Ackman Devoured 140,000 Pages to Prove `MBIA Was Never AAA'

By Christine Richard and Katherine Burton of Bloomberg

Jan. 31 (Bloomberg) -- It was the $109,000 photocopying bill that hedge fund manager William Ackman says made him realize how much he'd read and underlined before betting against bond insurer MBIA Inc. in 2002.

His law firm charged him for copying 725,000 pages of financial statements and other documents, 140,000 of them about MBIA, to comply with a subpoena. Following New York and U.S. probes of his trading and reports, Ackman persisted in challenging MBIA's AAA credit rating for more than five years, based on his own research.

Ackman may soon be proved right. MBIA, the largest provider of insurance against defaults in the global credit market, today reported a fourth-quarter net loss of $2.3 billion because of a slump in the value of mortgage-related securities it guaranteed. The independent research firm CreditSights Inc. this week said MBIA's credit rating may be downgraded. Ackman had warned that MBIA was magnifying its risks by backing instruments such as those based on loans to the least creditworthy homebuyers.

``It's in the nature of a shareholder activist to be persistent,'' says Ackman, now 41. ``I've been persistent because it's an important issue. People are obsessive about stupid things. They are persistent about important things.''

In the MBIA documents, Ackman says he saw that the insurer was guaranteeing untested asset-backed securities. He also found a reinsurance transaction that allowed the company to downplay a loss. MBIA agreed in January 2007 to pay $75 million to settle U.S. regulators' inquiries into that deal.

$2,000 Bet on SAT

Ackman peppered rating companies and regulators with letters, e-mails and presentations criticizing MBIA's credit rating. He also got then-New York Attorney General Eliot Spitzer, who was investigating Ackman's activities, to probe MBIA.

Shares of MBIA, based in Armonk, New York, fell $2.02, or 13 percent, to $13.96 yesterday in New York Stock Exchange composite trading. The stock is down 81 percent from a 52-week high of $72.85 on Feb. 6, 2007.

In high school Ackman bet his father $2,000 that he would get a perfect score on the verbal portion of the SAT college- entrance exam. He says his dad called off the wager the morning of the test for fear he would lose the bet, though Ackman ended up scoring wrong on one answer.

Betting against MBIA and the No. 2 bond insurer, New York- based Ambac Financial Group Inc., helped Ackman's New York-based fund, Pershing Square Capital Management, to return 22 percent net to investors last year. He says he plans to give his personal gains on the bond insurers to Pershing Square's charitable foundation.

Speaking Publicly

``He has spoken out publicly about it, approached regulators, talked to the media,'' says David Einhorn, 39, head of New York-based Greenlight Capital LLC, who also has wagered against MBIA. ``He's not more right today than he was five years ago that MBIA was never AAA.''

Yesterday, in a letter to the Securities and Exchange Commission and to New York Insurance Superintendent Eric Dinallo, Ackman said MBIA and Ambac may each lose $11.6 billion on guarantees of mortgage-linked debt and other securities. He posted a list of the securities the two companies guaranteed on the Internet, along with a model supplied by an unnamed investment bank, so investors could do their own forecasts of what the insurers might lose.

In 2003, as the New York attorney general's probe was under way, Ackman fired off a memo to MBIA posing 146 questions he says the company never answered. The first was, ``Why did you have me investigated?''

`Emperor Has No Clothes'

``No one wanted to believe that a AAA-rated company was doing what it was doing,'' says Roger Siefert, a forensic accountant Ackman hired in 2003. ``We were treated like the little boy saying `the emperor has no clothes.'''

Chuck Chaplin, MBIA's chief financial officer, says in an interview that Ackman's criticism reflects misperceptions of the bond insurer's business. He disputes Ackman's estimates of MBIA's losses and says the trader is benefiting more from lucky timing than smart analysis.

``He was at the right place at the right time,'' Chaplin says. ``The past six months turned out to be a good time to be short business sectors with mortgage-market exposure, and as it turned out, the bond insurers ended up being one of them.''

Martin Whitman, the 83-year-old chairman of New York-based Third Avenue Management LLC, dismissed Ackman's criticism of MBIA in a December interview on CNBC.

``Mr. Ackman is a slick salesman who doesn't know much about insurance,'' Whitman said. Whitman's firm owned more than 10 percent of MBIA's stock, he said in the interview.

Advertising Commissions

Ackman earned undergraduate and business degrees from Harvard. His father, Lawrence Ackman, recalls that his son and another student worked one summer selling advertising for the ``Let's Go'' travel guides and earned unusually high commissions of $15,000 to $20,000.

``The next year they reduced the commission rates and ruined it for all future students,'' Lawrence Ackman says.

Straight out of business school, Ackman started his first hedge fund, Gotham Partners, with fellow student David Berkowitz. In the mid-1990s, Gotham tried to buy Rockefeller Center. During the talks, Ackman, then 28, says he got a call from Donald Trump.

