Anybody using the financial services industry puts their faith and trust in a whole lot of people they have never seen or ever will. We all rely on regulators and regulations that are instituted by state and federal governments. In fact, almost anybody who has any savings probably has them parked in one of our financial institutions. To sharpen your focus on this, remember that about 80% of the balance of your checking account is tied up in loans that some strangers have promised to repay.
As a test of your thinking, how would you like to invest in this, as described in Wikipedia?
…2005 saw Man Financial make its largest deal with the transformative $323 million acquisition of client assets and accounts from entities of Refco, following the U.S. financial-services group’s collapse in late 2005. The Refco deal…boosted Man Financial’s scale in retail and institutional business.
In June 2007, Man Financial was spun off from Man Group as a separate, public entity, via an IPO, and renamed MF Global.
When a company spins off a subsidiary in an IPO (initial public offering of stock), it usually prefers to have the proceeds of selling it in lieu of continuing operating it. In other words, the sale proceeds would exceed ongoing expected profit.
And so MF Global enters our history. Before its first fiscal year was even completed, there were problems. As Wikipedia details:
On February 28, 2008, MF Global announced a bad debt provision in the amount of $141.5 million. The provision was the result of unauthorized trading by a representative in a MF Global branch office, who on February 27, 2008, while trading in the wheat futures market in his personal account, substantially exceeded his authorized trading limit.
MF Global was fined $10,000,000 by the CFTC [Commodity Futures Trading Commission] over the incident and an unrelated natural gas incident from 2003. The CME Group [Chicago Mercantile Exchange] also fined MF Global $495,000 over the wheat incident.
To follow this company a little more closely, we have selected data to bore in on its financial structure:
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Extracts from MF Global’s Financial Statements from 2007 to 2011 |
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(billions of $) |
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FYE |
3/31/2007 |
3/31/2008 |
3/31/2009 |
3/31/2010 |
3/31/2011 |
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Income |
Interest Income |
$4.090 |
$3.669 |
$0.816 |
$0.415 |
$0.516 |
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Interest Expense |
$3.739 |
$3.165 |
$0.431 |
$0.137 |
$0.229 |
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Net Interest Income |
$0.351 |
$0.504 |
$0.385 |
$0.278 |
$0.287 |
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Net Interest Margin |
8% |
13% |
47% |
67% |
56% |
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Total Revenue |
$1.378 |
$1.636 |
$1.426 |
$1.015 |
$1.069 |
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Expenses |
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Total Expenses |
$1.193 |
$1.624 |
$1.363 |
$1.169 |
$1.100 |
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Net (Loss) Income |
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$0.187 |
-$0.069 |
-$0.069 |
-$0.167 |
-$0.154 |
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Assets |
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Cash |
$1.692 |
$1.481 |
$0.639 |
$0.826 |
$0.649 |
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Restricted Cash |
$4.474 |
$5.976 |
$9.670 |
$9.693 |
$11.371 |
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Securities Purchased Under Agreement to Resell |
$19.056 |
$18.424 |
$12.902 |
$22.125 |
$9.499 |
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Total Assets |
$51.670 |
$49.254 |
$38.836 |
$50.966 |
$40.541 |
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Liabilities |
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Securities Sold Under Agreements to Repurchase |
$16.874 |
$18.638 |
$14.271 |
$29.079 |
$16.626 |
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Payables-Customers (Cash Deposits) |
$15.756 |
$15.302 |
$11.766 |
$11.997 |
$13.577 |
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Total Liabilities |
$51.125 |
$47.995 |
$37.394 |
$49.600 |
$39.037 |
This is not a background or performance that would inspire confidence. Wikipedia continues,”
…on March 17, 2008, shares of MF Global plummeted on liquidity fears.” Most people would just walk away from something like this. There doesn’t seem anything attractive to it. Who could see something in it? It would be none other than a former top executive of Goldman Sachs and recently retired Governor of New Jersey, Jon Corzine. Hmmm?? The combination of John Corzine and MF Global would create toxic waste for a lot of unsuspecting people.
So, how is it going at MF Global? Not very well. On Monday, October 31, 2011, MF Global filed for Chapter 11 bankruptcy. From Bloomberg Business Week:
MF Global listed $39.7 billion in debt and $41 billion in assets in its bankruptcy filing, and said it has about $26 million in cash. About $593 million of MF customer funds are unaccounted for, according to a person with knowledge of regulatory probes into the firms collapse.”
