Judgment Day Approaching For Bond Insurers

Hasta La vista, baby?

A belated downgrade of AMBAC yesterday by William Blair looks good given today's price action. With AMBAC down 60%, and the equity market cap under $500 million, most of the blood has gone out of this turnip. As they said in a note addressing the CEO's departure and record losses of $1.24 billion in various securities, "we view this development as a disappointment at the maximum point of stress in AMBAC's corporate history". Uh-huh.

But with the ratings agencies starting new reviews after affirming ratings on AMBAC and MBIA just one month ago, it appears the jig is up:

``No one knows when the end may be in sight, including the raters,'' said Richard Larkin, a municipal bond analyst at JB Hanauer & Co. in Parsippany, New Jersey. ``The rating agencies have lost as much credibility as the bond insurers. Every time you turn around they're changing their minds about what's going to happen in the subprime-mortgage market.'' Bloomberg

The dominoes are about to topple, we should soon see what this market is made of while the S&P 500 tenuously clings to important technical support levels. Perhaps we will get the capitulation everyone has waited for, although small-cap managers would laugh at that statement given what they have been though recently.

However, as bad as the news flow has been, some stocks have been hanging tough; Merrill Lynch is trading near levels from early November, but there have been many debacles unfolding in other securities since then, including the worst of the lot, AMBAC and MBIA. Ambac is calling Moody's decision "surprising", which is comical. The Street has had weeks, if not months, to prepare for this eventuality.

Bill Ackman's Pershing Square hedge fund has made a fortune off the trade to the short side. In November the bond insurers were predictably defending themselves from Ackman's onslaught:

Separated at Birth?

``We stand by the internal ratings of our book of business, which are almost 100 percent investment grade,’’ said Ambac spokesman Peter Poillon.

``We strongly disagree with Mr. Ackman’s statement that the company will be insolvent in the second quarter of 2008,’’ said Jeff Lloyd, a spokesman for MBIA, in an e-mailed statement. ``He made similar statements in 2002, none of which have come true.’’

Ackman famously claimed that he would donate his share of the partnership profits from his AMBAC position to charity:

Ackman said he personally stands to gain about $500 million if MBIA’s holding company failed and that amount would be donated to charity. The fund itself stands to make ``multiple billions of dollars’’ if the holding companies of MBIA and Ambac were to fail, he said.

``The hedge fund business is profitable. I’ve made more than I need,’’ Ackman said. ``I also think it’s the right thing to do.’’

Ackman’s Pershing Square Foundation funds such organizations such as the Council for Urban Professionals, in which Ackman’s compadre Whitney Tilson is also involved:

The Council of Urban Professionals (http://www.nycup.org) is a New York-based nonprofit organization whose members are primarily minority professionals.  CUP’s mission is to advance the agenda of urban professionals and their communities with a special emphasis on increased business opportunities, economic development, leadership development and education reform.  CUP is particularly motivated to improve educational opportunities for young people, especially low-income African-American and Latino children.  The Pershing Square Foundation is affiliated with Pershing Square Capital Management, a New York City-based investment firm.  REACH is the brainchild of CUP board member and education reformer Whitney Tilson, who is an advisor to The Pershing Square Foundation.

The good guys won here; and Ackman proved his point. On Wall Street, winning sometimes trumps money. Capitalism, and our capital markets, will survive despite the pain.

We would look for Ackman to book a flight to China as soon as their regulators allow short selling. Free markets, in all their imperfections, are the way to go. The communists have proven to be decent capitalists and quick studies, but might want to take away a few lessons away from this saga.

Moody’s, S&P Reviewing Bond Insurers as Losses Mount
Bloomberg

MBIA, Ambac Bear Ackman to Donate Profit to Charity
Bloomberg
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The content contained represent the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. No Positions

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