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.

corzine.jpgStop 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

Reader Comments

Joe Hensonn

November 2, 2011 7:33 PM

Are the valuation inaccuracies associated with mark to market accounting or irrational markets new phenomena? Given MF Global's history and origins they actually should have understood these things better than most.

jws

November 2, 2011 11:45 PM

I miss the point as irrational markets are a result of reckless risk.

Someone must be taking reckless risk during deleveraging as principal is not equal to principal plus interest. Somewhere principal must be extinguished to balance the books.

That is the game as designed.

Taking money from clients accounts is however not part of the game.

Ak

November 3, 2011 6:58 AM

What an article!!!! Are you guys joking??? Has everyone lost their minds in this financial world??? These guys tapped into segregated accounts!!!!!! What do you mean it's not only Corzine's fault. This is fraud!!! How can people trust institutions to park their money. And this is not parking even!!! You are not lending your money for overnight interest rate you are doing business, paying commision in return getting service. Service is gone.... Because as a broker you went into a business model that you cannot handle. You blew up. What ever your clients money in the segregated accounts you let them withdraw. Ooooppss sorry, something happened there and we don't know maybe we also invested your money in european bonds. Wake up America!!!!!!!!

scott

November 3, 2011 10:36 AM

Wake up man. You have to be kidding. Corzine doesn't know that markets are irrational. That's why he bet the farm on one trade. Wait, he didn't lose a penny.... I truly hope the regulators put him in jail for a long time

Dave

November 3, 2011 11:12 AM

The bad euro zone bet is not even the big deal here! How about the fact the firm failed to segregate customer accounts properly?!?! The big story is about where is the $600M+ in missing customer money? You can talk all you want about making contrarian bets but there was some fraudulent accounting going on here. If there wasn't an issue with fraud Interactive Brokers would've bought them on Sunday night and MF wouldn't have gone BK!!! Get on the real story!

Jackson

November 3, 2011 11:29 AM

Sorry Mark but you're an idiot. It's true that investing in bonds is not necessarily risky, but investing in junk bonds certainly is. And any investment that can lead to the collapse of your company is irresponsible.

blah blah

November 3, 2011 12:43 PM

Nice try, Mark -

Regardless of how the markets moved, MFG overleveraged its investments to the point that even regulators were concerned about capital adequacy.

The rating agencies were spot on this time.

It's one thing to make a risky bet, just make sure you have the capital to support it.

Paul

November 3, 2011 12:43 PM

The bet was not unreasonable. The size of the bet, however, was totally irresponsible. Betting $6.3bn on a binary trade when the net worth of the company was $1.5bn shows someone with an ego large enough as to be completely callous to the impact that bet could have on the lives of the 2.8k employees working at that firm.

brian

November 3, 2011 12:51 PM

understand that the liberal circle the wagon parade is about to take shape. they know the stupidity of the corzine actions they're trying to minimize the results. D Fuld H paulson S weil R Rubin h greenberg A Mozilla never went to jail. the machine goes to work so that others see why it can make u or break u

truspeek

November 3, 2011 1:21 PM

Why the parsing? Of course it was corzine's fault. He was in charge, he persuaded underlings to go along. He knew the risk and felt free to put the company in jeopardy.
OF COURSE IT WAS ALL CORZINE'S FAULT. QUIT MAKING THESE GUYS HEROES. THEY ARE THE PROBLEM, NOT THE SOLUTION. YOU JUST WANT TO MAKE IT "OK".

WRITE ABOUT SOMETHING YOU KNOW ABOUT!

Jim

November 3, 2011 2:01 PM

I wish I could see things from your perspective, but I cannot fit my head that far up my rear-end. You obviously do not know anything about the prudence involved in risk taking. The central tenent to successful investing and company management. Do not feel bad, none of the government regulators, auditors, exchanges, or ratings agencies do either.

Trader Hal

November 3, 2011 2:11 PM

It definately appears that Mr. Corzine and his bean counter's tapped into segrated trading accounts to cover their margin calls on a 6.3 billion dollar bet when the net worth of MF Global was only 1.5 billion.Yhe unique aspect of this endevor is that the hugh risk aversion to this trade was emmense.Especially considering Europe's poor econimis climate and unemployment level's.Greed-sometimes takes over practical trading applications one should use which affect's your Co.