Bankruptcy is a fierce legal fight about who gets what from the financial wreckage of bad business, or what, if anything, each creditor gets. As these disputes rage, it is very important to keep in mind how to measure exactly how much of the money the company actually owns or was put up by the owners themselves. This is critical to understanding all the bad information of the financial press. It sounds like a complicated process, but, in fact, it is very straightforward. The amount of owner’s money in a company is the sum of the equity contributed plus profits and minus losses.
An alternative calculation that should produce the same value is the same number as total assets minus total liabilities. So, take $41 billion and subtract $39.7 billion and you get $1.3 billion as the amount of money that the owners of MF Global had provided to do what they did, or the ratio of the people’s money to owner’s money is 30.5:1. Let’s look at their profits since the purchase of the company by its new owners in June 2007.
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Net (Loss) Income for MF Global from 2008-2011 |
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(billions of $) |
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FYE |
3/31/2008 |
3/31/2009 |
3/31/2010 |
3/31/2011 |
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Net (Loss) Income |
-$0.069 |
-$0.069 |
-$0.167 |
-$0.154 |
Other than a profit for the partial first year of business, the cumulative loss for the entire four years was $459 million. Needless to say, this was a consistently lousy performance.
And who really put the cap on the bad performance? From the October 31, 2011 Wall Street Journal:
The rapid decline of MF Global represents a stunning turn of events for Mr. Corzine. A former chairman of Goldman Sachs Group Inc., he took over at MF Global in March 2010, just four months after being voted out as New Jersey governor and two months after leaving office. He set out to change MF Global from a midsize derivatives broker to full-fledged investment bank that took risks with its own capital….
On Tuesday, MF Global said the positions added up to $6.3 billion as of Sept. 30. About two-thirds of the total is related to sovereign debt of Italy and Spain. In comparison, Morgan Stanley had $2.1 billion in net exposure to debt issued by the same countries and nearly 50 times as much cash and liquidity as MF Global….
Bet, bet, bet! This is what Wall Street is all about! You would think this would have ended after the recent financial crisis, but it is still unchecked.
There are some very bizarre changes in MF Global’s financial statements in the period between 2008 and 2009. In fact, the changes between these ending balance sheets suggest that the Federal Reserve may have bailed out MF Global during this time. If you look at MF Global’s change in interest expense and net interest margin, you see that something drastic and inexplicable happened between 3/31/08 and 3/31/09. Interest income dropped from $3.669 billion to $816 million (-78% decline) and interest expense dropped from $3.165 billion to $431 million (-86% decline). Yet, the net interest income only decreased from $504 million to $385 million (-23% decline). How could there be such a drastic contraction in interest income and interest expense while net interest income declined by a much, much smaller percentage. Let’s compare a couple of things in MF Global’s 3/31/08 and 3/31/09 Financial Statements.
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Extracts from MF Global’s Financial Statements for 2008 and 2009 |
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(billions of $) |
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FYE |
3/31/2008 |
3/31/2009 |
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Interest Income |
$3.669 |
$0.816 |
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Total Assets |
$49.254 |
$38.836 |
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Implied Return |
7.4% |
2.1% |
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Interest Expense |
$3.165 |
$0.431 |
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Total Liabilities |
$47.995 |
$37.394 |
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Implied Return |
6.6% |
1.2% |
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Net Interest Income |
$0.504 |
$0.385 |
Now let’s just suppose that the Federal Reserve was feeling real charitable toward all these institutions that made “bad bets” with their customer’s and creditor’s money, not their own. Maybe they helped them out by taking all MF Global’s bad assets off their balance sheet as collateral for a Federal Reserve loan in the exact principal amount of their underlying liabilities at the federal funds rate of 0.5%. MF Global would use this loan to buy U.S. Treasury Securities with a yield of 3.0%.
Income actually earned in the year ending 3/31/09 was $385 million. The net interest spread on the U.S. Treasury at 3.0% financed by a Federal Reserve loan of 1/2% is 2.5%. Therefore, the amount of Treasuries purchased would be $15 billion.
