Confidence Game - Christine Richard [5]
Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings—the credit-rating oligopoly—all assigned MBIA’s bond-insurance unit a triple-A rating. Using computer models and historical default data, analysts at the rating companies had determined that MBIA could weather another Great Depression and still meet all of its claims.
Ackman was not convinced.
MBIA held just $1 of capital for every $140 of debt it guaranteed. Although the company claimed it underwrote risk to a so-called “zeroloss” standard, its past performance hadn’t been free from error. The high leverage meant MBIA had virtually no margin of safety. The company’s underwriting, transparency, accounting, and track record all had to be beyond reproach. Ackman, a money manager known for his intensive research, thought he saw problems with every one of these issues.
Earlier that day, Ackman had met for lunch with Michael Ovitz, the founder of Hollywood’s Creative Artists Agency and a longtime investor in Ackman’s fund. As they worked their way through six different versions of toro, the Japanese fatty tuna delicacy, Ackman asked Ovitz’s advice about the upcoming meeting with Brown.
“It sounds like a very Japanese meeting,” said Ovitz. In other words, he said, “Just shut up and listen.”
ACKMAN’S TAXI STOPPED on Third Avenue outside the building where MBIA’s attorneys, Debevoise & Plimpton, have their offices. Together with Gotham’s general counsel, David Klafter, and one of the firm’s analysts, Greg Lyss, Ackman headed for the security desk in the lobby. The group was sent upstairs, where Ackman told the receptionist they were there for the meeting with Jay Brown. She pointed Ackman toward a closed conference room door just behind the reception desk. Opening it, he found Brown seated at a conference table with a dozen other men. The conversation in the room came to an abrupt halt. “Hi,” he said. “I’m Bill Ackman. I’m here to . . .”
“Wrong meeting,” one of the men said as he jumped up to close the door. Ackman returned to the reception area, convinced he’d just interrupted a tired and frazzled-looking Brown in a meeting with his crisis-management team. The Gotham group was shown to another conference room and told to wait.
ACKMAN COFOUNDED Gotham Partners in 1993 with David Berkowitz, increasing the hedge fund’s assets from $3 million to more than $350 million by 2001. The firm was small, with just nine employees. Ackman and the fund’s analysts sought out companies with securities that were mispriced or misunderstood by the market. In MBIA’s case, the market believed in the permanence of the company’s triple-A rating. If it didn’t, then the bond insurer’s ability to write new business would have disappeared overnight.
Ackman had placed his bet against MBIA principally in the credit-default-swap market. Credit-default swaps, or CDS contracts, are derivatives that allow parties to buy and sell protection against a default on a security. The contracts are essentially life insurance policies on companies. The protection buyer—in Wall Street parlance—makes regular payments over the life of the contract to the protection seller, who promises to make a lump sum payment to the insurance buyer if a security defaults. The cost of the insurance rises and falls minute by minute based on the market’s perception of the company’s credit quality. Default protection on a company with a triple-A rating, which MBIA had in 2002, could be purchased cheaply because the risk of default was perceived to be de minimus.