Call From Trump

``He said to me, `Bill, Goldman Sachs is stealing Rockefeller Center and we've got to sit down and try to work something out,''' Ackman says. The two never agreed to work together.

In July 1996, a group led by Goldman Sachs and David Rockefeller, the philanthropist and former chief of Chase Manhattan Corp., took control of the center for $1.2 billion in cash and assumed debt. Gotham made a profit selling a stake in the property to Goldman, Ackman says. Trump didn't respond to a request for comment.

Ackman took an interest in MBIA after asking a credit- market trader which companies didn't deserve AAA ratings, he says. In a report entitled, ``Is MBIA Triple-A?'' he argued that the company had insufficient reserves to cover potential losses and was guaranteeing increasingly risky debts.

He disclosed taking a short position in MBIA, in which an investor sells borrowed stock, expecting to repurchase it later at a lower price and return the shares to the owner. Ackman also bought credit-default swaps, financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. The swaps would rise in value if doubts about MBIA grew.

Spitzer Investigation

Late in 2002, Ackman published his MBIA findings on Gotham's Web site. Ron MacDonald, the head of reinsurance at MBIA until 1999, read the report early in 2003 and e-mailed Ackman praising it, MacDonald says.

Ackman learned in January 2003 from a Wall Street Journal reporter that Spitzer was investigating whether Gotham had engaged in manipulative trading on MBIA and other companies and that the newspaper would publish an article the next day. The SEC later started its own probe.

``This is going to be a good thing,'' Ackman says he told friends that evening. ``I'm going to meet Eliot Spitzer.'' He says he saw it as an opportunity to turn the tables and present his concerns about MBIA.

Spitzer was investigating not only Ackman's position in MBIA, but also his trading in two other companies, Pre-Paid Legal Services and Federal Agricultural Mortgage Corp., or Farmer Mac. Spitzer, now the New York governor, didn't respond to a request for comment.

Turning the Tables

Ackman and Siefert, the forensic accountant, drew investigators' attention to the reinsurance deal that led to the $75 million settlement a year ago. The transaction covered MBIA for losses related to the 1998 bankruptcy of a Pennsylvania hospital group.

Meanwhile, Ackman made a series of presentations to Moody's Investors Service Inc., the New York-based credit rating company, challenging the bond insurer's top credit grade. In 2005, he wrote to Moody's warning that it was risking its own credibility by keeping MBIA at AAA.

``I apologize for putting you and Moody's on the spot,'' Ackman wrote. ``I have simply lost patience, and it is 2 in the morning.'' A Moody's spokesman said no one was available to comment.

Ackman says he recently received notification that the SEC had ended its investigation of him without any finding of wrongdoing. The letter arrived only after he wrote to the SEC chairman and the agency's four commissioners demanding it.

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McDonald's Slides on Consumer Cutbacks

Ruthie Ackerman (Forbes)

McDonald’s fourth-quarter profit jumped on strong international sales, but flat domestic same-store sales in December sent the company’s shares sliding as investors worried that the downturn in the economy could impact the world’s No. 1 hamburger chain. The Oak Brook Ill.-based company’s shares slid 6.4%, or $3.48, to $50.62 in afternoon trading, but the decline held the Dow Jones industrial average back from even stronger gains. On Monday, McDonald's reported that its net income rose to $1.3 billion, or $1.06 per share, up from $1.2 billion, or $1 per share, in the prior year. Excluding income tax benefits of 33 cents per share, the company still earned 73 cents per share, beating analysts’ estimates of 71 cents per share. Sales rose 6% to $5.8 billion from $5.5 billion in the fourth quarter of 2006. Analysts polled by Thomson Financial predicted sales of $5.6 billion.

UBS analyst David Palmer said Europe's profit growth was the main driver in the quarter, but flat same-store sales in the U.S. were worse than expected. The company blamed its flat domestic same-store sales for December on winter weather and weaker consumer spending, but says it remains confident in its U.S. business. While its United States business posted same-store sales growth of 3.3% for the fourth quarter, global same-store sales soared 6.7% led by a 11.4% comparable sales increase in the Asia/Pacific, Middle East and Africa segment. Palmer said that McDonald's sales slowed substantially more than the industry in December, indicating that it benefited from Taco Bell's e-coli scare in December 2006. McDonald’s said it will begin paying its dividend on a quarterly basis in 2008. The next payout will be for 37.5 cents per share on March 17 for the first quarter to shareholders of record on March 3. The board will review the dividend rate on an annual basis each fall. Palmer maintained his "buy" rating and his $67 price target.