Thus their income would be restored in much more solid U.S. Treasury Securities while the Federal Reserve parked their bad assets on their balance sheet. You can decide for yourself, but all these radical changes in MF Global’s balance sheet between 3/31/08 and 3/31/09 can only be explained by something like this. Poorly managed companies like this make money while prudent savers don’t. Rescue caused greater destruction later.
Let’s look at just how dangerous such a balance sheet is. In 2008, MF Global earned $3.669 billion in interest income on total assets of $49.254 billion. To do this, they had total borrowings of $47.995 billion. But, it paid interest expenses of $3.165 billion, or an implied rate of 6.7%. Its net interest income was $504 million. Therefore, if the value of their total assets had declined just 1%, the company’s entire interest income would have been offset by the capital loss. Or, if its interest income had declined by 13%, it would have earned zero net interest income on $49.524 billion in assets. The risk in these types of balance sheets, which is typical of most investment banks, is insane. And this is why the Federal Reserve bailed out almost every major investment bank during the 2008 financial crisis. If you think this is an insane use of other people’s money to enrich the salary and bonuses of financial industry executives, you are probably correct.
These investment banks take a lot of other people’s money trying to make a leverage trade while borrowing money to buy interest-paying securities. In this case MF Global had only $1.3 billion of its own money in equity to support a total bet of $6.5 billion, or 4.8 times the firm’s entire equity. What hubris or worse?
Where, then, do these gamblers get other people’s money to make outrageous bets? From the November 16, 2011 Wall Street Journal:
As MF Global Holdings Ltd. was sinking in late October, trader Andrew Gochberg thought he was making all the right moves to protect himself if the securities firm failed.
The 52-year-old Mr. Gochberg closed his trading positions at MF Global, leaving the entire balance of more than $1 million in what he thought was a protected account at the New York company.
That account was supposed to be kept separate from the securities firm’s own money….
You can see on the financial statement cash securities restricted. This means the owners may not risk or use them for the firm’s benefit.
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MF Global’s Restricted Cash from 2007 to 2011 |
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(billions of $) |
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FYE |
3/31/2007* |
3/31/2008 |
3/31/2009 |
3/31/2010 |
3/31/2011 |
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Restricted Cash |
$4.474 |
$5.976 |
N/A |
$9.693 |
$11.371 |
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*FYE 3/31/07 was a partial year of 9 months. |
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But according to the November 16, 2011 Wall Street Journal:
More than two weeks after MF Global filed for Chapter 11, some 33,000 customers are stuck in a sort of purgatory, with no access to their cash until a trustee liquidating the securities firm says they can get it….
Scott Gettleman, 39, an independent natural-gas trader on the New York Mercantile Exchange, has roughly $100,000 locked up in MF Global.
The day the company filed for bankruptcy protection, he says, an MF Global representative told him he needed to stop trading. Instinctively, he closed out his open positions so he wouldn’t be affected by market movements.
‘I did the responsible thing,’ he said. He then rushed to MF Global’s offices, where a clerk gave him a check for most of his account. He deposited it immediately, but the check bounced. His bank charged him a $15 bounced-check fee.
For the same period, Payables to Customers were as follows:
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MF Global’s Payables to Customers from 2007 to 2011 |
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(billions of $) |
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FYE |
3/31/2007* |
3/31/2008 |
3/31/2009 |
3/31/2010 |
3/31/2011 |
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Payables to Customers |
$15.756 |
$15.302 |
N/A |
$11.997 |
$13.577 |
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*FYE 3/31/07 was a partial year of 9 months. |
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In futures trading, customers have to make deposits of cash to guarantee their performance at the settlement of their contracts. The net cash balances in their accounts are included as payable to customers. In a stock brokerage, the net cash balances in customers’ accounts free credit balances also constitute payable to customers. This is a lot of money. The $13.577 billion balance on March 31, 2011 is 10.4 times the firm’s equity of $1.3 billion. So, what was MF Global doing with their customers’ money, which it is not supposed to touch? From the November 15, 2011 Wall Street Journal:
Hundreds of millions of dollars might have gone missing from customer accounts at MF Global Holdings Ltd. as far back as four days before the securities firm filed for bankruptcy protection, people familiar with the situation said Monday.
