Ackman vs. MBIA: Self-Serving Propaganda Disguised as Analysis

The biggest flaw in Mr. Ackman's model is that he doesn’t appear to know the difference between an “insured credit default swap” and a plain vanilla credit default swap. That’s enough to dismiss his alleged analysis as self-serving propaganda. In most civilized countries, individuals actively campaigning to destroy important financial institutions would be behind bars where they belong.

Mr. Ackman has been short MBIA (MBI) for many years and his analysis has been wrong for many years. The travails of MBIA are the result of regulator-imposed, misguided changes in accounting rules - namely SFAS133.

This is a most important point:

Mr. Ackman has been consistent in his suggestion that his estimates of loss are more accurate than the company’s. He alleged, in his 2002 attack on the company, that our portfolio subject to FAS 133 would have $2 — $3 billion of losses. That portfolio, which has largely amortized or been prepaid at this time, experienced no loss. We don’t believe there’s any basis for giving his current estimates any more credibility than those from 6 years ago.

More from the MBIA letter on “Bond Insurer Transparency; Open Source Research”:

Ladies and Gentlemen:

We have completed a review of the letter you received on January 30, 2008 from William A. Ackman of Pershing Square Capital Management, LP, captioned “Bond Insurer Transparency; Open Source Research”. We would like to share with you our comments on the letter, including our response to its major errors and omissions.

The letter and the model itself are used as support for estimates of the potential for bond insurers MBIA and AMBAC (ABK) to incur claims on credit enhancement contracts we’ve written on collateralized debt obligations (CDOs) and residential mortgage backed securities [RMBS]. Mr. Ackman has a large short position in the shares and credit default swaps [CDS] of AMBAC and MBIA by his own admission, and the letter is clearly intended to influence the prices on those interests to his gain. Consistent with this, Mr. Ackman develops potential loss estimates that are a multiple of those estimated by MBIA, the ratings agencies and other serious analysts. The “Open Source Model” is an attempt to add credibility to those estimates, as is his assertion that the work of identifying the collateral underlying the CDOs was conducted by “a global bank.” We can only speculate as to the reasons the “global bank” desires to remain anonymous; but we are mystified as to how research conducted anonymously, and disclaimed by the party bringing it to the public, could aid in enhancing transparency.

The model and the data appear to have some major deficiencies, as follows:

— The model is described as a “security by security” analysis, while it actually uses an averaging of 1267 randomly selected securities to estimate losses. This is a much less specific approach than the loan by loan analysis undertaken by MBIA on most of our portfolio in formulating our loss reserves and capital forecasts.
— Assumptions driving loss estimates are proprietary to “Global Bank’s” trading model. This is a particularly opaque approach to enhancing transparency.
— The model does not take account of the structures of CDOs and our contracts that provide us protections. The model does not appropriately capture the triggers and cash diversion mechanisms that support the senior interests, nor the fact that we cannot be compelled to settle contracts in 2 years, as assumed. The ultimate principal payments on many of our contracts will take place 30-45 years in the future, and in 8 of the 16 deals we’ve done in 2007, we only guarantee payments that would occur at ultimate maturity.
— The model doesn’t take account of the tax impact of losses.
— The analysis of RMBS transactions employs a steadily increasing default rate which increases by the trend established in the three most recent months. In effect, the model assumes that the elevated default rates expected in the next 18-24 months continue for the rest of the lives of the securities. Although it’s not fully described, it seems likely that this will result in default rates being in excess of those listed in the appendix.

In addition to using a simplistic model that ignores many protections built into the CDOs and applying highly conservative assumptions to generate sensational “headline” numbers, Mr. Ackman also makes other specific points, which are also incorrect.

A brief analysis follows:

— It is asserted that by using internal estimates of credit losses, the bond insurers are somehow “determining the amount of statutory capital.” This is peculiar. All financial institutions who take and manage credit risk in buy and hold positions are required to make estimates of uncollectibility or credit impairment. MBIA has a rigorous process for determining the amount of credit losses in our portfolio of financial guaranty policies and our CDS contracts (it must be remembered that our CDS have the character of financial guaranty insurance policies, not tradable CDS as transacted by most market participants). The process of recognizing loss on our contracts for statutory reporting is governed by SSAP 5, which is consistent with FAS5 (Accounting for Contingencies). Our reserves are based on reasonable estimates of probable losses, in accordance with the guidance. There is no provision in GAAP or statutory reporting for reserving based on worst case hypothetical losses. In no way does the fact of internal estimates permit a bond insurer to “determine statutory capital.”
— It is also alleged that MBIA has said that “all mark to market losses would reverse to zero.” This is incorrect. We have consistently stated that in the absence of credit impairment, the mark to market would reverse over time. We have made that disclosure since the advent of FAS133, and only in Q4 2007 have we had an impairment of a contract subject to FAS 133.
— Mr. Ackman has been consistent in his suggestion that his estimates of loss are more accurate than the company’s. He alleged, in his 2002 attack on the company, that our portfolio subject to FAS 133 would have $2 — $3 billion of losses. That portfolio, which has largely amortized or been prepaid at this time, experienced no loss. We don’t believe there’s any basis for giving his current estimates any more credibility than those from 6 years ago.

— Finally, Mr. Ackman incorrectly suggests that MBIA had some scheme to avoid taking “live questions” during its fourth quarter earnings call. Our four hour call consisted of a two hour management presentation and two hours of questions — about 80% of the questions, including Mr.Ackman’s, were received in advance of the call, but every one of them, and virtually all the questions received during the call were answered.

