Book Review: Confidence Game

Christine S. Richard's new book, Confidence Game, tells the controversial story of how hedge fund operator Bill Ackman shorted municipal bond insurer MBIA. The short selling was done with credit default swaps, and the ultimate profit for his Pershing Square Capital Management was $1.1 billion. The controversy arose from first shorting the stock, then issuing a negative research report. Ackman engaged in what the book describes as “perhaps the most aggressive 'short' campaign in Wall Street history.”

The campaign included issuing more negative research reports, expanding Pershing Square's influence through the media, and going directly to rating agencies and regulators. Along the way, Bill Ackman was investigated by the SEC and Eliot Spitzer. Though one of Spitzer’s staffers told Ackerman to “bring his tooth brush” to his interview with the then New York State Attorney General, no charges were ever pressed. At stake for MBIA was its AAA rating, which allowed it to insure debt of $140 for every $1 of its capital. MBIA’s president stated that the insurer saw “no losses under the worst possible scenario.” In retrospect, this was an absurd statement by an insurance company and should have been a red flag to both investors and to rating agencies.

The short sale process in question occurred from 2002 to 2008, quite a long time in the trading business. Ackman, however, was unsuccessful in convincing others of the risks he saw until the late stage when MBIA reported a loss. By this time, MBIA was insuring credit default obligations on subprime mortgage pools. The resulting loss of MBIA’s AAA credit rating set off a cascade of price declines in securities held by the banks, adding to the financial crisis.

The profit potential of using credit default swaps is evidenced by Ackman buying insurance on $10 million of MBIA bonds for $16,000. This leveraged profit was combined with constant, intense in-depth research: Ackman is said to have read 140,000 pages of documents on MBIA.

Financial professionals should glean an important lesson about the magnitude of the potential reward from high levels of contrarian research in the hedge fund and derivatives world from Confidence Game. As research, hedge funds, and derivatives should continue to be very viable in the years ahead, this book should find a large audience for its insight into these important areas.

–Bill Hayes