Bond insurer MBIA, Inc. (NYSE: MBI) seem to be dropping like rocks, but that isn’t deterring respected value investor Martin Whitman’s Third Avenue Funds from increasing its stake in the company. The move pits him directly against the famous activist investor Bill Ackman’s Pershing Square, which has taken an aggressive short position in the bond insurers and sees imminent bankruptcy. So, where should you place your bets?

Whitman believes that there is much profit to be made in the bond insurers, whether they continue as going concerns or write no new policies and sell off their existing business. The value investor, known for buying up questionable assets, currently holds around 10 percent of MBIA. Whitman insists that the bond insurer is very well financed and it should easily qualify for an AAA rating with a $17 billion claims paying ability. The value investor went on to say that the MBIA is being victimized by a “well organized bear raid” headed by Ackman that is preventing it from winning a stable outlook.

Whitman believes that MBIA shares are currently trading at a 70 percent discount to tangible book value and represent a great investment opportunity. The value investor also believes that the company will be able to raise the cash that it needs to pay any upcoming claims. In fact, Whitman himself has put in over $300 million and now counts the company among his fund’s largest holdings. Meanwhile, the company itself is saying that the $3.7 billion mark-to-market loss on credit derivatives is completely reversible if the market doesn’t deteriorate any further. Obviously, any reversal in the losses and increased liquidity bodes well for the troubled firm.

Bill Ackman has taken the opposite stance, having been bearish on MBIA for around five years. He warned investors back in the 90s that the company’s collateralized debt obligations (CDOs) may put its Triple-A rating at risk and now his predictions are coming true. The activist investor also brought up several “questionable transactions” that involved insuring a loss after the loss and then collecting on the insurance. Ackman even decided to write a 60-page paper entitled “Is MBIA Triple A?” in December 2002 shortly before these problems began.

Ackman estimates that the bond insurer faces more than $11 billion of potential losses, which would make it nearly impossible to avoid bankruptcy if it does not find a substantial amount of outside capital. The activist investor took a particular interest in the holding companies, reasoning that if the bond insurers’ holding companies were deprived of cash flow, their ratings would fall, and their operating units’ ratings would fall as well. In fact, Ackman remains convinced that these companies will be forced into bankruptcy if they are not bailed out.

In the end, the reason these two great investors are at ends is a debate over liquidity. The crisis facing MBIA is not one based on losses perse, but rather one of how much loss they can handle before they are forced to sell. The fact is that nobody knows how much worse the credit markets will get and, as a result, how much lower these CDO valuations will become. Ackman estimates that claims will reach $11 billion, which would cause huge problems for MBIA. Meanwhile, the company itself and Whitman believe that the market will turn sooner than later and reverse Ackman’s fortune. Regardless, this is definitely a situation worth watching as two of the world’s best investors take opposite sides!

Related Companies
Ambac Financial Group, Inc. (ABK)
Assured Guaranty Ltd. (AGO)
Radian Group Inc. (RDN)
ACA Capital Holdings, Inc. (ACAH)
Security Capital Assurance Ltd. (SCA)
Berkshire Hathaway Inc. (BRK)
W.R. Berkley Corporation (BER)
MGIC Investment Corp. (MTG)
Hallmarket Financial Services, Inc. (HALL)
Markel Corporation (MKL)