Confidence Game is a real-world Emperor’s New Clothes, a tale of widespread delusion and a dissenting voice in the era leading up to the worst financial disaster since the Great Depression. Wall Street appeared to have found the secret for turning everything from risky mortgages to credit card bills into super-safe, triple-A-rated securities. Yet, behind this façade of safety, the financial system had become dangerously fragile. Few had anything to gain from pointing out the risk.
But in 2002, hedge fund manager Bill Ackman issued a critical research report on a triple-A-rated company called MBIA, Inc., which played a central role in the financial alchemy on Wall Street. "This company will spiral downward," Ackman warned, and he placed a bet against MBIA that would earn his investors billions of dollars if it did.
The backlash was swift. Ackman was branded a fraud in the press and investigated by Eliot Spitzer and the SEC. Despite the scrutiny, he spent years telling anyone who would listen why MBIA was a catastrophe waiting to happen.
When catastrophe arrived with the onset of the credit crisis, the problems exposed turned out to be bigger than MBIA. An unquestioning acceptance of credit ratings, a blind-eye to leverage, a dangerous reliance on financial models, and the abandonment of common sense had become part of a deeply flawed financial system. The collapse humbled nearly every large financial institution and plunged the country into recession.
Ackman's story captures an era of delusional confidence when debt exploded yet risk appeared to vanish. Told by award-winning bond market reporter Christine Richard, Confidence Game is a behind-the-scenes look at how warnings went unheeded as Wall Street careened towards disaster.
How a Hedge Fund Manager Called Wall Street's Bluff
by Christine S. Richard
Bloomberg Press/Wiley, 335 pages, $27.95
Confidence Game: How A Hedge Fund Manager Called Wall Street's Bluff came out in late April, and so far as I can tell it hasn't gotten much review attention from the "major" press outlets. The Wall Street Journal, the New York Times, and the Financial Times have all ignored it; I only stumbled upon the book via a mention in John Hempton's Bronte Capital blog.
The lack of attention is a shame, because it's an amazing, amazing book.
Hedge fund manager William Ackman gave author Christine Richard impressive access. She writes, "Ackman gave me a CD-ROM containing every e-mail he had written or received that mentioned MBIA as well as years of appointment calendars and access to an office filled with more than 40 boxes of documents he'd collected in researching MBIA. He encouraged colleagues, advisers, and friends to talk with me and spent hours answering my questions."
The result is a fast-paced, behind-the-scenes look at how a "short" investor uses the press, stock analysts, and the government to beat down the price of a stock he has bet against.
The first example the book recounts is a company called Federal Agricultural Mortgage Corporation, also known as Farmer Mac. Ms. Richard writes, "Before Ackman's involvement, Farmer Mac was rarely mentioned outside of trade publications such as Progressive Farmer and Pork Magazine. Ackman's research landed the company on the front page of the New York Times business section after he spoke with reporter Alison Leigh Cowan about his findings." Congress followed with its own investigation.
One meeting between Ms. Cowan and Mr. Ackman lasted "eight, maybe twelve hours," according to the book. Yet in Ms. Cowan's first two lengthy reports on Farmer Mac for the New York Times (see here andhere) Mr. Ackman's role as a source isn't mentioned, nor is his fund's short position in the stock.
The Farmer Mac battle is a mere prelude, however, to Mr. Ackman's campaign that is at the heart of this book, his war against Municipal Bond Insurance Association, or MBIA.
Here the key journalist seems not to have been anyone at the New York Times, or even Ms. Richard, who worked for Dow Jones and Bloomberg. No, it was "Marty Peretz, the editor-in-chief of the New Republic magazine, who had been Ackman's thesis adviser when he was an undergraduate at Harvard." (Ms. Richard doesn't say so, but for those who are interested, the thesis was titled "Scaling the ivy wall : the Jewish and Asian American experience in Harvard admissions.")
Mr. Peretz, reports Ms. Richard became the first investor in Mr. Ackman's hedge fund after Mr. Ackman "drove from Boston to Peretz's summer house on Cape Cod to pitch him the idea." (Mr. Peretz tells me the investment was $500,000, made at the time and not subsequently increased.)
By Ms. Richard's account, Mr. Peretz wasn't exactly what you'd call a passive investor. After the SEC didn't really follow up on a meeting in which Mr. Ackman aired his allegations about MBIA to SEC staff, Mr. Peretzwrote in July 2004 to the chairman of the SEC, William Donaldson, "with whom he was friendly." Reports Ms. Richard, "Peretz's appeal stirred a response at the SEC, which asked Ackman to return to Washington."
If the SEC did not act against MBIA, Mr. Ackman would try another regulator, the attorney general of New York, Eliot Spitzer. Ms. Richard reports that in January or February 2005: "Ackman, along with Marty Peretz, and Eliot Spitzer were huddled around a small table in the attorney general's office, eating pressed turkey sandwiches. Peretz had arranged the lunch meeting. Ackman wanted to point Spitzer toward the important issues at MBIA."
If Mr. Spitzer and the SEC both did not act, there was always the chairman of the House Financial Services Committee, Barney Frank. The book recounts Mr. Ackman and his lawyer flying to Boston on June 5, 2007 for a meeting with Congressman Frank, with whom they visited only after they "picked up Marty Peretz, who knew Frank from their student days at Harvard." Mr. Frank agreed to hold hearings on MBIA.
