Confidence Game - Christine Richard [7]
That’s not to say bond insurance required no capital. To enter the business, Butler had to prove to regulators that the company had the wherewithal to make good on its guarantees. That meant setting aside some fraction of the amount of each bond it guaranteed. But how much? To determine the amount, Butler hired George Hempel, an economist who had studied municipal bond defaults during the Great Depression. With Hempel’s help, Butler figured out how much capital a municipal bond-insurance company would have needed to weather the Depression. Although a large number of municipalities missed bond payments at the height of the Depression, most paid bondholders back, with interest, after just a few years. That meant a bond insurer didn’t really need to pay claims so much as advance money for brief periods during times of extreme financial distress.
Still, it was a business that required extreme caution. “It has to be underwritten to a no-loss standard, otherwise the leverage is deadly,” says Butler.
Butler and Lopp toyed with other business ideas, including manufacturing hollow golf balls. In the end, they went with municipal bond insurance. Bulter founded MBIA. Lopp, who died at age 51 of a heart attack on the tennis court of his vacation home in the south of France, started up Financial Security Assurance, another bond insurer.
FIFTEEN MINUTES AFTER Ackman and the others from Gotham were shown to the conference room, Brown appeared with MBIA’s general counsel, Ram Wertheim, whose first question to the Gotham group was whether it planned to record the meeting. Ackman told him no, then asked Wertheim whether he and Brown planned on making a recording. They did not, Wertheim said.
Brown wasted no time getting to the point. He had been in the insurance industry for years, and no one had ever questioned his reputation, Ackman remembers Brown saying, “No one has ever gone to my regulators without my permission.”
Ackman asked Brown whether he disputed any of the assertions Ackman had made about MBIA. Brown was aware of the issues in Ackman’s report from questions he had received from a Wall Street equity analyst with whom Ackman had shared his findings.
“This isn’t about the facts; it’s about process,” Ackman recalls Brown saying. “You’re a young guy, early in your career. You should think long and hard before issuing the report. We are the largest guarantor of New York state and New York City bonds. In fact, we’re the largest guarantor of municipal debt in the country. Let’s put it this way: We have friends in high places.”
In a follow-up letter to Ackman after the meeting, Wertheim reminded Gotham what was at stake: “MBIA is a regulated insurance company that operates in a regulated environment and acts in a fiduciary capacity for the benefit of our many constituencies—principally our policyholders, our customers, including the numerous states and municipalities that rely on bond insurance, and our stockholders but also our employees, our community, and the other people who rely on the vitality of the markets that we support. . . . MBIA’s credibility and reputation in the market, and its triple-A ratings, are critical to our continued ability to service these constituencies.”
In the meeting, Brown compared Gotham to Enron, which had been accused of manipulating California’s electricity market. Was Gotham seeking to manipulate perceptions about a regulated insurance company by taking positions in the unregulated CDS market? Brown also asked Ackman how long Gotham planned to hold its CDS position on MBIA.
Ackman explained that for the hedge fund to make money on its CDS position, it was going to have to be correct in its criticism of MBIA. Ackman told Brown that the CDS market was not liquid enough for Gotham to easily trade in and out of such a huge position.
Wertheim asked to see