Confidence Game - Christine Richard [89]
Ackman had read her reports and considered her to be the most upbeat of the analysts following MBIA. “Any friend of the Williams family is a friend of mine,” he said, shaking her hand. Then he added, “This isn’t the time or place, but I think you’ve got it wrong on MBIA.” He suggested that they should get together and talk about it back in New York.
Hunt seemed amenable to the idea, even though it looked like the short sellers had been wrong about MBIA. Even where the short sellers had been right in their criticism, it seemed MBIA was going to get the last laugh. On February 13, 2007, a judge ruled against the plaintiffs, a group of shareholders who were seeking to sue MBIA after its share price fell in the wake of the AHERF restatements. The reason for the ruling: The plaintiffs waited too long to begin questioning whether the company had committed fraud. Shareholders had a duty to begin investigating the AHERF transaction after it was described in Gotham’s report, the judge said. “When the circumstances would suggest to an investor of ordinary intelligence the probability that she has been defrauded, a duty of inquiry arises,” he wrote.
Events that give rise to a duty to inquire are referred to as “storm warnings,” and the court believed Ackman’s report was one of them.
“The Gotham Partners report, in conjunction with the earlier disclosures regarding the 1998 transactions, effectively put the market, including plaintiffs, on notice of the probability of misrepresentations and deception,” the judge wrote. The plaintiffs argued that they were thrown off track by management’s immediate denial of allegations raised in the report, but the judge had no sympathy. “Plaintiffs could not have reasonably relied on MBIA’s December 9, 2002, vague and general press release to allay the concerns raised by the Gotham Partners report and the series of prior disclosures,” the judge decided.
When I spoke to Roy Katzovicz, Pershing’s chief legal officer, he couldn’t help but admit to a grudging appreciation of the legal strategy.
“Remarkable development,” Aaron Marcu, the outside attorney who represented Gotham when it was investigated by the New York attorney general, wrote in an e-mail to Katzovicz and Ackman after a Bloomberg News article ran describing the ruling. “The chutzpah is stunning.”
AS MBIA PUT one crisis behind it, storm clouds were forming over the U.S. subprime mortgage market.
The subprime mortgage market had become an increasingly important part of the U.S. mortgage market. In the mid-1990s, only 5 percent of mortgages were considered subprime; in early 2007, that number grew to 20 percent. Outstanding subprime mortgages rose from $35 billion in the mid-1990s to $625 billion in 2005 and $1.7 trillion by 2007.
Most of these mortgages had been used to back trillions of dollars of supposed safe securities. A research report making the rounds in early 2007 reminded investors that it had yet to be seen whether the securitization market was sufficiently regulated, transparent, and stable to entrust with the funding of the U.S. mortgage markets. Josh Rosner, a consultant, and Joe Mason, a finance professor at Louisiana State University, warned that lenders had become far more aggressive in recent years, making it very difficult to predict default rates and losses on mortgages. If those losses exceeded expectations, then the deterioration in mortgage-backed securities could be dramatic.
“When mortgage pools do not perform . . . the outcome is final and dramatic,” Rosner and Mason wrote.
To complicate