Confidence Game - Christine Richard [62]
Almost immediately after the AHERF bankruptcy filing, MBIA sought to reassure investors by stating that it had $75 million of reserves that would be adequate to absorb the loss. Yet confidence in the bond insurer continued to falter that summer on a combination of AHERF concerns and the Asian financial crisis. For the first time, investors were asking whether MBIA’s triple-A rating was at risk. MBIA’s shares had been sinking all summer, dropping from a high of around $53 in April to $43 by late summer and then tumbling precipitously in early September.
On September 11, 1998, the company held a conference call to set the record straight. “I understand that we have exhausted the phone line capacity of the provider, and I think we have something like over 250 participants on this conference call,” MBIA’s then chairman and chief executive officer (CEO) David Elliott said.
Elliott told listeners that MBIA was in the process of making arrangements in the reinsurance market, which—at very little cost—would double its reserves, ensuring that even if the loss was larger than $75 million, the company could cover the loss and eliminate an impact on its earnings.
“We have an excellent track record,” Elliott said. “And we intend to keep that track record.” The stock ended the day more than 13 percent higher at $35.63.
The only problem, Ackman told Spitzer seven years later, was that MBIA didn’t really use reinsurance. It borrowed the money to pay for the loss and accounted for it improperly as insurance.
Spitzer called in the head of his investor-protection unit, David Brown, to join them. A former Goldman Sachs attorney who attended Harvard Law School with Spitzer, Brown had coordinated his boss’s assault on corrupt Wall Street research, improper trading by mutual funds, and kickbacks by insurance brokers. Brown seemed a bit stressed, Peretz recalls. “I had a dim foreboding that the attorney general’s office couldn’t confront another big scandal.” But Brown heard Ackman out, starting with the AHERF deal.
Ackman took the attorneys through the particulars of the deal: Three reinsurers—AXA Re Finance S.A., Converium Reinsurance (North America) Incorporated, and Muenchener Rueckversicherung-Gesellschaft (Munich Re)—agreed to make a payment to MBIA of $170 million in the fall of 1998. In exchange, MBIA agreed to reinsure $45 billion of bonds with the three reinsurers in the future. Converium reimbursed MBIA $70 million and was promised reinsurance business for which MBIA would pay it $102 million in premiums. Munich Re and AXA Re reimbursed MBIA $50 million each under the same type of policy. AXA was promised $98 million in future premiums; Munich Re would receive $97 million.
The transactions allowed MBIA to net the gains on its reinsurance contracts against its future AHERF claims payments, erasing the loss from its earnings statement. The reinsurance allowed MBIA to meet analysts’ expectations that it would earn $433 million in 1998 rather than report the first quarterly loss in its history.
“One simple question will enable you to determine whether reinsurance accounting is appropriate,” Ackman wrote in a follow-up e-mail to the attorney general’s office. “Ask the reinsurers whether they would have agreed to cover the $170 million in cash to MBIA to absorb the AHERF loss without some kind of offsetting arrangement—verbal, written, or otherwise.”
The answer would, of course, be no, Ackman wrote. The reinsurers took a $170 million cash loss the day they signed the AHERF reinsurance contract. “If you interview executives at Munich Re and they say that they would have agreed to cover the $170 million loss without a commitment of future premiums or some other form of reimbursement from MBIA, they are lying. The same, of course, holds true for the executives at the other reinsurers.
“Reinsurance of a known loss without some kind of payback is better known as a gift,” Ackman wrote. “As you know, there is no free lunch on Wall Street.”
The transaction, announced on September