NEW YORK (Reuters) – Bill Ackman, whose hedge fund has been bettingagainst bond insurers since at least 2002, said in a letter to U.S.regulators that rescuing the bond insurers will only prolong the creditcrisis, and the companies should instead be allowed to fail.
In the letter obtained by Reuters, Ackman said bond insurers inrecent years have become a means for banks to avoid reporting theirfull credit exposure and make their capital ratios appear stronger, butthat banks should be forced to own up to their full credit risk.
"(W)e understand that the banking industry counterparties to thebond insurers would prefer to avoid taking these … risks back onbalance sheet — particularly at a time when their balance sheets arestrained by subprime and other losses that have not been hedged,"Ackman wrote, adding that "there are no such free lunches available inthe capital markets."
Bond insurers have in turn been critical of Ackman and otherinvestors betting against the companies. On a recent conference call,MBIA Inc (MBI.N: Quote, Profile, Research)Chief Executive Gary Dunton railed against "the fear mongering andintentional distortions of facts about our business that have beenpumped into the market by self-interested parties."
New York State Superintendent Eric Dinallo is working with banks torescue bond insurers including Ambac Financial Group Inc (ABK.N: Quote, Profile, Research)and FGIC Corp, which face billions of dollars of potential losses afterguaranteeing bonds linked to risky subprime mortgages and other debt.
One idea floated by Dinallo early in discussions was banks puttingup a rescue fund of about $15 billion to save the insurers, accordingto a person briefed on the matter. That idea has now given way toseparate rescues of the companies, which collectively guarantee morethan $2.4 trillion of bonds.
But some analysts argue a rescue will take a lot more than $15billion. Sean Egan, managing director of independent credit rating firmEgan-Jones Ratings Inc, says the top six bond insurers face roughly $80billion of eventual losses, and probably need more than $200 billion ofnew capital.
Ackman said in his letter that given the eventual losses the bondinsurers face, banks that have traded with the companies should writedown their exposure today and raise enough new capital so they cancontinue to operate safely.
Banks and bond insurers should be forced to disclose their exposureto repackaged bonds and loans known as collateralized debt obligationsimmediately, Ackman added in the letter, which was addressed to FederalReserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson andothers.
Ackman is founder of Pershing Square Capital Management, which hassold shares of Ambac and MBIA short in a bet they will decline.Pershing Square manages some $6 billion. In addition to these shortpositions, the company also buys shares of companies and agitates forchange, as at McDonald’s Corp and Wendy’s.
THE INSURERS’ CASSANDRA
Investors for years ignored bearish analysts like Ackman, andinstead sent shares of bond insurers like Ambac and MBIA Inc to recordlevels as recently as the beginning of 2007.
But investors have become much more open to Ackman’s arguments inrecent months as bond insurers have reported billions of dollars ofpayouts, posted quarterly losses that eroded a substantial portion oftheir net worth, and edged closer to losing top ratings crucial fortheir business.
If U.S. bond insurers lose their top ratings, global financialmarkets could be hurt. Investors that can only hold top-rated bondswill be forced to sell them, while banks will be forced to recordlosses that some analysts estimate at $70 billion or more.
Bond insurers originally focused on guaranteeing municipal bondsagainst default. Tax-free bonds issued by cities, states, and othergovernment entities rarely default, which meant that bond insurersrarely had to make payouts, and could maintain fairly low levels ofcapital relative to their exposure.
But in the last decade, the insurers have sought higher returns byguaranteeing repackaged subprime mortgages and other risk assetsagainst default, which turned out to be a losing bet after housingprices stopped rising, borrower defaults jumped and credit markets wentinto a tailspin.
(Reporting by Dan Wilchins)
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