Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [99]
William (“Bill”) Ackman, head of Pershing Square Capital Management, warned the market for years that bond insurers underestimated the risk of structured finance business. Whitney Tilson, a value investor, made presentations at conferences with Bill Ackman supporting his view. David Einhorn, founder of Greenlight Capital, also made public his concerns about the overrated bond insurers. Ackman sold short the holding companies of the two largest publicly traded bond insurers, MBIA and Ambac. In 2007 he announced that he would donate his personal gains to the Pershing Square Foundation, a charity.11 Pershing Square’s hedge funds stand to reap billions, which benefits Ackman in the long run.
Ackman took the extraordinary step of using Internet-based Open Source to post the subprime related holdings of Ambac and MBIA. He, in turn, obtained the positions from an investment bank he declined to name. Usually, outing positions is not the done thing, but in this case I heartily approve. Ackman took flack because he put out high loss numbers for the bond insurers. He tried to make his opinion transparent, but the spread sheet is a black hole of time-sucking minutiae.
Armed with Ackman’s publicly available information, I simplified the analysis. According to Ackman’s spreadsheet, many of the CDO positions held by Ambac and MBIA are horrifying. Most bond insurers had CDO-squared positions, with inner CDOs including constellation deals and other CDO-squareds.12 On January 3, 2008, I wrote my clients that most of the bond insurers deserved much lower ratings, and all of the major bond insurers, including Ambac and MBIA—the largest insurers of municipal bonds—deserved to lose their AAA ratings.13 This was bad news for the municipal bond market. Ambac and MBIA insure around $2 trillion in securities, and FGIC insures another $315 billion. Ambac and MBIA insure most of the public finance market including $1 trillion of U.S. “guaranteed” municipal bonds. What’s more, investment banks that bought protection from bond insurers already had billions in mark-to-market losses. Investment banks would have to take losses of many billions more.
In early January 2008, I told CNBC that the bond insurers are in deep trouble: “They did the financial equivalent of insuring drunk drivers with bad driving records at the same prices as they would insure teetotalers with good driving records.”14 Management will have to go and there will have to be a restructuring. MBIA and Ambac need capital and there is a “crisis of confidence in that management.”15 CNBC’s Becky Quick asked why people were surprised by something that I had been predicting for a long time. Jack Caouette, then vice chairman of MBIA, had written a blurb for my 2003 book on securitization saying caveat emptor—yet, the bond insurers had been careless.
CNBC contributor David Kotok, chief investment officer of Cumberland Advisors, an investor in municipal bonds (among other things), did not agree with me. He said there are “seven triple-A municipal bond insurers,”16 and thought this was an opportunity. He said the municipal bond insurance would be fine. He seemed unaware of the ratings peril.
On January 10, 2008, MBIA paid 14 percent in interest to raise $1 billion in capital; the 10-year U.S. treasury yield was less than 4 percent.17 The market no longer seemed to believe that MBIA was AAA rated.Warren laughed as he asked me:“Did you ever think you would see a triple-A raise money at 14 percent [with treasury rates so low]?”
In January of 2008, Eric Danillo, the New York insurance regulator, called a meeting of investment banks to discuss the way forward for the monoline insurers. Based on market feedback, Danillo knew the bond insurers needed capital, and cash-strapped investment banks did not want to cooperate. Danillo, however, had more to say.
A key feature of credit derivatives is that fraud is not a defense against payment. That