipalities to issue much more debt. New York Governor Nelson Rockefeller, who used moral-obligation bonds to finance the construction of affordable housing in New York City in the 1960s, called Mitchell’s creation “the greatest system ever invented.” Mitchell’s former law partner, William A. Madison, summed up the moral-obligation concept this way: “It was a—sort of like a gimmick.”
In 1976, the state of New York outlawed the use of moral-obligation bonds after a Moreland Act Commission found the debt had contributed to the state’s fiscal crisis the year before. The commission concluded that the sale of such bonds created “a dangerous and misleading illusion.” It allowed politicians to put a growing and unrecognized burden on taxpayers, according to the report.
In a November 1984 interview in Bond Buyer magazine, four years before Mitchell died, he was asked to respond to critics’ charges that moral-obligation bonds bypass the voters’ right to a referendum on debt issues. His answer: “That’s exactly the purpose of them.”
Brown explained it to Ackman when they met in August 2002. “Public finance is illogical. A moral commitment,” Ackman scrawled in his notes. “Once you get below state level, there is someone who can help out. Feds won’t let a state go broke.”
It was not a topic that interested the investigators.
Waldman asked Ackman to turn to page 23 of Gotham’s report—Is MBIA Triple-A?—referencing the portion of the report that discussed the off-balance-sheet special-purpose vehicle (SPV) called Triple-A One Funding. It quickly became clear that Gotham’s views on Triple-A One were a major focus of the investigation.
Triple-A One was an asset-backed commercial paper (ABCP) issuer set up by MBIA in an obscure but booming corner of the financial markets. It sold commercial paper to risk-averse investors such as money market funds and used the proceeds to purchase securities. Like a bank, Triple-A One borrowed short-term funds and made longer-term investments. Unlike a bank, it wasn’t regulated.
The market for ABCP would top out at around $1.2 trillion in 2007 before plunging by two-thirds as investors questioned for the first time the quality of the assets backing the commercial paper.
Ackman had cracked open the door on Triple-A One in his report. He listed some of the assets held by the SPV. They included mortgage loans to “credit-impaired borrowers