Bill Ackman & MBIA

Joe Nocera of the New York Times has an article describing Bill Ackman's pursuit of MBIA. For those not familiar, Bill Ackman is an investor that has been bearish on bond insurers for many years. He recently gave a presentation at the Value Investing Congress implying that companies like MBIA and Ambac are insolvent if they can't raise capital. Let me quote some key comments in the article:

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 purchased credit default swaps as a way to profit in the event of a bankruptcy by the holding company.

The impressive thing about Bill Ackman is that he has stuck to his original thesis. It would have been extremely difficult for an average person to be bearish and short MBIA since 2002. The stock, along with other monolines, have run up so much in the last few years that most people would have been tempted to change to their opinion and move on to other investments.

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...

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.

Clearly everyone, whether a bull or a bear, are staking out their position and have a good case for their thesis working out.

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.

I think the monoline superbears, such as Bill Ackman, Reggie Middleton, and others, clearly think that the whole bond insurance business makes no sense. A key reason many of these people are extremely bearish (you can't get more bearish than saying a company may be insolvent without it actually being right now) is that they don't think insuring a bond to a higher rating, say AAA, from AA, is a viable business.

The author of the article goes on to point out that wrapping municipal bonds to AAA may make sense but the others (like structured finance products) are too risky and not a viable business. People who are bullish, like me (although I have no position in any of the monolines), don't buy that view. In any case, whatever the case may be, it is up to the market to indicate whether this a viable business or not. I think we will know for sure in 5 years, when the market refuses to buy AAA wrapped insurance on bonds, or, instead, still keeps paying for the insurance. Of course, for contrarians like me, that's well after the investment opportunity in monolines has passed.