Sunday, May 19, 2013

Lessons Learned, and a New Blog Title

It strikes me that the MBIA v BAC saga can serve as a cautionary tale, and afford all of us a rich opportunity to reflect upon what lessons we have learned, as investors, from the litigation and settlement.  Here is my take on some lessons I am still cogitating over:

1. As a shareholder in MBIA, prior to settlement, I was a speculator, not an investor.

I knew this, but I didn't appreciate it as vividly as I do now.  How does one distinguish between an investment and a speculation?  In brief, you know you are a speculator rather than an investor when, in addition to exposing your invested money to the whims of financial fate and often harsh destiny, your return is wholly subject to the subsurface predilections of an overworked and underpaid person wearing a black robe.  I say predilections with full intent, as anyone who thinks that what is involved in a case is only the objective force of the law, and not the subjective biases and too often lazy reasoning failures of that person in the robe, needs to spend some time in court.  It seems to me that the ability of judges if charted would resemble more a barbell than a bell curve, and which end of the barbell you confront as a litigant has an inordinate effect upon your investment.  If that doesn't turn an investment into a speculation, I don't know what does. I will have more to say about this in section 2 below.

In my view, this distinction between investment and speculation should govern the mindset that you bring to the shareholding.

The mindset of an investor should be that losses are not tolerated.  While all investors are human and will suffer losses, the mindset should be to find a stock that offers a margin of safety, and provides reasonable assurance of continued operational and financial success.  No one pointed this out better than Ben Graham, some 80 years ago. One looks for moats, barriers to entry, long term sustainable performance, and most importantly a good entry price.  One looks for what could go wrong, and tries to make sure that there is sufficient likelihood that adverse outcomes will not come to pass.

The mindset of a speculator should be the reverse.  A speculator's mindset should assume, going into the investment, that a complete loss has provisionally been incurred once the stock is bought.  If that assumption is too sour to swallow, the speculator is probably really an investor and should take a pass.  If one can't tolerate a speculative loss, one is really an investor with an identity crisis.  A speculator looks for what could go right, and tries to make sure that there is sufficient likelihood that favorable outcomes will come to pass.

At one point with respect to MBIA, when I was suffering from a particularly virulent bout of MBIA-fatigue (long term holders of MBIA will know what I mean), in order to reinforce this speculator's mindset, I actually wrote onto a sheet of toilet paper the word MBIA and the amount of my holding, and I flushed it into the toilet and watched it swirl away.  This "offering to the gods" actually had a cathartic effect, because it reinforced in my mind the stakes involved, which forced me to reexamine my analysis of the MBIA shareholding. Upon this reexamination, I found that my analysis of a favorable outcome for MBIA was still intact, which reinstilled in me the analytical will to continue to own the stock for what turned out to be a longer period than I had expected.

If my view on the difference between investment and speculation has merit, this implies that an investor should set up two stock accounts, an investment account seeking investments and a speculation account seeking speculations, and maintain an investment Jeckyll and Hyde dichotomy in one's approach to the two accounts.  I have done this, though I have my investment account professionally managed by others, to keep my speculating hands off the investments.  I could do a lot of damage on that side of the ledger.

I suppose my main point is that acknowledging that a stockholding is a speculation doesn't excuse sloppy analysis or shortcuts in diligence. Indeed, such an acknowledgement should only reinforce the care and thoughtfulness that one brings to the speculation.  Speculation should not be disparaged; only speculation masquerading as investment should be shunned.  The best way to avoid mistreating a speculation as an investment is to make sure you bring to the speculation the proper mindset, and therefore bring to the speculation the requisite level of investment diligence.

Moreover, by adopting the speculator's mindset, it is more likely that you will adopt hedging strategies and limit your maximum exposure to an individual speculation than you would if you were simply in investment mode. Since a speculation offers no internal margin of safety, the speculator has to be more careful to bring some measure of safety to the position through the structure of the holding.

But amidst all of these ministrations of caution, let's not forget what likely has attracted you to the speculation in the first place.  You have the opportunity to reap outsized returns, and if you have the proper mindset for the speculation, and therefore approach it with the proper respect for the diligence required, you will come out ahead of the investor, even on a risk-adjusted basis.

Post settlement, I think MBIA has transitioned from speculation into investment.  I think there is substantial support for holding MBIA as an investment, rather than a speculation.  Hence, the change in name of the blog, as this blog will continue even as the MBIA v BAC litigation has ended...and it will focus on remaining speculations in the mbs litigation space.

2.  Even if one is right on the law, one can be wrong on the judge.

Alison Frankel recently wrote an excellent article,  N.Y. judges split on time bar for billion-dollar MBS put-back claims, that serves as the poster child for how a litigant can be right on the law and wrong on the judge.  This is as good as any example of the legal contingency that lies at the core of a speculation in a monoline insurer pursuing mbs recoveries.

The exact same question was presented to New York Commercial Division Justices Kornreich and Sherwood, and they issued two decisions that are diametrically opposed to each other.  One justice is right, and the other justice is wrong.

The question is when does the 6 year statute of limitations start to run on a claim that an mbs originator has breached its obligation to repurchase putback loans. Justice Sherwood stated that the time limitation for claims starts to run from the closing of the original transaction.  In so holding, Justice Sherwood has imposed, like plucking nitrogen out of the air, a judge-created 6 year period during which any and all claims must be asserted that ignores the putback repurchase breach as being separate from the representation and warranty (R&W) breach, in a transaction that can last as long as thirty years and in which the parties to the agreement specified no such limitations.

One wonders whether Justice Sherwood has made any large deposits into his bank account recently.

Justice Kornreich held otherwise and, of course, Justice Kornreich is dead right and Justice Sherwood is dead wrong.  Yet if you are a litigant in front of Justice Sherwood, you have to await the one year appeals process to have the 1st Department reverse this travesty.  This has an effect on your speculative return, and indeed on your willingness to engage in the speculation in the first place.

Another example of being right on the law and wrong on the judge is the question of whether monoline insurers have as a "sole remedy" the putback protocol set forth in the PSA, or whether the monoline can sue for compensatory damages under the NY insurance law.

In this recent example, Justice Bransten was right on the law, and Justice Ramos was wrong on the law.  I will cover this example in a future blog post, but this example has particular significance to speculators in Ambac stock, as two of Ambac's largest R&W cases are in front of, you guessed it, Justices Bransten and Ramos.

In future posts in this blog, I will focus on Ambac's cases in particular, as I have a dog in that fight. Ambac is the monoline that has the largest potential fraud and breach of contract damage recoveries remaining among the monolines, and it appears that it may just be catching the wave.

I use the catching the wave metaphor because you should view the developing caselaw in the mbs litigation space like a rolling wave in front of which various surfers (monolines) are paddling their boards.  MBIA, Assured Guaranty and others have gotten up on their boards earlier than Ambac, and have obtained important settlements (MBIA, Assured Guaranty and Syncora) and a courtroom victory (Assured Guaranty).  But as more decisions are handed down, and the legal position of the monolines becomes increasingly secure, it appears that the mbs litigation wave is rolling to shore with increasing amplitude, and Ambac is now in the best position to catch this wave.

NB:  this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice.  Investing is a tough game, and everyone must do and "own" their own work, because you will certainly own your investments.

Disclosure: long MBI; AMBC.  Follow me on twitter.

5 comments:

  1. Regarding the AMBAC speculation it looks like they are already accounting for 2.5 billion in subrogation. So what is the upside if they are already accruing it in the loss reserves.

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  2. @bob see http://www.scribd.com/doc/141956633/BTIG-Ambac-Financial-Group-Initiation-5-16-13

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