Short Seller Sinks Teeth Into Insurer
“I’m going to try to give shorter answers,” said William Ackman, with an awkward smile.
It was Wednesday, and Mr. Ackman, a 41-year-old hedge fund manager, was in the middle of a surprisingly well-attended news conference. He had just finished an hourlong presentation at an investment conference in Midtown Manhattan, and if truth be told, the only reason it had been contained to an hour is that Mr. Ackman had rushed through it, burying his audience in a blizzard of facts, while flipping through an astonishing 145 slides.
If the presentation and ensuing news conference proved anything, it was that Mr. Ackman was incapable of giving short answers. Then again, that’s usually the way it is with obsessives.
Mr. Ackman is an emerging star in the “shareholder activist” division of the hedge fund big leagues. In the last few years, he has taken aim at McDonald’s, Wendy’s and, most recently, Target, usually emerging from these tugs of war with profits for his hedge fund.
His firm, Pershing Square Capital, which he founded in 2004, now bulges with over $6 billion in assets. “If I think I’m right, I can be the most persistent and most relentless person in America,” he says. But for sheer, obsessive doggedness, nothing he has ever done can compare with his pursuit of a company called MBIA Inc. In fact, I don’t think I’ve ever seen a fund manager grab a company by the tail and simply not let go the way Mr. Ackman has done with this once-obscure holding company, whose main subsidiary, MBIA Insurance, is the nation’s largest bond insurer.
Though he says he is not typically a short seller, Mr. Ackman has been shorting MBIA’s stock since 2002. He began his assault with a highly unusual move for a short seller — he posted a lengthy report, laying out his case against MBIA, on the Internet, for all to see. (“I believe in free speech,” he says now, by way of explanation.)
He purchased credit default swaps as a way to profit in the event of a bankruptcy by the holding company. He talked to the S.E.C., the New York State Insurance Commission and the New York attorney general’s office about the company. (He also claims that MBIA was behind a short-lived investigation by the attorney general’s office aimed at him. MBIA declined to comment on the accusation.)
And that’s not all. He held hours of meetings with analysts at Moody’s and Standard & Poor’s, the two big bond rating agencies, trying to persuade them to lower MBIA’s credit rating. He once buttonholed the chief executive of PriceWaterhouseCoopers, MBIA’s accountant, at a charity dinner, and sent him his report. He has made allegations of accounting shenanigans. He has talked to reporters and analysts, and given presentations like the one he gave this week. All the while, he has continued to dig into the company, searching for dirt he could use against it.
For most of that time, his efforts have come to naught. Despite the fact that MBIA, at one point, had to restate five years of earnings — after being tripped up on an accounting problem that Mr. Ackman brought to light — its stock continued to do well. The analysts and rating agencies continued to side with the company. Indeed, the more dogged Mr. Ackman became, the more the company seemed impervious to his slings and arrows.
And then came the subprime crisis, which in recent months has wreaked havoc on MBIA’s stock price, and raised questions about its business model. Sean Egan, the co-founder of Egan-Jones, an independent bond rater, believes that MBIA and the other big bond insurers will be saddled with billions of dollars in losses as collateralized debt obligations stuffed with subprime debt — so-called C.D.O.’s — they have insured continue to go south. So does Mr. Ackman, who believes that as losses pile up and the bond insurer has to pay them off, it will have to shut off the supply of money it sends to the holding company.
At the investor presentation he held this week, Mr. Ackman predicted that the holding company could be bankrupt by February, which MBIA says is preposterous. (“MBIA does not expect material losses in its C.D.O.’s because they were structured with high levels of subordination in excess of triple-A levels and other structural protections,” said its chief financial officer, Chuck Chaplin.) Mr. Ackman now stands to make, personally, hundreds of millions of dollars on his bet against MBIA — which he says he will donate to his charitable foundation. If you sense some defensiveness in that gesture, well, so do I. The question — and it’s the one that always seems to crop up when short sellers are involved — is whether Mr. Ackman’s single-minded pursuit of MBIA is something he should feel defensive about.
There’s no doubt about what drives Bill Ackman crazy about MBIA. For all the many issues he has raised, his objection really comes down to a single fact: MBIA has a triple-A rating, the highest any company can get — indeed, a rating more normally associated with Treasury bills, which are backed by the full faith and credit of the federal government. And it’s not just the fact of MBIA’s triple-A rating that drives Mr. Ackman batty; it’s its transcendent importance to the company’s business. As Gary C. Dunton, the company’s chief executive, told me recently, “Our triple-A rating is a fundamental driver of our business model.” No triple-A, no business.