The possibility of a shortfall in customer funds on Oct. 27 suggests problems might have emerged sooner than MF Global officials initially indicated to regulators and exchange operator CME Group Inc. [Chicago Mercantile Exchange].
As the firm was fighting to survive a customer exodus during the week before its Oct. 31 bankruptcy filing, MF Global officials didn’t indicate there were any deficits in customer accounts, according to people familiar with the matter. On Oct. 28, MF Global officials reported to CME Group that the customer funds at the firm were in good shape, according to people familiar with the matter.
The October 28 statement appears to have been a great big lie to the entire regulatory apparatus. But then, from the same article:
Just hours before the bankruptcy filing, though, MF Global executives told regulators they believed a shortfall had somehow occurred, possibly starting on Oct. 27 or Oct. 28, these people said. Customer funds were found to be short by about $200 million on Oct. 27, according to people familiar with the matter.
Details of the disclosure haven’t been previously reported. As regulators investigate the company’s collapse and search for the missing money, estimated at about $600 million, the timing of the shortfall could be crucial. If regulators had known sooner about the missing money, they might have intervened faster or differently. Instead, they were left with a bigger mess after MF Global tumbled into bankruptcy.
To imply that the regulators didn’t have a much earlier indication of potential bad mismanagement is ridiculous. The fact the new ownership had losses for each of the last 4 years should have set off the alarm bells at both the CME and CFTC.
As is the case in these collapses, the damage to the innocent parties always increases with time. From the November 22, 2011 Wall Street Journal:
The amount of money missing from customer accounts at MF Global Holdings Ltd.’s brokerage unit could total over $1.2 billion, more than double the previous estimate.
The surprise revelation by the trustee overseeing the unwinding of the securities firm formerly run by Jon S. Corzine raised the stakes in a widening regulatory and legal hunt for the missing money and the circumstances of the firm’s collapse into bankruptcy three weeks ago.
The jump from the original estimate of a $600 million shortfall also cast deeper doubt about the ability of the bankruptcy trustee to make former MF Global customers whole anytime soon-or perhaps ever.
Remember that the ratio of MF Global’s “money” to other people’s money was 39.1/1.3 or 30.1:1. Is it a coincidence or a surprise that the customers’ loss of $1.2 billion is slightly less than the owners’ equity? From the same article:
The outcome ‘will all depend on how much more property the trustee can identify and get under control,’ said Kent Jarrell, a spokesman for the trustee, James W. Giddens. He said the trustee remains committed to his goal of returning 100% of customer money….
‘I just feel sick in my stomach today,’ said Gary Li, president of Washington Asset Advisors LLC, a hedge fund in McLean, Va., that had more than $70 million of his firm’s cash locked up with MF Global. ‘I feel absolutely appalled.’ His money is still frozen, he said….
…Money that MF Global may have moved outside the U.S. could be particularly snarled. MF Global might have lost money in trades that the trustee has no way of recovering.
The trustee should consider lawsuits against MF Global executives and board members for trading that possibly violated multiple regulations. These people always seem to have vast net assets. According to the June 7, 2000 issue of Time, John Corzine made $400 million when he sold his Goldman Sachs’ stock.
But, in the Wall Street culture, the problems are always in the “accounting” systems (i.e.-the accounting system did it). From the November 15, 2011 Wall Street Journal:
…The CFTC also is examining whether hundreds of millions of dollars in customer accounts were transferred at MF Global during the week that began Oct. 24. The transfers weren’t recorded in the firm’s general ledger reviewed by exchange officials, according to the agency.
‘We’re still trying to assess how far this goes back,’ Thomas Smith, a Commodity Futures Trading Commission official involved in the MF Global probe, said in a staff briefing with the Senate’s agriculture and banking committees Monday.
As we just said, MF Global’s continuing losses for the last four years should have made it clear that a firm with a debt to equity ratio of over 30:1.3 was going to have a bad ending. From the same article:
Mr. Smith said a failure to record the transactions in the general ledger is one reason regulators have had trouble finding the missing funds. The CFTC is attempting to trace the movement of the funds. The CFTC believes the money could still be inside MF Global, though it thinks that is a remote possibility, according to people familiar with the agency’s thinking.
…Typically, such moves are reflected in the general ledger. People familiar with the company’s thinking say the general ledger reflected customer transfers in the early part of the week.