William J. Leitold

November 3, 2011 2:23 PM

Mr. Corzine became the CEO of MF Global 2 years ago. He took a small successful clearing firm (a processor of trades) and tried to turn it into a major investment bank by pilling on a lot of risk with no disastrously failed heavily concentrated bets on European sovereign debt. This is like putting a 747 jet engine in a VW Beatle. Today MF Global filed for bankruptcy, destroying jobs and the trust of shareholders, customers and the American public.
What has been missing from the discussion about Mr. Corzine is his risk-return sensibility. Let’s look at some examples; he routinely rode in his New Jersey State chauffeured SUV, refusing to wear his seatbelt before he had his major accident. His driver was blamed for Mr. Corzine’s recklessness, and as now once again his employees are suffering for his recklessness. New Jersey’s state pension plans had excessively optimistic return assumptions of 8.25%, and are grossly underfunded using that wildly optimistic assumption. Then there is the risky behavior with Ms. Karla Katz his former girlfriend who he carried on improper discussions with regarding the labor negotiations that the State of New Jersey was having with its public sector unions.
In short Mr. Corzine’s prudential sensibility is seriously misaligned, and it is the root cause of the current mess at MF Global, as it was in other past failures of judgment. The only good thing is that no one but a “fool and his money” will ever venture near to Mr. Corzine’s ventures again. It would be tragic if all of this crossed the line to criminality but that is yet to be revealed.

W P Gardner

November 3, 2011 2:29 PM

I read your entire article and it did not mention the 40:1 leverage MF Global used. I searched it in the browser for the word "leverage" and only found it in the comments. You really don't seem to get the core fact, which is that it's how MF Global funded their bet that broke them.

I used to trade futures through MF Global and I really liked the people I dealt with (former Lind-Waldock employees) over the phone. MF Global acquired Lind-Waldock. Now these people won't have jobs.

Anthony

November 3, 2011 2:46 PM

I hear the regulator was a long time associate at GS. How convenient.

Jed

November 3, 2011 2:54 PM

Wow Mark your readers just gave you a heck of a negative response.

wek

November 3, 2011 3:10 PM

Right, the devil made him do it !
Enough nonsense and excuses already; he was in charge, it happened on his watch, end of story.
PS
I bet he is still solvent and in good shape financially !

wek

November 3, 2011 3:10 PM

Right, the devil made him do it !
Enough nonsense and excuses already; he was in charge, it happened on his watch, end of story.
PS
I bet he is still solvent and in good shape financially !

JimmyD

November 3, 2011 3:43 PM

Mark: Corzine became the CEO of a stable firm. In the typical "Casino America" fashion of the 1%'ers he rolled the dice. The Firm, it's Employees and Clients all lost. He walked away with how much in Severance? I may have seen $12M (not sure on that point). How can you say he's not responsible?

Pablo

November 3, 2011 3:46 PM

It was a very smart bet that went wrong. Put yourself in Corzine's place. If the bonds paid off, he would get a big bonus and be considered a genius. If the bonds defaulted and the company went bankrupt, he would sell the company and get a $12.5 million severance pay package. This is what I understand the deal was. The only reason he couldn't sell the company on Monday morning were some discrepancies in client accounts. I hope these are resolved because I have an account with them and all my money is gone for the time being.

Pablo

November 3, 2011 3:47 PM

It was a very smart bet that went wrong. Put yourself in Corzine's place. If the bonds paid off, he would get a big bonus and be considered a genius. If the bonds defaulted and the company went bankrupt, he would sell the company and get a $12.5 million severance pay package. This is what I understand the deal was. The only reason he couldn't sell the company on Monday morning were some discrepancies in client accounts. I hope these are resolved because I have an account with them and all my money is gone for the time being.

Max

November 3, 2011 6:24 PM

Please NO EXCUSE for fraud, if any, for greediness, i would say evident, and to run a firm in bankrupt taking down thousands of employees and investors...

Michael

November 4, 2011 11:26 AM

So many problems, here with MF Global and beyond. We shouldn't be surprised because we've seen it before, but when will it end?

Here's a commentary:

http://www.woodbineassociates.com/uploads/Woodbine_Opinion_-_Why_Are_We_So_Irresponsible_-_11-04-11.pdf

BigDaddy

November 12, 2011 11:31 AM

I hope Brad and David hired their own attorneys.I'm sure the feds are investigating their activities.Both of them should be in jail.

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"The Wealth Debate" is a running discussion of wealth, poverty, the economy and income inequality in the U.S. and the world. It was started shortly after the Occupy Wall Street movement sparked a global protest about the fallout from the financial crisis and money in politics. You can reach the editors, Dan Beucke and Mark Gimein, by email, or follow BloombergNow on Twitter to keep up with posts.

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