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FT Alphaville warning: This post is long. But worth reading. Bill Ackman has not only provided the rationale for his continued shorting of the monolines, but he’s also put the numbers for his risk modelling up on the internet - as open source.

To:

Ladies and Gentlemen:In an attempt to improve the level of discourse in the marketplace regarding potential losses in the bond insurance industry, we are releasing today a dynamic financial model (the “Open Source Model”) that contains extensive detail on the precise CDO and related exposures of the insurance operating subsidiaries of both MBIA and Ambac. The Open Source Model can be customized to allow users to estimate losses using their own assumptions.The Open Source Model has been posted on the Internet at:
Our primary goal is to initiate what we call “Open Source Research” where all market participants can have equal access to the primary source data and construct their own views of losses without reliance on the analytical judgment of rating agencies or the bond insurance industry. By focusing the discussion on a fundamental, data-driven approach, we expect that the dissemination of the Open Source Model will enable market participants and regulators to accurately estimate probable losses by relying on rigorous fundamental analysis of specific credit exposures, a departure from relying on the opaque, faith-based pronouncements that the bond insurance industry has promulgated to the marketplace.In order to facilitate a comprehensive and accurate estimate of probable losses in the bond insurers’ exposures, we believe that you, as their regulators, must require the bond insurance companies to provide full disclosure to the market of their entire portfolio of insured exposures. This should include not only confirmatory data on CDO and related RMBS exposures detailed in the Open Source Model, but also municipal and other structured finance exposures, especially those exposures that have been or are in remediation, are rated below-investment grade, require claim payments or otherwise have been or are carried on so-called “classified watch lists.” Additionally, companies must disclose which exposures have been reinsured along with the names and specific exposures of their reinsurance counterparties. Only with a complete understanding of all of the bond insurers’ gross exposures to potential losses can the market gain a complete understanding of the insurers’ capital adequacy.If the bond insurers truly believed that greater disclosure would help confirm the veracity of their loss estimates, one would have expected them to provide full transparency to the marketplace. Indeed, given the announced plan for a public rights offering by MBIA, it is difficult to see how that offering will proceed without adequate disclosure. If disclosing more granular detail to the market would confirm the bond insurers’ capital adequacy, it begs the question as to why have they not already done so? We believe the answer to this question can be found in the conclusion of a detailed analysis of the facts that are presented below. The detailed methodologies and assumptions in the Open Source Model are disclosed in the attached Exhibit.

The Open Source Model will materially improve the quality of information in the market in the following ways:

• All of MBIA’s CDOs of ABS and CDO-Squareds from 2005-2007 are identified by name, information MBIA has been unwilling to disclose to date.

• All of the underlying collateral within the CDOs of both Ambac and MBIA are identified by CUSIP, along with a description of collateral type, par outstanding, and original and current rating, where available.

• The data distinguish among subprime, midprime, Alt-A, and prime RMBS collateral within CDOs, material distinctions that MBIA and Ambac have failed to provide in their disclosures.

• Users of the model can drill down multiple layers to identify and analyze individual credits of not just the outer CDOs, but those exposures of the CDOs owned by outer CDOs (”inner CDOs”) and further, to identify the specific exposures of the “inner-inner CDOs” owned by those inner CDOs that are, in turn, owned by the outer CDOs that have been guaranteed by MBIA and Ambac.

• The Open Source Model may contain information on collateral within inner CDOs and inner CDOs of inner CDOs that even the bond insurers themselves do not have.