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Pressure Mounts on ECB to Trim Rates

By JOELLEN PERRY (Wall Street Journal)

DAVOS, Switzerland -- As recession fears rout global markets, the Federal Reserve slashes interest rates and the governor of the Bank of England hints of another rate cut, what will it take for the European Central Bank to finally cut its short-term interest rates? The short answer now: A little time.

The ECB has been an outlier among major central banks since the summer, keeping its key rate on hold as inflation worries trumped growth concerns, even as the Fed, the Bank of England and the Bank of Canada cut borrowing costs to rescue ailing economies. "Now, the question for the ECB is not if they'll lower rates, but when," says Neville Hill, economist with Credit Suisse in London.

Pressure on the ECB is mounting. Investors Tuesday priced in up to three one-quarter-percentage point ECB rate cuts this year, which would bring the ECB's key rate to 3.25%. Markets are betting on a rate cut in May; some economists say signs of a weakening in euro zone growth prospects could bring a rate cut as early as March.

Despite some recent softening in their rhetoric, ECB policymakers have, so far, maintained that strong domestic momentum coupled with solid global growth could help the 15 nations that share the euro currency expand close to its 2% trend rate this year -- even as the U.S. slows. But "if the US problem is so large that the Fed has this kind of reaction, then it will have an impact in Europe as well," says Marco Annunziata, chief economist with UniCredit in London. "So the idea that Europe is doing just fine doesn't hold anymore."

But subtle shifts in ECB officials' recent rhetoric suggest the 21-member Governing Council may be starting to worry more about weaker growth than higher inflation. Several have suggested that new central-bank staff growth projections in March could come in under December's estimate of gross-domestic-product growth around 2% this year. Others have stressed that the current inflation increase will be short term and highlighted the rate should fall back below 2% in 2009. And tough ECB rhetoric about inflation preceded rate cuts back in 2001.

Moreover, lower rates in the U.S. -- and in the U.K. -- without a cut in European rates would put even more upwards pressure on the euro, which some analysts predict could hit $1.50 in the wake of the Fed's cut as investors flock to the promise of higher returns. That could crimp European export growth and suppress import prices, both of which could help push ECB policymakers towards lowering rates.

Bank of England Governor Mervyn King said in a speech Tuesday that U.K. economic growth could slow "quite sharply" near-term even though consumer-price inflation may accelerate. Speaking to businessmen in the west of England, Mr. King said that the central bank's key interest rate is probably restricting economic growth.

"In the short run, [tighter credit conditions] will slow economic activity, possibly quite sharply," Mr. King said, acknowledging that the central bank faces the difficult balancing act of supporting growth, while not allowing inflation to get out of control. "But we start the year from a position in which Bank Rate, at 5.5%, is probably bearing down on demand," he added.

The next meeting of the Bank's Monetary Policy Committee is now set for Feb. 6-7. Most economists expect it to reduce the key rate to 5.25% then; it cut the rate in December for the first time since August 2005.

Unlike the Fed, which is responsible for maximizing growth and minimizing inflation, the ECB's sole mandate is keeping euro zone prices steady. For policymakers to consider a cut, euro zone growth prospects need to deteriorate enough for policymakers to be able to argue that inflationary pressures are ebbing. There are signs of such deterioration already.

The ECB's most recent bank lending survey showed euro zone banks further tightened lending standards for households and firms late last year and expect to continue doing so. Policymakers and private economists alike already expect euro zone growth for the last three months of 2007 to come in well below the third quarter's 0.8% pace, perhaps as low as 0.3%. Fresh evidence of weakness could come this week, as both the euro zone purchasing managers' index -- which the ECB watches closely -- and a key survey of German business expectations are likely to continue slipping.

"Together with the ongoing weakness the US, that would be enough to make them change their rhetoric and make a U-turn on rates," says Mr. Annunziata. But he doesn't expect an ECB move until summer.

ECB policymakers have made clear why they haven't yet joined the Fed in cutting rates: Domestic inflation pressures remain strong. On the heels of two years of solid growth, unemployment hit a record low of 7.2% in November and factories continue working at near-capacity. In addition, soaring food and energy prices pushed euro zone inflation to a six and a half year high of 3.1% in November and December, well above the ECBs goal of just below 2%. Consumer inflation expectations are at multi year highs.

Paramount in the minds of policymakers is the danger that rising commodity prices will lead euro zone workers leverage to demand productivity-beating wage increases. ECB President Jean-Claude Trichet stressed after the ECB's most recent policy meeting on Jan 10 that the bank would act "pre-emptively" to forestall such spillovers. Days later, German train drivers won an 11% pay increase, in a deal that could herald similarly generous rises across the bloc.

As successful as the ECB was at keeping markets afloat with its liquidity injections last year, some economists say the continuing credit crunch offers a lesson on the primacy of the interest rate. "Ultimately, all the different vehicles the central banks have tried to provide liquidity to the system without changing the interest rate have proven only modestly helpful," says Kenneth Rogoff, a Harvard University economist. Since U.S. remains at the center of the subprime storm, "the ECB has the luxury of waiting longer. But eventually, they're going to have to turn course as well."

