Herzeca: I believe MBIA locked itself into an expected recovery by recording an insurance receivable on its balance sheet equal to the amount that it expected to recover from suits like these against Bank of America and others. As a result, the case didn’t settle earlier because Bank of America never offered MBIA an amount that was consistent with this recovery expectation until the very end of the litigation.
As I’ve posted in my blog, when Bank of America Corp (NYSE:BAC) found itself subject to litigation from multiple parties, it had to defend against the actions not only on their individual merits, but also with an eye to whether decisions in one case would create disadvantageous precedents for all of the others. This is essentially a legal risk management issue, and I would give Bank of America an “F” with respect to the manner in which it managed this.
In the MBIA case in particular, legal decisions reached by the court just weeks before the case was settled stand as persuasive precedents that are adverse to the bank in other matters. Why Bank of America didn’t settle this case earlier in order to avoid these adverse, and foreseeable, precedents is a question that its board of directors should be asking management.
Maxfield: One of the more interesting aspects of the case was the fact that it was fought on multiple fronts. MBIA sued Countrywide alleging breach of representation and warranties, yet it owed Merrill Lynch billions of dollars on CDS contracts. Meanwhile, Bank of America joined a contingent of other lenders in a case against MBIA to reverse the insurer’s reorganization into two separate businesses — cleaving off its comparatively healthy municipal bond unit from its sickly mortgage unit. And finally, at the end of last year, Bank of America sued MBIA for allegedly interfering with a tender offer to buy MBIA’s bonds.
How did all of these pieces fit together? What’s your view of the settlement terms? And what was your take on Bank of America’s legal strategy throughout the case?
Herzeca: Bank of America’s legal strategy was to starve MBIA into an advantageous settlement, inasmuch as the MBIA subsidiary plaintiff, MBIA Insurance, was seeing its liquidity suffer as the case dragged on. As well, by challenging the transaction approved by the New York Department of Financial Services that separated MBIA Insurance from National, the MBIA municipal insurer that was far more creditworthy, Bank of America was trying to improve the value of insured credit default swaps that MBIA Insurance had issued to Merrill Lynch.
Both strategies made sense, but the problem for Bank of America was that both its transformation transaction challenge and its defense in the representations and warranties case were ultimately losing cases on the merits. Strategy cannot trump the legal merits. So by playing the cases out as long as possible, the bank was unable to achieve litigation victories even as it was able to press MBIA Insurance to the point where it faced a real risk that it would be placed in rehabilitation by state regulators.
The problem for Bank of America was that the placement of MBIA Insurance into rehabilitation would have hurt the bank (by reducing the value of its CDS swaps that were insured by the insurance unit) as well as it would have hurt MBIA. As a result, once Bank of America lost the transformation transaction challenge, its legal strategy became self-defeating.
Maxfield: Many of the analyses that I read throughout the ordeal pitched it as a kind of David versus Goliath struggle — with MBIA playing the role of David, and Bank of America serving as Goliath. And just like the parable, I always got the impression that the caricature was about more than just size — that there was also an element of morality and social justice at play.
