Tavakoli Structured Finance LLC

The Financial Report

By Janet Tavakoli

Bill Ackman, MBIA, a Confidence Game, and a Big Short

When nobody seems to be losing money, nobody cares. If a corrupt scheme is “making money,” everyone involved–from the culprits to the dupes–viciously attacks anyone who tries to expose it. Bill Ackman, manager of hedge fund Pershing Square Capital Management, L.P., learned this lesson the hard way.

“Friends in High Places”

In 2002, Ackman used credit derivatives (and shorted stock) to place a “short” bet against MBIA, the largest of the municipal bond insurers. (Ackman later bet against other bond insurers.) Joseph “Jay” Brown, then MBIA’s Chairman and CEO, met with Ackman in 2002 about a negative report Ackman was about to release. In Christine Richard’s new book, Confidence Game, Ackman recalls this power-play:

“You’re a young guy, early in your career. You should think long and hard before issuing the report. We are the largest guarantor of New York state and New York City bonds. In fact, we’re the largest guarantor of municipal debt in the country. Let’s put it this way: We have friends in high places.”
Confidence Game: How a Hedge Fund Manager Called Wall Street’s Bluff, Christine Richard, P. 6, (Wiley, 2010).


Ackman published the report on his fund’s web site: “Is MBIA Triple-A?” Among other issues, Ackman questioned MBIA’s foray into credit derivatives and synthetic CDOs.

Here’s some ironic background you won’t find in Confidence Game. In 2003, Jack Caouette, then Vice Chairman of MBIA,* wrote a blurb for my book on the dangers posed by credit derivatives and synthetic CDOs, Collateralized Debt Obligations & Structured Finance (Wiley, 2003):

“Caveat Emptor! Never in the history of finance has this warning been more appropriate. With the development of esoteric structured finance techniques, the savvy as well as the novice are exposed to a bewildering array. An outstanding mixture of exposition, mathematics and skepticism.” [Excerpt]

Ackman’s concern was reasonable. Structured finance is easily gamed, and fraud was common. Ackman’s early bet didn’t pay-off, and he was not just ignored, the financial media raked him over the coals. Moreover, Ackman was correct about several other accounting issues unrelated to synthetic CDOs.

Ackman persisted, MBIA protested, and in early 2003, the SEC and New York Attorney General’s office investigated him. The NY AG’s office, then headed by Eliot Spitzer, grilled Ackman for six days. Ackman’s activism eventually led to a two-year investigation of MBIA resulting in its restating seven years of earnings and a $75 million fine.

Ackman didn’t stop. He hired a top forensic accounting expert and several times brought evidence of fraudulent accounting to Moody’s, the leading credit rating agency. Meanwhile, MBIA restated its numbers twice. At the end of 2005, Ackman wrote Moody’s board of directors:


“Moody’s Aaa rating is so powerful and credible that investors don’t do any due diligence on the underlying credit. Every day that Moody’s incorrectly maintains an Aaa rating on MBIA, these extremely risk-averse investors unwittingly buy bonds that are not deserving of Moody’s Aaa rating.”

Confidence Game, Christine Richard, P. 137. (Wiley, 2010).

MBIA escalated its risk. The bond insurer wrote credit derivatives on new “Triple-A” risk backed by malignant mortgage loans, including built-to-fail mezzanine CDOs. It didn’t matter how much “confidence” Wall Street, rating agencies, bond insurers, and regulators had in maintaining a collective financial lie, MBIA was unstable.

In February 2008, MBIA cut its dividend and suspended structured finance activities. Jay Brown wrote MBIA’s investors that Ackman’s “campaign” was an attempt to destroy his business. Ackman’s shorts weren’t the problem. MBIA could have used some shorts of its own, since it was long with too little coverage. MBIA had insured rotting mortgage risk with too little capital to maintain even an investment grade rating.

By June 2008, MBIA and Ambac, the largest municipal bond insurers, lost their “AAA” ratings and slid fast from there. At the end of 2008, Ackman took $1.1 billion in gains for Pershing Square, enough to offset losses in other investments, some of which subsequently rebounded.

Bankers Get Bonuses, USA Gets the Great Recession

Wall Street banks with financial ties to mortgage lenders fueled bad–and often fraudulent–mortgage lending, created phony mislabeled securities, and off-loaded the temporarily disguised risk on bond insurers (MBIA, Ambac, AIG, FGIC, and more) and naïve investors to keep the Ponzi scheme going. A housing bubble fueled by corrupt finance damaged the U.S. economy, and taxpayers bailed out the chief culprits. (“Goldman Sachs: Spinning Gold,” TSF, April 7, 2010)

Those with “friends in high places” did the most damage to the nation’s economy and personally profited the most. It’s also noteworthy that Ackman’s outrage was not directed at investment banks with whom he traded and that underwrote fraudulent value-destroying CDOs, fed him internal CDO data, internal CDO models, and information on MBIA’s and Ambac’s positions, all of which bolstered his confidence to continue with his short positions.The high pay of Wall Street and its cronies doesn’t reflect efficient markets or individual brilliance; it’s a market anomaly born of information advantages and mutual protectionism.

The Great Bailout protected debt holders and some shareholders in corrupt financial institutions. Culprits involved in phony securitizations that damaged the economy have windfall gains and are now heavily subsidized with taxpayer dollars. Bill Ackman’s ordeal shows us how much endurance will be required to reverse these mistakes and reform the financial system.

Endnote: In the interest of full disclosure, I attended Bill Ackman’s book launch party, and I am quoted in the book.

* Jack Caouette retired from MBIA in early 2005 and is now Chairman of Channel Capital Group.

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