The months that followed probably mark the period during which Ackman’s optimism-to-reality ratio hit a peak. As the case against MBIA was building, Gotham was falling down. Ackman and Berkowitz’s performance had been lackluster for several years running. Gotham had made several investments in privately held companies, and like many hedge funds in 2008, it found itself stuck with these illiquid assets as some investors were asking for their money back. Ackman and Berkowitz decided they had to wind Gotham down.

Things got worse. In January 2003, the office of then New York State Attorney General Eliot Spitzer subpoenaed Ackman. The Securities and Exchange Commission began an informal inquiry a few weeks later. At first glance, Gotham’s MBIA report looked as if it might be a case of a hedge fund trying to generate a huge amount of negative attention for a stock and then profit from the fear—a “short and distort” campaign. Gotham was pilloried in the press.

A dual investigation is almost every hedge fund manager’s nightmare. Not Ackman’s. “Now I’m going to be able to sit across from Eliot Spitzer and explain to him my concerns!” he told his skeptical Gotham colleagues.

Between March and June, the attorney general’s investigators hauled him in for six grueling days of testimony. Aaron Marcu, Ackman’s lawyer, tried to rein him in and keep him from saying anything that might later be used against him. Once, he interrupted Ackman to tell him he had already answered a question.

“Leave me alone,” Ackman snapped. “I’m not finished yet.” With that, he rose, unbidden, to a large pad perched on an easel and started diagramming MBIA’s serpentine financial structure. He expected to flip the AG’s team against MBIA.

Remarkably, he succeeded.

After a nearly four-year-long investigation, MBIA agreed to settle civil securities-fraud cases with the SEC and the attorney general’s office, paying $75 million in fines and restating seven years of earnings. David Klafter, who was then working as Gotham’s general counsel, says, “How often does a complaint go to a regulator and it boomerangs and the complainant ends up getting sanctioned? Not often, right? It happened to Bill.”

By January 2004, Ackman was back in the investment business, launching his current hedge fund, Pershing Square Capital Management. Over the next few years, he honed his approach to shareholder activism, scoring big investment wins with Wendy’s and McDonald’s.

Throughout that time, though, MBIA’s stock held strong. Employees at Pershing Square “thought I had gone off the deep end. And there were investors who did not invest in Pershing Square because they thought I had just lost it on this MBIA thing,” Ackman says. As time went on, he couldn’t stop thinking about the company. “I have trouble saying ‘MBA’ without saying ‘MBIA,’ ” he tells me. Once he was walking down a street on Manhattan’s Upper West Side, and he saw a woman wearing a sweatshirt with MBIA on it. Was it some kind of division of the company that he didn’t know about, he wondered? He repeated the word on the sweatshirt out loud to himself: “Co-loo-M-B-I-A, Co-loo-M-B-I-A.” Suddenly, he realized he was looking at a woman dressed in Columbia University garb.

In his office one recent late afternoon, he beckoned me over to his computer, with a look of pride. He launched a video of two young girls performing a catchy, singsongy tune. A few years ago, his two daughters had composed this song-and-dance routine as a present for their father:

MBIA is a bad company

Yes it is. Yes it is. Yes it is.

Ackman’s MBIA investment led him to a conclusion that proved pivotal in light of the coming credit crisis. In the spring of 2007, when the Dow was over 13,000 and the world was awash in money, he began giving a speech to investors called “Who’s Holding the Bag?”

The talk began with a warning that a virtuous credit cycle works viciously in reverse. It discussed the risks in mortgage-backed collateralized-debt obligations, corporate lending, and commercial real estate markets. He raised alarms about the credit-rating agencies’ conflicts of interest in the structured-finance market. He concluded that since the most highly rated paper, the triple-A portion, was more vulnerable than anyone realized because of poor lending, bond insurers like MBIA were in deep trouble. And if they were in trouble, all the parties that thought they were insured would also be in trouble. “When the losses hit, these guarantees will have no value, and counterparties are left holding the bag,” he said.