MF Global Provides Lessons; The Question is: Will We Learn?

MF Global Holdings’ bankruptcy underscores just how easily Europe’s problems can reverberate throughout the financial system.

MF Global is the biggest failure by a securities firm since Lehman Brothers Holdings Inc. filed for Chapter 11 in September 2008. MF Global lacked a sufficient capital cushion when its bets on $6.3 billion in European debt went bad. The firm had gambled on buying the bonds of financially troubled Italy, Portugal, Spain and Ireland.

Why did MF Global take this risk?

European sovereign debt was yielding 2 to 3 percent interest, versus the near-zero rates on U.S. Treasury securities. MF Global hoped to hold these bonds to maturity and enjoy a positive carry.

And Jon Corzine, former U.S. senator and governor of New Jersey and former CEO of Goldman Sachs, the chief executive of MF Global, apparently played a large role in the decision.

A MF Global trader told The New York Times that Corzine pushed traders to take chances on all sorts of trades. “He was instrumental in pushing our firm forward with risk-taking in every book (investment category), whether it was U.S. government bonds, currencies, or in repos. Everything was full-throttle go.”

Why was this bet so risky? The Egan-Jones rating agency reported that MF Global was leveraged about 40 to 1, which means a 3 percent drop in asset values would eliminate all its equity. In addition, MF Global relied almost exclusively on short-term funding (repurchase agreements) to make its big bets. When the company could not roll over its borrowings, it faced a liquidity crisis.

Did MF Global do more than place a bad bet with borrowed money?

The Wall Street Journal, in an article entitled “MF Global Masked Debt Risks,” reported that for possibly as long as two years, the firm might have hidden its debt levels from investors by temporarily slashing its borrowings before publicly reporting its finances each quarter.

Mark Williams, author of “Uncontrolled Risk,” a book that analyzed the collapse of Lehman Brothers, called MF Global “an Enron, a Lehman Brothers and a Refco all rolled up into one.” He said on ABC News that “the bank (MF Global) apparently engaged in unethical behavior and took risky bets using excessive leverage.”

Federal authorities, including the FBI, have stepped up an inquiry into why the firm apparently failed to keep its customers’ money separate from the company’s — a regulatory violation.

What are some of the possible longterm results of the firm’s collapse?

Amid charges that MF Global’s customer accounts are short by about $633 million, the Commodity Futures Trading Commission’s proposal to tighten restrictions on futures-trading firms investing cash sitting in customer trading accounts should now gain support.

MF Global’s collapse validated the concerns of Paul Volker, who has campaigned against proprietary trading on Wall Street. Proprietary trading occurs when a firm trades financial instruments with the firm’s own money as opposed to its customers’ money in order to make a profit for itself. U.S. Sen. Carl Levin said in an emailed statement, “The Volcker rule needs to be fully implemented quickly to ensure that banks can no longer put taxpayers at risk for making the kind of proprietary trades MF Global made.”

MF Global could be proverbial canary in the coal mine.

We are reminded daily about the risk of contagion from the plight of beleaguered European nations. Their problems pose risks to the U.S. economy in general and American banks in particular. In recent days, the equity prices of Morgan Stanley, Bank of America and the U.S. investment bank Jefferies Group Inc. have dropped precipitously in the wake of rumors over their Eurozone exposure.

Williams, author of the book on Lehman Brothers, said MF Global was almost a textbook example of greed-driven disaster, one so egregious that Occupy Wall Street protesters should drop all their other placards and simply declare, “Remember MF Global!”