Confidence Game - Christine Richard [86]
AT THE END OF 2006, however, bond insurers and their supporters were confident in the future. At a conference on the financial guarantors at the Sofitel in Midtown, Moody’s Investors Service analyst Jack Dorer took the stage. The first slide of his presentation showed how the bond-insurance business had grown from $450 billion of guarantees outstanding in 1995 to $1.8 trillion in 2006. “That’s remarkable,” Dorer said before moving on to the next slide.
Despite this phenomenal growth, risk remained well contained, according to Moody’s. Dorer flipped to another slide to show that losses were expected to remain extremely rare. “What it’s saying,” Dorer explained, “is [that] for every 100 dollars of par outstanding, a company would lose 39 cents.”
Not everyone was convinced. A week before Christmas 2006, Sanjay Sharma, the chief risk officer of Natixis, a European financial institution that owned bond insurer CIFG, wrote a letter to his boss. He was frightened by what he saw unfolding: “The housing market [has become] systemically susceptible to a significant downturn given the current market weakening in home prices, increasing delinquencies, and the low visibility of mortgage performance in a stressful environment.”
Sharma believed that CIFG needed to immediately pull back from the market. “The risks are heightened by the nontraditional risk layering inherent in many current mortgage products,” Sharma added, referring to collateralized-debt obligations (CDOs). Sharma’s advice to drastically slow the business of guaranteeing CDOs was rejected. He received a quick response: “The U.S. mortgage market is one of the deepest, most studied, most liquid, and most orderly markets in the world,” Charles Webster, CIFG’s chief risk officer, wrote in reply. “While not immune to volatility, there are too many participants in the mortgage market for it to fall apart. The market is so broad that there are many places of relative safety.”
Almost everyone was certain that bond insurers had found one of those safe places. As 2006 drew to a close, Ackman wrote to his investors: “MBIA is, by a large margin, our largest loser for the year.”
But the hedge fund’s short position on MBIA was more than that. It was Ackman’s obsession with an overleveraged company that needed—but did not have—a near-perfect track record. It was also a great hedge, downside protection for the fund in the event that years of ballooning debt, easy money, and investor complacency ended in disaster.
Credit-default-swap contracts on MBIA were priced as if the company was only slightly riskier than the U.S. government. Yet with leverage of 140 to 1, MBIA was vulnerable to the unexpected. “If nothing else, MBIA was virtually zero-cost financial-disaster insurance,” says Ali Namvar, one of Pershing Square’s analysts. And by late 2006, with the U.S. housing market faltering, disaster was on its way.
“Let’s hold off on more [credit-default swap] purchases,” Ackman wrote to Erika Kreyssig, the Pershing Square trader, in an e-mail in late 2006. “We are big enough in MBIA so that if it works, we will be happy.”
Chapter Fifteen
Storm Warnings
MBIA holds itself out to the investing public as a company that does not risk significant losses on the insurance it writes. In fact, MBIA’s winning streak came to an end in 1998.
—NEW YORK ATTORNEY GENERAL’S COMPLAINT AGAINST MBIA, JANUARY 2007
ON THE LAST FRIDAY in January 2007, word began to circulate that MBIA was about to announce a settlement with the New York attorney general’s office and the Securities and Exchange Commission (SEC). The settlement had been expected any day for more than a year. Now it appeared that the probe into the Allegheny Health,