Confidence Game - Christine Richard [91]
At each step in the chain, an entity agreed to assume the risk that the CDOs could fall in value, but that entity immediately contracted to offload the risk to someone else. FGIC agreed to be the last in the chain only because it believed the ultimate risk resided in the first link of the chain back at IKB.
FGIC officials later met with Stefan Ortseifen, the head of IKB in Dusseldorf. In court documents, they recalled Ortseifen’s stressing the importance of Rhineland to IKB. The bank would always stand behind Rhineland and had in the past taken 10 CDOs out of Rhineland when they performed poorly, though the bank had no obligation to so. And although Rhineland had liquidity contracts with banks, it would be unthinkable for IKB to draw on those contracts and to shift distressed assets to third parties, the FGIC employees remember being told. The risk came full circle back to IKB, or so IKB seemed to be saying. On paper, FGIC assumed much of the risk, although the company’s business model called for assuming essentially zero risk. Somewhere in between IKB’s assurances that FGIC would never have to cover losses and FGIC’s promises to cover any and all losses, the risk vanished.
Bill Gross, manager of PIMCO, one of the world’s largest bond funds, might have been poking fun at the goings-on in Las Vegas that year when he wrote about the market’s dangerous reliance on the triple-A ratings assigned to securities backed by subprime mortgages:
“AAA? You were wooed, Mr. Moody’s and Mr. Poor’s, by the makeup, those six-inch hooker heels, and a ‘tramp stamp.’ Many of these good-looking girls are not high-class assets worth 100 cents on the dollar.”
WHEN ACKMAN WROTE to investors in the early spring of 2007, he had never been more enthusiastic about the fund’s MBIA position. “For some time, I have believed that our investment in MBIA credit-default swaps offers the most attractive risk/reward ratio of any investment I have come across in my investment career,” Ackman wrote in a March 5, 2007, letter to investors. It cost the fund about $10 million a year to have a bet on MBIA in the credit-default-swap market. The potential payout in the event MBIA filed for bankruptcy was $2.5 billion.
“The price of CDS on MBIA today continues to imply that the market assesses the probability of the company defaulting to be nominal,” Ackman wrote. “We believe otherwise.”
On the same day, Ackman sent an e-mail to his investment team: “I think we should short some Ambac.” He had been reading Ambac Financial Group’s 10-K filing, and the second-largest bond insurer had “larger mortgage-backed securities and home-equity exposure than MBIA, at around $60-plus billion, or approximately 10 times shareholders’ equity.”
The e-mail raised concerns for the team. Now Ackman was looking to short a second bond insurer. Scott Ferguson countered Ackman’s suggestion by saying that the shares of both MBIA and Ambac traded at around 10 times earnings per share. “I’m not bullish on multiple contraction from here,” said Ferguson, “unless we have a view that the market thinks ‘fair’ for these guys is eight times earnings.”
Someone else noted that virtually every analyst had upgraded MBIA in the last two or three months, “which seems to indicate that the stock price is just going to go right back up to the mid-70s.”
“My understanding of the reason for being short MBIA is because we think it is a fraud. If no one is willing to pursue and punish them for it, should we still be shorting it?” Mick McGuire wrote.
But Ackman found their arguments unconvincing. They were in deep trouble, he argued, given “what is going on in the subprime