Merrill Lynch Posts a $9.8 Billion Loss

By JENNY ANDERSON (NY Times)

Merrill Lynch, a firm one-third the size of Citigroup, posted an equally huge fourth-quarter loss of $9.8 billion on Thursday, fueled by write-downs totaling $16.7 billion, more than double the firm’s 2006 profits.

The staggering losses came from packaging and holding onto complex securities that seemed safe but have recently unraveled. The result was the worst quarterly loss in Merrill Lynch’s history, underscoring both the severity of the credit crunch and the brokerage firm’s failure to adequately understand or manage the risks it was taking.

For the year, Merrill lost $7.78 billion, compared with profits of $7.5 billion in 2006.

Merrill’s stock was down almost 8 percent in midday trading as analysts expressed concern about remaining exposure to the mortgage market — from the subprime market to the safer so-called Alt-A market and commercial real estate — as well as the reality that the firm will be constrained in many aspects of its business.

“There is still a lot of uncertainty ahead for Merrill,” said Brad Hintz, a securities analyst at Sanford C. Bernstein & Company.

Like Citigroup, Merrill Lynch has been forced to tap capital — from locales as close as New Jersey and the Upper East Side of New York, and as distant as Singapore, Korea, Japan and Kuwait —to plug the gaping holes left by losses associated with complex debt instruments packed with mortgages whose value has plummeted. Merrill earlier this week raised $6.6 billion from Korea, Kuwait and Japan. In December, the bank raised an additional $6.2 billion from Singapore’s Government Investment Corporation and Davis Selected Advisors.

John Thain, who took over as Merrill’s chief executive officer in December, called the firm’s results “unacceptable” but expressed certainty that the firm would not have to raise any more money. “We’re very confident that we have the capital base now that we need to go forward in 2008,” he said.

Mr. Thain tried to highlight the positive elements of the firm’s results — record results in equity capital markets, investment banking and global wealth management — but expressed a certain level of dismay at the risks taken to incur such hefty losses. “They shouldn’t be taking risks that wipe out the earnings of the entire firm,” he said, referring to the trading desk.

In his first weeks, Mr. Thain said he focused on three things: the firm’s liquidity, its capital, and its reporting structure, which he said should be flattened to “reduce the siloing that has taken place at Merrill Lynch over the last few years.” Merrill announced the appointment of Noel B. Donohoe to co-chief of risk, joining Edmond N. Moriarty, and Mr. Thain said he would hire a new global head of trading, reporting directly to him.

Merrill losses included a $9.9 billion write-down on collateralized debt obligations, a $1.6 billion write-down on subprime mortgages and a $3.1 billion write-down on exposure to bond insurers, who themselves have come under tremendous pressure for insuring securities that are defaulting a record rates. Other areas for write downs include $900 million in Alt-A and residential mortgages outside the United States and $230 million related to its $18 billion commercial real estate portfolio.

Mr. Thain made it clear that he did not think that so-called asset-backed collateralized debt obligations — instruments that have leveled Citigroup, Morgan Stanley and UBS — would rebound in any way. “I don’t think we’re likely to get back much on these,” he said.

Citigroup wrote down $23.2 billion in mortgage-related losses and provisions for future bad loans while also reporting a $9.83 billion fourth-quarter loss. The firm has raised $19.1 billion from sovereign wealth funds and investors.

HD DVD player prices plummet (TGDaily.com)

By Mark Raby

Last week's CES was supposed to be an opportunity for the fledgling HD DVD to prove itself, but outside circumstances led to it being more of a death knell for the format, and now player prices are less than half of their respective pre-holiday MSRPs.

On Amazon, Toshiba's HD-A3 player is now priced at under $135, a new non-sale low. The A3 is Toshiba's current low-end model and does not offer full 1080p high definition output (its maximum is 1080i).

Toshiba's HD-A30, its least expensive device to offer 1080p playback, now has a suggested retail price of around $200. Before CES, it was $400, and at retailers like Amazon and Sam's Club, the price has dipped even lower, to around $180.

Just one day before much of the electronics community headed down for the Consumer Electronics Show in Las Vegas, Warner Bros announced it was ditching HD DVD in support of backing Blu-ray exclusively. Sister companies HBO and New Line followed suit shortly thereafter.

At CES, the HD DVD booth sat meekly behind a glorious Blu-ray booth and garnered very little attention. Nearly every company with Blu-ray ties snuck in some way to slam HD DVD, while those connected to the failing format tried to get by without commenting on the format war. This could be the start of a slew of "fire sales", marking the beginning of the end for the unfortunate format.