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Fund chief warns that two pillars of the markets might crumble.
NEW YORK: While the U.S. Federal Reserve tries to soothe the nerves of Wall Street, a hedge fund boss has managed to fray them by warning that two pillars of the financial markets might crumble.
Even while the Fed delivered another big cut in interest rates Wednesday, William Ackman, a prominent money manager, fanned growing fears that the bond insurance industry might suffer crippling losses.
Ackman, who runs a New York hedge fund called Pershing Square and has bet against the insurers' shares, issued a report Wednesday afternoon predicting that two of the companies, MBIA and the Ambac Financial Group, might lose a combined $24 billion on complex mortgage investments that they have guaranteed. Such a hole might threaten their survival and touch off a chain reaction of losses at some of the biggest Wall Street banks, as well as raise borrowing costs for states and municipalities.
His report, along with the downgrade of a smaller bond guarantor, helped quash a rally in the stocks sparked by the Fed's rate cut. The Standard & Poor's 500 index closed down 0.5 percent after being up by as much as 1.7 percent an hour before the close. Shares of financial services stocks fell about 1.1 percent.
"Here comes Ackman at the 11th hour upsetting the apple cart," said Douglas Peta, chief market strategist at J.&W. Seligman. "I don't think anybody has really thought it all through, but we all understand the implications of real trouble in the bond insurers could be far-reaching."
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Together, MBIA and Ambac guarantee more than $1 trillion in municipal, corporate and mortgage debt and carry a mark of distinction, an AAA credit rating - a boast that even the most well-heeled of corporations like International Business Machines cannot make.
Ratings agencies like Standard and Poor's and Moody's Investors Service have said they are considering downgrading the insurers because the companies might not have enough capital to pay claims on future losses in the complex mortgage-related investments they have insured. At the same time, insurance regulators hope to head off the downgrades by persuading Wall Street banks to inject capital into the companies or provide them with backup lines of credit.
Highlighting the uncertainty facing the insurers and regulators, S&P said Wednesday that it had already downgraded or was considering reducing the rating on more than half a trillion dollar's worth of mortgage securities. These are the kind of investments that MBIA and Ambac have insured, and are required to make interest and principal payments on, if homeowners default and their homes are sold at a loss.
For their part, MBIA and Ambac have argued that concerns about their viability, let alone their AAA rating, are overblown. They say defaults will not be high enough that they would suffer significant losses, and even then they say the claims would be minimal and have to be paid over years, not right away.
MBIA, which was scheduled to report fourth-quarter earnings Thursday night, said Wednesday that it had secured $500 million in capital from Warburg Pincus, the private equity firm, as part of a previously announced $1 billion investment. The company also added two representatives from Warburg Pincus to its board and said an executive from Deutsche Bank would be leaving the board.
Investors in the stock market appear to have little faith in the insurers. Shares of MBIA and Ambac have plunged more than 80 percent during the past 12 months.
On Wednesday, Ackman released detailed estimates for losses on mortgage securities guaranteed by MBIA and Ambac that he said were based on conservative assumptions. He said the data, which he released online so it could be analyzed by other investors, would give the lie to the companies' assertions that they only insured safe securities.
"Now it's a level playing field," Ackman said by telephone. "We are putting it out there and we are saying don't rely on us. Do your own work. Here is the data that you can use."
In a letter addressed to insurance regulators and the Securities and Exchange Commission, he said that he received details of the bonds that the two companies have insured from an unnamed "global bank." Ackman said the bank, which he believed also had bearish positions on the insurers, gathered the data from publicly available sources that included the companies' financial statements and regulatory filings.
MBIA declined to comment and Ambac officials did not return a telephone call.
Meanwhile, Fitch Ratings downgraded another insurer, Financial Guarantee Insurance, to AA, from AAA, after the company failed to meet a deadline to raise $1 billion in new capital. The loss of the rating will make it harder for the company to write new insurance policies.
Michael M. Grynbaum contributed reporting.
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