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Lindley Estes is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Lindley Estes.
Bond insurers’ role in crisis examined in “Confidence Game”
This was my Business Browser column in Sunday’s Free Lance-Star. It didn’t make it online previously, so here it is.
Richard’s “Confidence Game” focuses on hedge fund manager Bill Ackman’s years-long campaign to convince regulators, bond-rating agencies and the general public of the vulnerability of bond insurers and the ramifications that had on the overall economy.
The book focuses on Ackman’s battle with Municipal Bond Insurance Association, a New York-based bond insurer better known as MBIA Inc.
For many years MBIA and rival Ambac Financial Group Inc. were viewed as ultra-safe Triple-A rated companies engaged in the profitable and plain-vanilla business of insuring municipal bonds.
Issuers of municipal debt paid the firms a fee to insure their bonds, and as a result received a lower interest rate on the borrowed money. That saved taxpayers money and led to steady profits for MBIA and its counterparts.
Things started to go downhill for MBIA and other bond insurers as they ventured into insuring the more complex bonds created by Wall Street to fuel the housing boom in the early- to mid-2000s. Eventually the rising levels of bond defaults swamped the insurers’ ability to pay, leading to ratings cuts, big losses and problems for the institutions that paid for the insurance guarantee.
Ackman’s close examination of MBIA’s books in the early part of the decade convinced him that the insurer was overleveraged and destined to fall. Ackman bet on a collapse of the firm, a wager that eventually earned his Pershing Square Capital Management investors more than $1 billion.
It wasn’t an easy road to that billion for Ackman or his investors. He faced an investigation on charges of market manipulation and a bitter public feud with MBIA’s executives. The investment went south for years before taking a dramatic turn toward profitability.
Ackman read every state ment, analyst report and news article about MBIA. Investors who aren’t willing to dive that deep or stick with their conclusions when the market temporarily goes against them should consider whether they’re equipped to jump in at all.
Though it focuses on MBIA, “Confidence Game” raises broader questions. Bond insurers guarantee against municipal defaults, but many issuers have financial strength that rivals or bests the insurers. When municipal finances have degraded to the point that a bond insurer might have to step in, pressure has been put on state governments to bridge the gap.
Given all that, the book leaves you wondering, exactly what service are bond insurers providing?
The book also casts a critical eye on Moody’s, Standard & Poor’s and Fitch for waiting so long before cutting their credit ratings on MBIA and fellow insurers. The SEC and other agencies are shown dithering amid Ackman’s persistence.
“Confidence Game” is also interesting given the revelation that star mutual fund manager Bruce Berkowitz, who oversees the $15 billion Fairholme Fund, has taken an 11 percent stake in MBIA. The bet shows that the story of MBIA, so well covered in the book, isn’t over yet.