Confidence Game - Christine Richard [44]
“I would say probably not.”
“None? Suppose there are only three trades?” Waldman insisted.
“I would much rather rely on a trade of a comparable instrument than I would on any model.”
“Suppose there is only one trade. Do you like that better than a model?” asked Waldman.
“Yes. If it is between a willing buyer and a willing seller. Yes. Absolutely.”
“You don’t think there could be any extraneous influence on the trade?” Waldman pressed.
“A lot less than there is on the models performed by management. MBIA has set aside only $10 million of reserves for losses against its entire $65 billion portfolio,” Ackman told Waldman. “That’s MBIA’s best estimate.”
“Ten million dollars out of $65 billion?”
“Correct. The dealers say the number [the mark-to-market losses] is closer to $5 [billion] to $7 billion.”
“You’re not suggesting, are you, that they should have a loss reserve—or are you—of $5 billion to $7 billion?”
“I’m saying that with respect to their synthetic CDO portfolio, they’re hugely under-reserving,” said Ackman.
“And one of the things auditors do, don’t they, is analyze whether reserves for losses are adequate?” Waldman pointed out.
“No.”
“They don’t?”
“That’s correct. They don’t.” Ackman replied.
“They just accept whatever the reserve is? No test, no nothing?”
“That’s correct,” said Ackman. “Basically what the auditors do is examine the processes that management uses to determine reserves and decide whether the process is reasonable or not.”
“In this case, the process apparently does not include the mark-to-market methodology your dealers employed?”
“That’s correct.”
“Do you know who the auditors were?” asked Waldman.
“PriceWaterhouse.”
Waldman wondered aloud if it ever gave Ackman pause that such a well-known accounting firm didn’t insist on the valuation process Ackman was using.
“No, not at all,” said Ackman. “Unfortunately, the auditors are not particularly good on the subject of reserves.”
“Even if—for the sake of argument—your estimate of the bond insurer’s losses are right, would it have any real impact on MBIA’s ability to meet its obligations?” Waldman asked.
“It really depends,” Ackman said. If these losses caused the credit-rating companies to rethink MBIA’s triple-A rating, things could start to unravel, he explained. MBIA insures lots of the bonds it holds in its investment portfolio. These would be worth less if MBIA were downgraded. For that matter, bonds insured by other financial guarantors that MBIA held in its portfolio would also likely fall in value.
“I suspect that the circumstances in which MBIA would be forced to mark to market its CDO portfolio would be the same circumstances in which Ambac and FSA would be forced to mark to market their portfolios, which would in turn cause a downgrade of each of the respective companies,” Ackman said. “MBIA buys insurance from Ambac, and Ambac buys insurance from MBIA, and so their fate is tied together.” The company might find its counterparties on derivative transactions asking for more collateral if it were downgraded, Ackman said. A loss of the company’s top rating also might cause investors in Triple-A One Funding’s commercial paper to shun the securities at the next auction.
The large mark-to-market losses don’t immediately cause a drain on the company’s cash, Ackman explained. But a series of events, one event tripping the next, creates the problem. It requires one to think about MBIA within a broader context to see that risks become correlated when things go wrong in credit markets. The shield that protects MBIA is its triple-A rating. “As long as this thing is triple-A rated and sailing through unnoticed, this company is fine,” Ackman said. “The moment it’s downgraded, it’s no longer fine. The business is at significant risk because the entire enterprise depends on that triple-A rating—their investment portfolio, their ability to revolve their commercial paper, their ability to borrow money, collateral for derivatives.