Bloomberg has an interesting tale about hedge-fund biggie Bill Ackman’s “greatest short ever,” in an excerpt of a forthcoming book by reporter Christine Richard.
Ackman saw way back in 2002 that monoline insurer MBIA was headed for deep trouble. The company was rated AAA even though it was levered 140 times, and he thought it had “inadequate reserves, undisclosed credit-quality problems, aggressive accounting and substantial unconsolidated indebtedness contained in off-balance-sheet special-purpose vehicles.”
Richard reports that Ackman shorted MBIA using credit-default swaps, which are essentially insurance against a company’s demise. Now, in regulated insurance markets (CDS—thanks Phil Gramm, Bob Rubin,and Larry Summers—are unregulated) you can’t buy insurance on something you don’t own. That’s unlike a traditional short sale, which entails borrowing and selling a company’s stock in the hope that you can replace it with cheaper shares later. We’re not told in this excerpt why Ackman bought CDS instead of shorting the stock, but the bet paid off to the tune of $2 billion.
You can often tell whether a company is a good short or not by how they react to being shorted. If you’ve got a solid company, you don’t tend to worry about such things. Fundamentals will prevail. If you’re weak, you do worry about them. That’s what Ackman says happened here (emphasis mine):
“This isn’t about the facts; it’s about process,” Ackman recalls Brown saying. “You’re a young guy, early in your career. You should think long and hard before issuing the report. We are the largest guarantor of New York state and New York City bonds. In fact, we’re the largest guarantor of municipal debt in the country. Let’s put it this way: We have friends in high places.”
The meeting ended abruptly. As the men filed out of the room, Ackman reached out to shake Brown’s hand.
“I don’t think so,” Brown said, refusing to extend his hand.
One thing missing here is any discussion of the long-term nature of the bet. Ackman placed it in 2002, but MBIA stock didn’t crater for another five years. It’s sort of kind of implied that MBIA’s early actions helped him have faith in such a long bet.
But it’s an interesting behind-the-scenes look we get at a confrontation between a short and his target.
UPDATE: It was also interesting when Jesse Eisinger wrote about it in Portfolio a year ago. Credit where it’s due.