Confidence Game - Christine Richard [98]
By mid-July, the structured finance market was collapsing into crisis. On July 17, investors in one of the two troubled Bear Stearns hedge funds received the bad news: They wouldn’t be getting any money back after the fund was forced to sell its assets at distressed prices. On July 18, 5-year credit-default swaps on MBIA’s holding company were quoted at more than 100 basis points, indicating that it now cost $100,000 a year to buy protection against a default on $10 million of MBIA debt. The next day, S&P downgraded 75 synthetic CDOs—securities backed by Credit default swap (CDS) referencing bonds. By mid-July, the structured finance market, the multitrillion-dollar experiment that had helped fuel years of debt-propelled spending across the U.S. economy, was shutting down.
Not everyone noticed that the music had stopped. On July 19, the Dow Jones Industrial Average closed above 14,000 for the first time ever.
In Dusseldorf, FGIC and IKB officials were toasting the closing of the Havenrock II transaction. A July 25 dinner followed all-day meetings during which the group discussed its next joint venture, Havenrock III. That transaction was expected to provide another $5 billion in liquidity support for Rhineland Funding and its CDO holdings. Over dinner, Winfried Reinke, the managing director from IKB, brushed off the recent decline in the bank’s share price. FGIC executives would later recall that Reinke attributed the drop to activity by short sellers.
Two days after the celebratory dinner, with rumors of IKB’s exposure to subprime swirling in the markets, Rhineland Funding was unable to sell new commercial paper. IKB called on Deutsche Bank to provide it with funding under a credit line. Instead of providing the funds, bank officials telephoned German banking and finance regulators and reported that IKB was in financial trouble. Over the weekend, officials began to piece together a rescue. Although it had been deemed an unthinkable scenario, Rhineland called on Calyon to buy $2.5 billion of its CDOs. Calyon, in turn, called on Havenrock II to compensate it for the losses on the CDOs. Havenrock II called in its guarantee from FGIC.
It turned out that Rhineland Funding was supporting an additional 32 special-purpose vehicles known as the Loreley Purchasing Companies, which bought CDOs. The Loreleis are a group of rocks in a particularly beautiful and treacherous stretch of the Rhine River. They are immortalized in German opera and poetry as enchanting female spirits that lured men to their deaths.
That same week, MBIA announced earnings for the second quarter. It posted profits of $1.61 per share, largely in line with expectations. But the market was nervous. MBIA’s shares, which had traded above $70 in April, had dropped to just above $57.
MBIA insisted it had anticipated the problems in the subprime market and would evade the losses. “We didn’t insure a single residential mortgage-backed securities deal in the quarter,” MBIA’s chief financial officer Chuck Chaplin told listeners during the July 26 call. But it was hard to be certain it had avoided the danger. MBIA did “insure two multisector CDOs, both high-grade CDOs with approximately 50 percent subprime residential mortgage-backed securities in their collateral pools,” Chaplin added. These were “super-senior” guarantees, of course, reflecting a level of protection that would withstand a near end-of-the-world scenario before MBIA took losses.
MBIA also announced it had taken a $10-million charge to write off more than 90 percent of its investment in the Bear Stearns mortgage hedge fund. The amount of the write-off was immaterial to MBIA, yet it was one more disconcerting indication that the very people on Wall Street who were supposed to understand the risk were the ones who had been fooled.
On July 30, 2007, the MBIA investigation