Confidence Game - Christine Richard [93]
The Lippman meeting had started a bit after 5 p.m., but the group was still in the conference room at 8:30 p.m. Several of the attendees canceled dinner plans as the meeting ran late and lights in surrounding office buildings clicked into darkness.
“It was an epiphany moment,” says McGuire.
Chapter Sixteen
An Uncertain Spring
As recently as February, there were people saying, “Oh, in the spring buying season, the housing market’s going to come back.” But right now, on the precipice of July, all of those numbers support a very bearish view.
—KAREN WEAVER, HEAD OF GLOBAL SECURITIZATION, DEUTSCHE BANK, JUNE 2007
GREETINGS FROM ARMONK, where it is springtime,” MBIA chief financial officer Chuck Chaplin told listeners on MBIA’s first-quarter conference call. It was April 26, 2007, the company had put a more than two-year regulatory investigation behind it, the subprime mortgage crisis wasn’t going to touch the company, and the board had authorized a huge share buyback plan.
“We continue to monitor the developments in the subprime mortgage market, but at this time these developments have not caused any significant concern,” Chaplin told investors. MBIA’s total direct exposure to the subprime market was $5.4 billion, or “less than 1 percent of the outstanding book of business,” Chaplin said. The company always explained losses or exposure as a percentage of total exposures, which helped to make the problem appear immaterial. More relevant was looking at MBIA’s ability to withstand a loss. MBIA’s insurance unit had assets of $11 billion in 2007 and an approximately $1 billion cushion protecting it from a downgrade of its triple-A rating. In that regard, $5.4 billion was an enormous number.
MBIA had backed away from the subprime market over the previous several years, recognizing that the lending had become too risky. Yet MBIA ramped up its business guaranteeing collateralized-debt obligations (CDOs) even though CDOs were backed by securities that were, in turn, backed by subprime mortgages. The important point to remember, however, was that all of these CDOs had “super-senior” underlying ratings, Chaplin reassured listeners.
If ever there was a hint that ratings in the structured-finance market had become inflated, it was the creation of the term “super-senior.” Less publicized—but key to understanding the success of the bond insurers—was another revelation about ratings. In the spring of 2007, Moody’s Investors Services released a report that showed how municipal bonds would be rated if they were analyzed the same way corporate bonds were. The ratings on city, state, school-district, and sewer-system debt would be much higher if Moody’s evaluated the bonds based on the likelihood of default, the report said. In assigning municipal ratings, Moody’s ignored the long history of taxpayers and higher levels of government bailing out municipal bond issuers if they came to the brink of default. Instead, they rated these public entities with the assumption they wouldn’t be bailed out.
That explained the existence of bond insurance. It explained why the state of California could be insured by a tiny company in Westchester County. Bond insurers weren’t less likely to default than the municipalities they insured. They just had a “better” credit rating because they were rated on the corporate scale.
With the help of municipal bond analyst Matt Fabian, I estimated that the double-standard credit-rating system cost municipalities about $3.6 billion on bonds sold in 2006.
“It’s the biggest open secret in the market that insurers are insuring municipal bonds that don’t need it,” JB Hanauer & Company analyst Richard