How did we compile this data? For some time, we have endeavored to obtain high quality data on MBIA’s and Ambac’s ABS CDO portfolios. Recently, a global bank (the “Global Bank”) has contributed to our open source research by collecting the detailed information described above. The Global Bank has identified all but a handful of the thousands of subprime, midprime, prime, Alt-A, HELOC and Closed-End Second RMBS and CDO transactions guaranteed by MBIA and Ambac, and provided a CUSIP-by-CUSIP analysis of all CDOs, CDOs within CDOs, and CDOs within CDOs within CDOs by stressing the underlying exposures on a CUSIP-by-CUSIP basis within these transactions. While we do not know the specific pecuniary interest of the Global Bank that has contributed to this project, you should assume that it (like we) have bearish positions on the bond insurers’ holding companies.We have reviewed the methodology and source data underlying the model and we believe them to be reasonable; however, we can make no representations regarding the accuracy or completeness of the materials. To improve the model, we welcome any suggestions from you and/or other market participants. To the extent that the companies themselves continue to refuse to make full and fair disclosure regarding their exposures, we hope that others update and publicly release their own improved models and valuation analyses.Under the assumptions used in the Open Source Model, the losses to MBIA and Ambac from these exposures are materially higher than suggested by the rating agencies or the bond insurers themselves. They are closer, in fact, to public estimates by certain other global banks:

• Ambac will incur approximately $11.61 billion of losses on its net RMBS and ABS CDO exposures.

• MBIA will incur approximately $11.63 billion of losses on its net RMBS and ABS CDO exposures and $12.56 billion of losses if one reincorporates certain 2007 CDOs of ABS that have been reinsured.

• MBIA will have an additional $928 million of losses on just those 2007 ABS CDOs it reinsured with a reinsurer which we believe to be Channel Re, in the likely event that Channel Re will not have the wherewithal to make good on its obligations to MBIA.

• MBIA’s and Ambac’s losses may be larger when the questionable creditworthiness of their reinsurers is incorporated into this analysis.

Other Important Findings

• We believe the Open Source Model is more rigorous and complete than the analysis published by the rating agencies whom we believe have not done a security-by-security analysis within the inner CDOs of MBIA’s and Ambac’s insured CDOs.

• The Open Source Model allows users to evaluate the losses of inner CDO collateral by looking at the specific collateral underlying each individual inner CDO rather than by using generalized assumptions. By failing to analyze the specific underlying collateral of all inner CDO exposures, we believe that rating agency loss results are understated by billions of dollars as these additional losses typically impair the AAA tranches guaranteed by the insurers dollar for dollar.

• From 2005-2007, the total universe of ABS CDOs outstanding is comprised of approximately 534 deals. While MBIA and Ambac appear to have only limited direct exposure to this pool (having directly guaranteed only 25 and 28 CDOs, respectively), in fact, MBIA and Ambac are actually exposed to at least 420 and 389, respectively, of the 534 total CDOs outstanding if you include the CDO exposures within the CDOs they have guaranteed. The fact that MBIA and Ambac have direct or indirect exposure to 79% and 73%, respectively, of all ABS CDOs issued from 2005-2007 directly contradicts the insurers’ public statements about their “highly selective” approach to CDO guarantees.

• MBIA and Ambac’s exposure to nearly the entire universe of CDOs also compounds their exposure to many other classes of RMBS securities with MBIA and Ambac being exposed to 3,131 and 4,179 unique tranches of ABS respectively. These large numbers of exposures will likely cause MBIA and Ambac to experience losses similar to that of the entire RMBS market.

The Open Source Model provides information useful for determining the extent of CDO losses in the bond insurance, banking industry, and capital markets, at large.

• The Open Source Model estimates that probable losses on the entire universe of 534 ABS CDOs issued between 2005-2007 will be approximately $231 billion, with super senior tranches accounting for approximately $92 billion of this total.

• Assuming a combined market share of guarantees to ABS CDOs for MBIA and Ambac of approximately 48% implies that the bond insurance industry as a whole stands to incur losses of $27.5 billion from ABS CDOs alone, before taking into consideration the questionable creditworthiness of its reinsurance agreements and additional exposures to troubled direct HELOC and Closed-End Second mortgage exposures.

We believe the assumptions used to calculate the above losses provide a reasonable basis for estimating probable losses on these exposures. We believe many of the model’s assumptions are conservative. For example, the Open Source Model intentionally makes overly conservative assumptions because of a lack of data or for simplification purposes. The Open Source Model assumes:

• Zero losses on $5.3 billion of MBIA CDO exposure to European mezzanine and other collateral, CDOs insured in the secondary market or multi-sector CDOs insured prior to 2004 that have not been identified.

