Confidence Game - Christine Richard [42]
Meanwhile, Ackman had received expressions of interest from some of the Gotham Credit investors wanting to add capital to the bet against MBIA. None of the investors expressed any interest in selling their positions. “I currently plan to take in the new capital on a mark-to-market basis and reinvest in five-year swaps at current pricing of approximately 60 basis points,” Ackman explained in a letter. At that level, the fund could buy protection against default on $10 million of MBIA debt for $60,000 a year. It was a chance to “average down” the cost of Gotham’s previous investment by adding to the investment at a lower cost and to extend the term of the contracts further into the future. “So for each million, if MBIA defaults within the next five years, we earn 100 percent of our original $29 million of capital back,” he explained.
A few weeks later, in June 2003, Ackman was back on the receiving end of questions about MBIA. Down at 120 Broadway, Waldman showed Ackman an e-mail Ackman had written to Alice Schroeder regarding MBIA that read “And most significantly, we believe they are in violation of the New York State insurance regulations.” “Exactly what insurance regulations did you believe they were violating?” asked Waldman.
“Well, I am not a lawyer, but there is a fairly strict prohibition against insurance companies generally not guaranteeing—using insurance company capital to guarantee—derivatives,” Ackman said. “I think there is actually an outright prohibition.”
Ackman explained that MBIA got around this prohibition with a special-purpose vehicle (SPV) that’s also known as “an orphaned transformer.” It was orphaned because the equity was owned by a nominee or a charity rather than MBIA, and it transformed the business from one that MBIA couldn’t do directly into one it apparently could do indirectly, he explained. This orphaned transformer did not have the financial wherewithal to actually pay counterparties in the event it needed to make good on a credit-default-swap contract, but MBIA insured all of the SPV’s obligations so counterparties would be willing to trade with it. “The entity is called LaCrosse Financial Products—LaCrosse like the game,” Ackman said.
“What about the company?” asked Waldman. “Did you ask MBIA about whether they were violating the law? Did you ask whether [the SPVs] were legal or not?”
“No.”
“Why not?”
“I assumed they thought it was legal.”
“What about the state insurance department?” asked Waldman. “Did you take your question to regulators?”
“We told the insurance department what [MBIA] was doing and their reaction was: ‘Are you sure they’re using insurance capital to guarantee credit derivatives through this entity? Or is it the holding company that’s providing the guarantee?’ They asked us this question multiple times.”
Ackman told Waldman that he attempted to bring an insurance law expert to his first meeting with the insurance department. He had contacted Bonnie Steingart, an attorney at Fried, Frank, Harris, Shriver & Jacobson and the former general counsel for the New York State Insurance Department. According to Ackman, Steingart told him that she believed arrangements like LaCrosse Financial would not be legal under New York insurance law.
Steingart never got a chance to tell the New York State Insurance Department what she thought. After Ackman and Steingart spoke by phone, Ackman decided to retain her to represent Gotham. Indeed, plans were made on a Friday for Steingart to attend a meeting with Gotham at the insurance department the following week, Ackman told Waldman. All had agreed that her presence at the meeting would add credibility to Ackman’s arguments. But the day before the meeting, Steingart called and canceled, Ackman explained.
“After consulting with some of her partners in the structured finance group, she said they would not let her represent us because Fried Frank