…During its final days, MF Global was dealing with a torrent of requests from customers trying to get their money back.
For anyone who has received financial statements from the financial services industry, data are typically accurate and are correctly posted, whether the focus is on purchases, sales or earnings. Computers merely record input; they don’t create it. “Breakdowns ” are the product of human error or fraud, From the November 30, 2011 Wall Street Journal:
Regulators poring over MF Global Holdings Ltd.’s books have been flummoxed by a tangled money trail that crosses borders and different parts of the securities firm. The hunt for hundreds of millions of dollars in missing customer money has even put the regulators at odds.
These regulators failed to react to early signs of financial weakness caused by bad management that facilitated the damage to the customers. From the same article:
On Oct. 31, the same day the New York firm filed for Chapter 11 bankruptcy-court protection, MF Global shifted $220 million in money it claimed as its own from reserve accounts in its broker-dealer unit to customer accounts in its futures merchant operation, according to people familiar with the situation.
This is stealing from Peter to pay Paul. The Journal continues:
The futures business is overseen by the Commodity Futures Trading Commission, while the Securities and Exchange Commission regulates the brokerage unit. MF Global moved the money despite objections by SEC officials, who said the $220 million should stay put because it wasn’t clear if the cash belonged to MF Global or customers, these people said.
“Too big to fail” apparently means that regulators lack the ability or willingness to investigate corrupt executives. The regulators’ prime responsibility is to the customer whose assets they are supposed to protect from bad management. The Journal continues:
Since the move was made, CFTC officials have argued the cash should stay in the futures account, already short by hundreds of millions of dollars, people familiar with the matter said.
The shorts in all these customers’ accounts should have been detected months, if not years before, because of ongoing losses at MF Global. All these firms have to post financial statements with regulators. Apparently, they don’t look at them. The Journal continues:
For their part, MF Global officials believed the money was excess cash held in reserve for customers, based on calculations made Oct. 28. MF Global’s push to move the $220 million was part of a broader effort to fill a shortfall in customer assets that had been identified and communicated to regulators early in the morning of Oct. 31, people familiar with the firm’s thinking said….
Meanwhile, officials involved with the investigation have said that MF Global’s chaotic recordkeeping and failure to record in its general ledger all transactions made in the week before the Chapter 11 filing make tracking the money difficult. CFTC officials overseeing the futures merchant have struggled to track the flow of customer cash after it was shifted, people familiar with the matter said….
This has all the appearance of fraud. And the regulators continue to confess that problems were rampant. Ah, yes, the regulators are always behind the eight ball after the crime has occurred when they should have enforced their regulations before the crime happens. From the November 16, 2011 Wall Street Journal:
The Commodity Futures Trading Commission on Friday held a large meeting about the bankruptcy of MF Global Holdings Ltd. One person missing: CFTC Chairman Gary Gensler.
The hard-charging chairman late last week removed himself from the investigation into MF Global Holdings Ltd.’s sudden implosion. Mr. Gensler’s decision was made to eliminate the perception of a conflict of interest due to his long-standing ties to the now-departed chief executive of MF Global, Jon S. Corzine….
How can the Chairman of the Commodity Futures Trading Commission exculpate himself from a meeting dealing with probably the largest collapse of a futures trading company? This has nothing to do with whether or not he knew Corzine, and everything about how the possibility, if not inevitability, of MF Global’s failure could go unrecognized for so long. As such a large firm, it should have had their regulators living in house with MF Global. It was not a profit-making firm with a huge balance sheet. This made it the perfect candidate to do exactly what it did; destroy assets of unsuspecting customers and clients. By law, when a stock brokerage cannot meet its statutory capital requirements, it must self-report and shut down within 24 hours. If MF Global had been filing financial statements with the CFTC, alarm bells should have gone off since the day it started losing money. This is what Mr. Gensler needs to explain. But, maybe he was so close to Mr. Corzine that he breached and compromised all his fiduciary and regulatory obligations. From the November 30, 2011 Journal article:
…Mr. Gensler worked at Goldman Sachs Group Inc. in the 1990s, when Mr. Corzine was the securities firm’s chairman and senior partner.