This fact has been widely accepted on Wall Street and in the marketplace. “The model is the model,” shrugged one person who keeps close tabs on the company (and who declined to be quoted by name because he isn’t supposed to talk to the press). Mr. Ackman, however, thinks it is lunacy — and he’s right.
Think about it: if a company needs a triple-A rating just to stay in business, that fact alone probably means it doesn’t deserve the rating. After all, if triple-A-rated General Electric got a downgrade, would it really affect its business? Not really. Companies that merit triple-A ratings are those that are impervious to small — or even medium-sized — bumps in the road. Besides, MBIA takes on a lot of risk for a company with a triple- A rating.
It wasn’t always thus, which explains how MBIA got its rating in the first place. MBIA began life in the early 1970s guaranteeing nice, safe municipal bonds. (Its initials originally stood for Municipal Bond Insurance Association.) But while municipal bonds rarely default, most don’t get triple-A ratings — and the lower the rating the more a municipality had to pay in interest. By “wrapping” such bonds, MBIA could envelop them in its triple-A rating, and in so doing save money for towns and cities all over the country.
Gradually, though, the business model changed. In the 1990s, MBIA began to guarantee not just muni bonds but so-called structured finance vehicles, including those now infamous C.D.O.’s that are causing so much trouble. “If you analogize it to life insurance,” said Mr. Egan — who uses the kind of pithy language that escapes Mr. Ackman — “it is as if they once insured only 18-year-old women who didn’t smoke or drink. Now they are insuring the Evel Knievels of the world.” (He said this before Mr. Knievel died yesterday.)
Nonetheless, MBIA insists that the C.D.O.’s it guarantees are the crème de la crème — not just plain-vanilla triple-A tranches, but the so-called “super senior triple-As.” (“Super senior?” You gotta love Wall Street.) These C.D.O.’s, it says, are the least likely to default, and, according to its analysis, it would take an unprecedented cataclysm for it to have to pay off insurance claims.
Except that Merrill Lynch and Citigroup and a dozen other big investment banks held super senior C.D.O.’s, and they have indeed dropped in value — so much so that the banks have written down billions of dollars. The market has come to realize that the triple-A rating for these derivatives is pretty meaningless — that the rating agencies were just as blind to the coming subprime meltdown as everyone on Wall Street, and developed models for rating C.D.O.’s that were far too optimistic.
The problem for investors is that it is impossible to know what, exactly, is in the individual C.D.O.’s that MBIA insures. “The company is something of a black box,” said that same person who won’t be quoted by name. MBIA executives have been loudly making the case that the C.D.O.’s it insures are fine, that it has plenty of capital to cover any possible claims, and that its triple-A rating is safe — even though the rating agencies are currently reviewing their ratings of the bond insurers. But the rating agencies know full well how important the triple-A is to these companies, and they are loath to lower the ratings.
(When I spoke to Moody’s, its executives denied showing any special favoritism toward MBIA, and insisted that its rating system was as pure as the driven snow.)
Which brings me back to Mr. Ackman. On Wall Street, his nonstop assault on MBIA is highly controversial, and a number of people I talked to about MBIA spoke of it — and him — with distaste. Their central point is that MBIA is in a business that depends, to a large degree, on the market’s confidence in its ability to insure bonds — and that Mr. Ackman’s attacks are an effort to undermine that confidence. They pointed to his prediction that the holding company might soon be bankrupt as an example.
MBIA insists that the holding company has only $80 million in corporate debt and $500 million in cash and that it is completely healthy. Indeed, it says that his bankruptcy prediction “reflects a fundamental misunderstanding of MBIA Inc.’s capital structure and financial statements.” When Mr. Ackman uses the word bankruptcy, he is, in effect, tossing gasoline on a fire.
On the other hand, Mr. Ackman has been remarkably prescient. When I went back and reread his original report, “Is MBIA Triple- A?,” I could see a few incendiary claims. But I also saw him make the case that those C.D.O.’s MBIA insures would eventually come a cropper. And now they have. Companies that are knee-deep in C.D.O. exposure have routinely had their own debt downgraded in recent months, as the rating agencies have belatedly woken up to the problem. Why should the bond insurers be exempt?
It is easy to understand why MBIA’s executives are unhappy with Mr. Ackman. But the other participants in the marketplace — the analysts and rating agencies and institutional investors? They should be thanking him. He may be aggressive, he may be over the top, he may not be able to speak in short sentences. But he’s doing the hard work, and thinking the hard thoughts, that they refused to do for far too long.