• Zero losses on CMBS, Prime RMBS, CLOs, Corporate Bonds and Other ABS securities (Auto Loans, Student Loans, Credit Card Securitizations, etc.).

• Zero losses on pre-2005 CDOs of ABS and direct RMBS exposures.

• Zero losses on RMBS or CDO securities held in bond insurer investment portfolios.

• Zero losses on direct HELOC exposure for which detailed underlying data is unavailable.

Open Source Model version 1.0

The Open Source Model is a preliminary attempt to provide the marketplace with a comprehensive set of fundamental data and a construct for analyzing the information using customizable assumptions. There are limitations to the Open Source Model v1.0. For example:

• While CUSIP information is listed for direct RMBS exposures, including HELOCs and Closed-End Second mortgages, the assumptions that drive loss estimates for these securities are not currently dynamic. These losses were estimated by the Global Bank’s model and assumptions which its proprietary trading desk uses to value RMBS securities based on loan-level performance data.

• The model assumes that the performance of a sample set consisting of 1,267 subprime (44% of sample, FICO below 625) and midprime (56% of sample, FICO of 625-700) RMBS securities within the outer CDOs is representative of the entire universe of subprime and midprime RMBS securities held by all inner CDOs. We and the Global Bank believe that the performance of this data set is a fair representation of the entire universe of similarly rated and identified securities. Furthermore, if one accepts MBIA’s and Ambac’s public statements that they have been highly selective in the RMBS securities they have guaranteed, one can safely assume that using the performance of this 1,267 security sample set to estimate the performance of RMBS securities within inner CDOs is necessarily a conservative assumption because these inner RMBS securities were not selected by the bond insurers.

• The impact of reinsurance is imperfectly captured by the model. For example, reinsurance detail is not readily available for direct RMBS exposures for either MBIA or Ambac. Losses are only analyzed on a gross basis before reinsurance for a portion of MBIA’s CDO transactions. The credit quality of the reinsurers is also not considered by the model.

We encourage all market participants to use the Open Source Model as a tool to arrive at their own conclusions and report their findings to the market to further improve the process of evaluating the risk of loss in the bond insurance industry. With each iteration and enhancement, the Open Source Model will become an even more useful tool for regulators, rating agencies, and investors.In particular, we would encourage the rating agencies to update their analysis, specifically their approach to estimating losses on inner CDOs. With the detail provided by the Open Source Model, a full analysis of all collateral within the inner CDOs can be accomplished, including those securities held by the inner CDOs within the inner CDOs. As stated above, we believe that incorporating these additional layers of detail will likely increase rating agency loss estimates by billions of dollars as additional losses likely impair the AAA tranches of the primary CDOs on a dollar-for-dollar basis.The Self-Graded Exam: Historical Disclosures and Understated Losses

Until now, investors have had to estimate bond insurer potential losses based on the limited information that is available. We believe that this has enabled the bond insurers to understate the amount of losses they report in their SEC and statutory filings because it is difficult for an outsider to validate their estimates.

The critical importance for the capital markets of ascertaining the amount of these losses is self evident. Perhaps most importantly for policyholders, the accuracy of management’s judgment in estimating losses is critical because it determines how much capital can be extracted from an insurance subsidiary for the benefit of holding company debt and equity holders. It is also essential for determining GAAP book value and earnings for analysts and investors. By using their own estimates for losses, rather than a market-based measure as required by FAS 133 and FAS 157, without appropriate regulatory intervention, the bond insurers effectively can determine the amount of their statutory capital and policyholder surplus for the purpose of calculating amounts available for holding company dividends.

We are concerned by statements made by Ambac management on their Q4 call that it can take $50 million of dividends each quarter from its insurer without regulatory approval. Ambac’s (and MBIA’s and other bond insurers’) ability to extract a dividend from its insurance operating subsidiary is a function of the accuracy of management’s estimates of probable and estimable losses. If Ambac has understated its losses (whether knowingly or otherwise), it has overstated its statutory surplus, thereby inflating the amount of dividends that can be distributed to the holding company without regulatory approval.