Mr. Gensler also provided financial support to Mr. Corzine’s political aspirations. Mr. Gensler, a prolific Democratic donor, gave the New Jersey Democratic Party $10,000 in 2005, the year Mr. Corzine was its candidate for governor, according to state election records. It is the only donation Mr. Gensler has made to the New Jersey Democrats.
…But the downfall of MF Global appears likely to give new momentum to a regulation that Mr. Corzine firmly opposed-and Mr. Gensler had championed.
Still, the case marks a setback for Mr. Gensler, who transformed himself from an opponent of tighter oversight of the financial industry when he served in the Clinton administration Treasury Department in the late 1990s into one of the most aggressive regulators in the Obama administration….
…Mr. Gensler proved one of Mr. Corzine’s fiercest opponents over a proposed regulation to clamp down on how firms such as MF Global invest the cash sitting in customer accounts-an issue that stands at the heart of MF Global bankruptcy…. The cause of the missing money remains uncertain.
How long were Mr. Gensler and Mr. Corzine having this bitter disagreement? On the very day they had it, Mr. Gensler should have flooded MF Global with regulators to see why Mr. Corzine was resisting further regulation to protect cash in customers’ accounts. From the November 16, 2011 Wall Street Journal:
In a December 2, 2010, comment letter, jointly written with brokerage firm Newedge USA LLC, MF Global said the proposed restrictions were seeking to ‘fix something that is not broken.’ They could ‘decrease significantly the income [futures clearing merchants] derive…from prudently investing in customer segregated funds….’
As is so often the case, the regulated get to write the regulations. It is bizarre that Mr. Corzine would have anything useful to say about protecting customers’ accounts. From the November 7, 2011 Wall Street Journal:
The debate centered on a little-known CFTC rule called Regulation 1.25, which covers how futures commission merchants-firms that take orders to buy or sell futures contracts on behalf of clients-could invest customer funds.
The CFTC had proposed changes to the rule to protect customer funds, including tighter restrictions on so-called internal repurchase, or repo, agreements. In such transactions, the firm swaps customer funds for securities such as corporate bonds or sovereign debt held at another part of the firm. The firm can book the excess interest as profit or pass it on to the clients.
In effect, the CFTC allows firms to borrow the customers’ money without having to pay interest. From the same article:
Mr. Corzine strongly opposed the proposed restrictions on internal repo operations. On a July 20 conference call with CFTC officials, including Mr. Gensler, Mr. Corzine argued that the restrictions on internal repos would hurt MF Global and its customers, according to people familiar with the call….
A July 20 conference call would have happened just about three months before the bankruptcy. In it, the heart of the beast is revealed. From the November 16, 2011 Wall Street Journal:
…so-called internal repurchase, or repo, agreements. In such transactions, the firm swaps customer funds for securities such as corporate bonds or sovereign debt held at another part of the firm. The firm can book the excess interest as profit….
As late as July 20th, then, Mr. Gensler had a chance to enforce existing regulations that might have saved some of the customer funds. And this argument must have been going on for well before July 20, the day the regulators should have taken over MF Global. The regulators obviously knew there was a major problem, but gave into Mr. Corzine anyway.
Repo-it seems we have encountered that word somewhere else. How about a zero maturity repo? From the November 29, 2011 Wall Street Journal:
…Over the past two months, the large Japanese investment bank said it cut its use of a financing tool known as ‘repo-to-maturity’ transactions backed by European debt.
Previously, Nomura had several hundred million dollars worth of such trades, which allow a borrower to benefit from favorable interest-rate situations but expose it to the risk that lenders will demand more collateral in a down market, potentially creating a financial strain.
The firm’s pullback is noteworthy because similar repo-to-maturity trades-on a much greater scale-played a role in last month’s collapse of MF Global Holdings Ltd….
Repos to maturity are a variation on traditional repurchase agreements, or ‘repos’-a key form of financing in which a securities-trading firm borrows money on a very short-term basis, and pledges securities as collateral, promising to repurchase them later. Repos to maturity are longer-term, designed so that the borrowing and the pledged securities mature at the same time.
That offers liquidity advantages-the firm doesn’t have to return to the market constantly to refinance its borrowing. Also, accounting rules allow repos to maturity to be recorded as sales rather than financings, so a firm can take the pledged securities off its balance sheet, reducing its reported leverage….
