Confidence Game - Christine Richard [38]
Ackman had gone one step further and suggested this off-balance-sheet SPV could cause a run on MBIA.
Waldman asked Ackman to read from his report. “We believe this SPV’s commercial paper creates significant liquidity risk for MBIA,” Ackman read. “In the event of a decline in MBIA’s actual or perceived credit rating, these CP buyers may withdraw their support of Triple-A One Funding, requiring the SPV to draw upon its outstanding bank liquidity lines.”
A liquidity line is an arrangement under which a bank agrees to buy commercial paper in the event the mutual funds and corporate treasurers who usually buy the short-term debt reject it.
“How can the commercial paper conduit create a risk if the banks fund the liquidity lines?” Waldman wanted to know.
Ackman said that by reading an article in the December 2001 issue of a trade publication called Financial Stability Review, he learned that liquidity facilities often had “outs,” or reasons a bank could cite for refusing to buy the commercial paper. MBIA didn’t publicly disclose enough detail for outsiders to be sure what those outs were.
The questioning about Triple-A One continued into a second day. The transaction made for dizzying rounds of questions. While the cash flow from the loans held by Triple-A One supported repayment of the CP, MBIA insured the assets in case the loans didn’t pay off. The banks provided the liquidity backup for the CP in case investors shunned the short-term debt. MBIA, however, insured the liquidity providers against taking any losses on the CP if they wound up having to purchase it.
“Where is this going to break down and why?” Waldman asked Ackman.
There might be circumstances under which the banks would be allowed to walk away from their obligations, Ackman said. He hadn’t been able to find any disclosure on that, however.
“Would you mark this as Exhibit 5,” Waldman said as he placed a report on the table.
It was a Standard & Poor’s research report on Triple-A One Funding. The report, Waldman explained, described the conditions under which banks could stop providing support. But that didn’t end the disagreement. Waldman pointed out that the SPV had to be insolvent for the banks to back out. So didn’t this prove that Ackman was wrong and that the banks would remain on the hook?
Ackman disagreed. “I would say it implies that I’m correct,” Ackman said. “Solvency is defined as assets exceeding liabilities.”
Waldman fired back: “Solvency also can mean ability to pay when [liabilities] come due, as you well know.”
“I think it doesn’t have the ability without a guarantee from MBIA,” Ackman said, referring to the MBIA insurance policy on the assets. The circularity of the arrangement was making it impossible to untangle the ownership of the risk.
“It has a guarantee?” Waldman asked.
“Right,” Ackman said.
“I’d like to move on,” Waldman replied.
While Waldman almost certainly had been briefed by MBIA’s advisers on the SPVs, the details of how they worked seemed maddeningly elusive.
In November 2007, four years after Ackman and Waldman debated the risks of MBIA’s SPVs, Bill Gross, founder and co-chief investment officer of PIMCO, wrote an editorial in Fortune magazine titled “Beware Our Shadow Banking System.” The term was created by his PIMCO colleague Paul McCulley to describe the thousands of off-balance-sheet entities that engage in lending outside of the banking system with its capital requirements and regulatory oversight. “[The shadow banking system] has lain hidden for years, untouched by regulation, yet free to magically and mystically create and then package subprime loans into a host of three-letter conduits that only Wall Street wizards could explain.”
Waldman and Ackman were bogged down in the workings of this as-yet-unnamed shadow banking system as they went round and round about Triple-A One Funding. The entity was a labyrinth of assumptions, interpretations, and contingencies. The few public references to the special-purpose