Comments

[SchraderTrader:]

If MBIA wasn't in serious trouble and Ackman was completely wrong, why wouldn't Buffett simply acquire the entire package? Why is he going through the startup expense of launching a new insurer? Or why haven't any of the larger banks acquired these insurers? We know they could get an excellent value at this level just purchasing outright based on the long shot you're proposing that MBIA will be fine. HMMMMM, maybe it's because Ackman may be somewhat correct and these companies which acted against their traditional models are going to have to eat a huge piece of humble pie. Maybe they're responding so aggressively because the executives don't want to lose their jobs. Or maybe they are ok, but stepping back and seeing the grander picture tells me otherwise. If they were going to be ok, they would have been acquired by now.

Ackman did his own due diligence and has attempted to warn people for years about this. You've simply taken what MBIA has provided as a response and created your own personal attack. Well done.

Finally, you can't blame the guy for positioning himself well prior to announcing his own research, and with FULL DISCLOSURE. I don't know Ackman and I personally hope the insurers do survive but I think personal attacks without one's own evidence is absurd.

All The Best

2008 Feb 15 08:22 AM

[User 124892:]

MBIA
It is a bargain, could be a long term buy, after the Bush, administration bails it out.

2008 Feb 15 09:21 AM

[SchraderTrader:]

As it stands now though (assuming financial difficulties are on the way), I don't see it as a bargain. The risk is greater on the downside than missing potential upside. There will need to be a strong catalyst (as User124892 stated) to change things.

2008 Feb 15 09:42 AM

[Etz:]

It's amazing that people can be so naive.
MBI officers are either lying or don't understand their own business.

2008 Feb 15 10:00 AM

[SchraderTrader:]

The real question: what happens to them when they're broken up?

2008 Feb 15 10:05 AM

[GKM:]

I agree with most of the comments here in contradiction to the article. Keep it simple. Has Ackman been right? Yes. Are the monoline insurers in big trouble? Yes.

Sure Ackman has his own motivations for what he is doing and maybe he isn't getting the fine print exactly right but who cares. Do you really want to trust MBIA or Ambac's executives that they aren't putting their own spin on things? Did you trust Ken Lay or Angelo Mozillo or Tyco's executives or MCI's? I tried to find a list of the worst/most fraudulent CEO's in history and couldn't find one. If we don't keep track of history, aren't we doom to repeat.

Time will tell who is ultimately right but Ackman is leading by a mile (on a quarter mile track). You can have my share of the cool aid Mr. Kommer.

2008 Feb 15 03:02 PM

[Johnny Bitc...:]

JC you are a DA.

I agree with the previous posters comments that you add nothing when you simply cut and paste MBIA management critique.

The idea that a man with an informed opinion about MBIA's business is a danger to the financial system is absurd. Ackman has been largely correct and MBIA has failed to timely disclose material information.

MBIA management is a much greater danger to the system than Ackman.

Quit your whining and take your losses like a man.

jbd.

2008 Feb 15 03:27 PM

[RPK:]

These are models, garbage in = garbage out. Three years ago most would have considered MBIA to be correct and Ackaman to be wrong.

2008 Feb 15 09:50 PM

[FIG trader_:]

Bitchdog; well said, The funny thing is if Ackman is still short and correct that BK is a 2008 event, this will go to zero and JC will lose even more. Does JC he think its going back above $70, or is he hoping for a double to $25. I think he is in the former camp, like many disbelievers. I for one applaud Ackman for doing what no other analyst (or very few) was able to do, defy the sellside, rating agencies, and the whole machinery of Wall Street singlehanded

2008 Feb 16 06:04 AM

[valueinvest...:]

Ackman can only make the stock go down so much. In the end, it is MBIA's results that have hurt the stock the most. This is why some of Ackman's longs like SHLD and BGP have had horrendous results since he announced his stake. In the long run he does not move a stock and MBIA's share drop is a reuslt of their terrible results.

2008 Feb 16 12:45 PM

[Johnny Bitc...:]

I am not even sure how much impact Ackman had in the short run. In the end it took the credit crisis as a catalyst to expose the fraud and related vulnerability in the ratings system driven markets.

No doubt Ackman might have impacted the speed of adjustments as the market came to understand more clearly that the ratings fraud could no longer be perpetuated, but where it has settled or ultimately will settle is purely based on economics. There is simply too much focus on this thing by value oriented investors to expect it to be hugely under or over-valued at any given point in time.

It could skyrocket or crash at any time depending on uncertain regulator actions or credit events, but that doesn't mean it's not at an equilibrium, albeit tenuous, right now.

My personal view is that the equity holders won't lose it all unless there is a liquidity crisis. If the regulators force a split based on speculative future losses, it will be nearly impossible to do this without treating equity holders well. If the regulators over-reach by destroying equity value, the threat of future lawsuits is too great.......

I look for a break-up solution which treats the equity holders reasonably well, at least in the short-run.....

In the long-run I look for continued deterioration in the credit markets including muni's to further destroy equity value.....

It's a buy more than a sell currently on a break-up solution that will be acceptable. but it's a sell on long run economics.

how's that for taking both sides ?!

jbd.

2008 Feb 16 01:10 PM

[hook:]

this is just an awful whining article by JC. why is this guy a seeking alpha writer? it takes away from the value added of other authors.

2008 Feb 16 01:50 PM

[calvino:]

The biggest flaw in your argument is that you do not know the difference between an insured credit default swap with an insolvent counter party and a plain vanilla credit default swap with an insolvent counter party. There is no difference. Since Ambac and FGIC and Cross Channel and MBIA have been insuring each others swaps, there is no insurance. The biggest howler is 'the tax impact of losses' defense. That worked really well for GM last week or you could just say billions were written off the balance sheet because GM said they will never have the income to take advantage of the writeoffs. Good grief.

2008 Feb 16 11:50 PM