MF Global: It's Not Just Corzine's Fault
Posted by: Mark Gimein on November 2, 2011 at 5:50 PM
The basic storyline about MF Global seems to be solidifying: ex-Goldmanite Jon Corzine digs into a hole and blows up a company with risky bets on sovereign debt. Just another chapter in the story of reckless speculative excess on and around Wall Street.
Stop that train for a second. To recap what happened, MF Global had major holdings in bonds of Belgium, Italy, Spain, Portugal and Ireland. Those bonds were set to mature late next year. If none of those countries defaulted before then, MF was home free. That is not an unreasonable bet: even if you are pessimistic about the long term, none of those are likely to default that soon.
Unfortunately, MF Global’s sovereign debt position becoming public—at the demand of regulators—led to a series of downgrades on MF Global’s own debt and margin calls that brought down the company. The affidavit of MF Global chief operating officer Bradley Abelow—incidentally, Corzine’s chief of staff when he was governor of New Jersey—in MF Global’s bankruptcy (hat tip to Zero Hedge):
Dissatisfied with the September announcement by MF Holdings of MFGI’s position in European sovereign debt, FINRA demanded that MF Holdings announce that MFGI held a long position of $6.3 billion in a short-duration European sovereign portfolio financed to maturity, including Belgium, Italy, Spain, Portugal and Ireland. MF Holdings made such announcement on October 25, 2011. These countries have some of the most troubled economies that use the euro. Concerns over euro-zone sovereign debt have caused global market fluctuations in the past months and, in particular, in the past week. These concerns ultimately led last week to downgrades by various ratings agencies of MF Global’s ratings to “junk” status. This sparked an increase in margin calls against MFGI, threatening overall liquidity.
If MF Global had disclosed its positions in the first place, it wouldn’t have faced the pressure from regulators and rating agencies. It was a dumb call. But that doesn’t mean the investments themselves were irresponsibly risky.
In the lead up to the mortgage crisis investment banks and ratings agencies consistently and hugely overvalued junk loans and CDOs. So there’s a lot of good reason to be conservative in marking loan portfolios to market. And yes: every hedge fund manager who’s ever failed says that if only he had more time, he’d be in the black. At Bloomberg View, Roger Lowenstein compares MF Global to the famous case of Long Term Capital, another firm run by smart people that got caught in a liquidity trap.
That’s fair. But here’s the thing: the premise behind mark to market accounting is that markets can judge value with some degree of accuracy. Often they don’t. They’re prone to bubbles on the upside and panics on the downside. After the financial crisis, folks talked about fixing a system that (a) encourages reckless risks and (b) accelerates panics and liquidity traps.
The consensus seems to be that you can chalk the MF Global fiasco up to reckless bankers—specifically Corzine. There’s evidence for the second option—irrational markets—too. Take your choice. After the mortgage crash, we were supposed to fix both. There hasn’t been much headway with either.
Update: Just read Brad DeLong unraveling MF Global. His take on a hypothetical MF Global position:
MF Global is thus making two directional bets: the bet that southern Europe will pay off, and the bet that the market will remain tolerant of southern Europe risk in the meantime … If either of those bets fails, MF Global is toast.
The first of these is not unreasonable. The second … well, I can’t do it justice here. If you want to dive that deep, read his post
Photographer: Chris Ratcliffe/Bloomberg