(The whole issue of whether or how Mr. Peretz's business agenda with these regulators affected The New Republic's coverage of them during this period goes unmentioned and unexplored by Ms. Richard. The New Republic ran a fawning profile of Mr. Donaldson referring to him as an "unsung hero": "given the speed and effectiveness with which Donaldson has turned around an ailing agency, it's no small stretch to call him the only bright star in the very dim galaxy of the Bush economic team." Mr. Peretz himself wrote an article for the magazine over his own byline, suggesting that Senator Kerry choose Mr. Spitzer as his vice presidential running mate: "Call me hyperbolic, but Spitzer reminds me of Theodore Roosevelt--not the TR of bluster, but the TR of remedy and of vision. … Spitzer is a popular hero because he is the one politician to have done something concrete for all the people. …. Spitzer's mind cuts sharp and runs deep. His liberalism is of the muscular sort." In 2008 The New Republic ran a profile of Mr. Frank referring to him as "indispensible."
I asked Mr. Peretz whether his regulatory business before Mr. Donaldson, Mr. Frank, and Mr. Spitzer affected The New Republic's coverage of them in any way, and he replied to me, "I had no fiduciary business before or with Donaldson, Spitzer or Frank. … In my writings I am never influenced by my investments or, for that matter, by my financial holdings or position….The bottom line: I introduced friend to friend; the government officials found what I told them intriguing and persuasive; they did what they did because of that.")
There's plenty of other rich detail here. The broker who gave Mr. Ackman the idea to short MBIA worked for, of all places, Lehman Brothers.
The dependent relationships among short-sellers, regulators, and the press are illuminated for all to see. At one point, Mr. Ackman asks an SEC official what it would take to get the agency to act. The SEC official's reply? "A story on the front page of the Wall Street Journal or the New York Times, especially the New York Times."
Also illuminated are the interactions between and among the shorts. When Morgan Stanley put out a research report on MBIA, Jim Chanos and David Einhorn emailed Mr. Ackman about it. Daniel Loeb, who "had talked to Ackman for several years about MBIA" and "also held short positions on the bond insurers," sent Mr. Ackman a book in the mail as a gift.
What to make of the whole episode? Well, it's certainly a newsworthy tale, and not only for those interested in hedge funds or short-selling. One MBIA vehicle named something like Latin for "black hole," Ms. Richard reports, "owned liens on 11,000 properties in Pittsburgh, nearly 10 percent of the entire city."
As an investment idea, shorting MBIA was a big success. The shares lost more than 80% of their value. "Pershing Square investors made about $1.1 billion," Ms. Richard reports. About $140 million of that was Mr. Ackman's personally, though, Ms. Richard reports, he has pledged the entire amount to charity.
The firm did not, however, go bankrupt, as Mr. Ackman had bet it would; in fact, it lasted longer than Lehman Brothers, which, recall, according to Ms. Richard, was the firm that had given Mr. Ackman the idea to short MBIA. MBIA did eventually pay $50 million to settle civil securities fraud charges brought by the SEC. But surely not every overvalued stock or highly leveraged company is a case for a congressional hearing or an investigation by the SEC or the New York attorney general.
Those troubled by Mr. Ackman's use of the regulators to press his position at least have to concede that MBIA and its allies also used the regulators to press their own case against Mr. Ackman, subjecting him to SEC and New York attorney general inquiries that were eventually dropped.
While Ms. Richard's book is finished, the story isn't over. A Marketwatch story from July 13, 2010 began, "Shares of MBIA Inc. rose 11.5% Tuesday after it was disclosed late Monday that top fund manager Bruce Berkowitz had taken a large stake in the company. Shares of MBIA closed at $7.17 after a regulatory filing showed that Berkowitz owned an 11% stake in the bond insurer. The filing showed that Berkowitz's investment-management firm, Fairholme Capital Management, holds slightly more than 22 million shares of MBIA. The stock is up roughly 80% in 2010."
While the shares may have not been worth the more than $70 a share they were trading at during times when Mr. Ackman was shorting it, they may be worth more than the $2.29 they were trading at in March 2009. What's more, if Mr. Berkowitz makes money on his position, it may be because the company he has invested in has grown its profits, while Mr. Ackman's big bet was that the company would go bankrupt, a course that would have probably also entailed laying off a lot of employees.
It's all something to keep in mind as the short-sellers circle the for-profit education industry using the same strategy of press and regulatory pressure that was deployed so successfully against both Farmer Mac and MBIA.
For public companies, the threat of getting Mr. Ackman and Mr. Peretz and their friends at the SEC, the New York attorney general's office, and the House financial services committee on your case should provide plenty of incentive to manage your affairs super-carefully, if any such incentive were needed. And for private companies, the threat of being targeted by short-sellers and the regulators and press they bring in tow provides some argument for avoiding a public listing altogether.
As for those who have abiding faith in government regulation, beware. While the SEC was ignoring Bernie Madoff, it was busy investigating the allegations of Mr. Peretz's friend Mr. Ackman, or at least coaching him that if he really wanted SEC action the key to it would be a front-page New York Times article. It's not exactly the impartial rule of law as envisioned in a typical civics textbook.
Disclosures: Where to begin? I once wrote an article for the New Republic. I own stock in Leucadia National Corp., which, according to its most recent annual report, had about $33.5 million invested in an Ackman-managed fund called PershingSquareIV, L.P. (That fund invested in the retailer Target.) Some of the people who were my partners in the New York Sun invested in Mr. Ackman's funds, and some of the investors in the Sun invested in The New Republic while Mr. Peretz was editor-in-chief. Mr. Peretz and I are both Zionists. At least one of my friend's charities gets money from Mr. Ackman. The New Republic recently annoyed me byaccusing me, falsely and without seeking comment from me, of ignoring my children, and then by trying to charge me money for the privilege of responding to the attack.