We note that, between the third and fourth quarter of last year, Ambac changed its methodology for estimating CDO losses. The change increased Ambac’s reserves for losses by $1.1 billion. Based on the conclusions of the Open Source Model, we believe the amount of Ambac’s actual CDO losses is more than six times Ambac’s management estimates and that these losses are both probable and estimable.

Because a bond insurer’s calculation of statutory capital is effectively a self-graded exam, one would expect management to estimate losses at a level which allows the insurance subsidiary to pay holding company dividends. Rarely is a man willing to sign his own death warrant. At a minimum, one has to question the credibility of management’s estimates when 90 days prior, the Company stated that all mark-to-market losses would reverse to zero in future years. Now, Ambac management states that all but $1.1 billion of its $5.4 billion in mark-to-market losses will reverse to zero over time. MBIA management’s recent statements admitting that now some of its mark-to-market losses are true economic losses when months earlier they said that all mark-to-market losses would reverse to zero tell an identical story.

It Is Hard To Fill A Bucket With A Hole At The Bottom

As the principal regulators for the bond insurers, we understand that you are presently doing what you can to assist the bond insurers in raising additional capital to meet obligations to policyholders. We believe such an approach should begin with preserving whatever capital the bond insurers have today. Both MBIA and Ambac have stated publicly that they can and will continue to take ordinary dividends from their insurance subsidiaries in order to pay holding company expenses, fund dividends to shareholders, and pay interest on holding company debts.

MBIA has stated that it can take $450 million of dividends beginning April 2008 and Ambac has said that it can take $50 million per quarter beginning this month. If you continue to allow ordinary dividends to go to holding companies, you will be depriving the policyholders of capital that is needed to meet their obligations. In addition, we believe that by permitting regular dividends to the holding companies, you risk undermining your capital raising efforts. Stated simply: it is hard to fill a bucket with a hole at the bottom.

We encourage you to complete your own analysis of the bond insurers’ RMBS and CDO exposures. In addition, it is essential that you evaluate the bond insurers’ other exposures. While the media and analysts have focused on the bond insurers’ RMBS and CDO exposures, we believe there are significant losses embedded in non-taxpayer supported municipal obligations including hospitals and other healthcare exposures, project finance including tax-exempt housing, toll roads, and other infrastructure guarantees. These losses have been hidden because of the bond insurers’ ability to “remediate” exposures through refinancings and mergers with other bond insurer guaranteed issuers, or due to otherwise inadequate disclosure.

The market’s loss of confidence in the bond insurers’ creditworthiness will make these loss postponement transactions more difficult (and likely impossible) in the future. Accordingly, we believe that historically low default rates for non-general obligation, muni-related bonds understate the level of losses that will be sustained on a going-forward basis. We expect, therefore, that non-taxpayer supported municipal finance will begin to generate material losses in the future.

If, as we expect, the results of your analysis show significant losses that will reduce and/or eliminate policyholders’ surplus, you can place the insurers under supervision, or take other remedial efforts, so as to increase the probability that policyholders’ obligations can be paid.

Lastly on the subject of transparency, MBIA’s fourth quarter conference call scheduled for tomorrow will be “listen only” and will not allow live questions from analysts and investors. The company will only answer questions it selects from those submitted by email in advance of the call. This is a further reduction in transparency to the markets from MBIA’s typical earnings call where a select group of analysts and investors are screened and then permitted to ask questions. We intend to release the list of questions we email to MBIA to the public. We believe these questions will assist the markets in understanding the company. If the company thereafter chooses not to answer these questions, its silence will speak for itself.

We would like to meet with you and your advisers to discuss the Open Source Model and its conclusions in greater detail. We are available at your convenience.

Please note that Pershing manages funds that are in the business of trading - buying and selling - securities and credit default swaps. While Pershing currently maintains a net short position in MBIA Inc. and Ambac Financial Group and may have other positions in the industry, Pershing may change its position regarding the companies and possibly increase, decrease, dispose of, or change the form of its investment in the companies for any or no reason.

PERSHING SQUARE CAPITAL MANAGEMENT, L.P.
Respectfully submitted,

William A. Ackman