Now go back to our chart of extracts of the low lights of MF Global financial statements. There were some massive changes in relevant accounts. The periods in question are the 12-month periods ending 3/31/08, 3/31/09 and 3/31/10.
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MF Global’s Significant Balance Sheet Changes from 2009 to 2011 |
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(billions of $) |
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FYE |
3/31/2009 |
Inter-Period Change |
3/31/2010 |
Inter-Period Change |
3/31/2011 |
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Securities Purchased Under Agreement to Resell |
$12.902 |
$9.223 |
$22.125 |
-$12.626 |
$9.499 |
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Securities Sold Under Agreements to Repurchase |
$14.271 |
$14.808 |
$29.079 |
-$12.453 |
$16.626 |
|
Payables-Customers (Cash Deposits) |
$11.766 |
$0.211 |
$11.997 |
$1.600 |
$13.577 |
|
Securities Loaned |
$5.951 |
-$4.962 |
$0.989 |
$0.431 |
$1.420 |
With our new knowledge of a zero maturity repo, we are startled by the fact that between 3/31/10 and 3/31/11, MF Global’s securities purchased under agreement to resell declined $12.626 billion and the liability securities sold under agreement to repurchase declined by an almost exactly matching amount of $12.453 billion. Were these zero maturity repos that “a firm can take off its balance sheet?”
Under this scenario, the new borrowing between 3/31/09 and 3/31/10 was $14.808 billion. Since the increase in the asset of securities purchased under agreement to resell was only $9.223 billion, we surmise that the new borrowing of $14.808 for the same period would have applied as follows: $14.808 billion less $9.223 billion securities purchased less decrease in the securities loaned liabilities of $4.962 billion.
Therefore to transfer off the balance sheet $12.626 billion of zero maturity repo securities -when there was only an increase of $9.232 billion in the category of securities purchased under agreement to resell it-would have required that $3.394 billion had already been on the books. Perhaps they borrowed the money from the pools of customer funds? It is interesting that the only people complaining about losses are customers.
But another group damaged by the hiding of $12 billion in liabilities has been the lenders who provided MF Global with $325 million as recently as August 2011. From Bloomberg Business Week, December 19, 2011:
…U.S. regulators questioned MF Global’s use of so-called repo-to-maturity transactions as early as March, well before the company issued two tranches of $325 million in debt and the company disclosed the $6.3 billion bet on Europe’s most indebted nations that prompted regulatory concerns and ultimately its bankruptcy….
If MF Global was arguing with the CFTC in March 2011, by implication, the Commission must have known about it as well that month.
But to really understand the cause of this crime, let’s focus on John Corzine. From the November 23, 2011 Wall Street Journal:
Wall Street traders who make bets with a firm’s own money usually have at least several sets of bosses looking over their shoulder.
At MF Global Holdings Ltd., where Jon S. Corzine made $6.3 billion in trades on European sovereign debt that sank the company last month, a different set of rules applied.
Wait a minute. The whole financial industry seems to be intellectually compromised. We just showed MF Global’s “owner’s own money” was only $1.3 billion. Anything above this was other people’s money. And thank you Wall Street Journal for using the word “bets” at least 100 times in every edition, because that really is all Wall Street is doing these days. They bet big sums of other people’s money so they can pay themselves outrageous salaries. If they lose these big bets, the stockholders, lenders depositors and ultimately the U.S. taxpayers are the losers.
Now look at this set of facts from the same article:
Mr. Corzine, the 64-year-old former New Jersey governor and Goldman Sachs Group Inc. chairman who took over as chairman and chief executive of MF Global in March 2010, reported only to the company’s board of directors.
That means when Mr. Corzine put on the European trade, he didn’t rely heavily on the risk-management department at MF Global, a system of internal oversight and controls….
At MF Global, Mr. Corzine and a seven-person board that included directors with several decades of combined experience in the financial industry had several ‘vigorous debates’ about the European bets he began making in September 2010, according to a person briefed on the situation. Those discussions continued as the size of the trades swelled earlier this year.
People familiar with the matter say the board set specific limits so that the overall bet on bonds of countries such as Portugal, Ireland, Spain and Italy wouldn’t grow larger. Those restrictions suggest that MF Global directors may have viewed themselves as Mr. Corzine’s risk-management department….
Given that the Board of Directors appointed themselves the supervisors in charge of enforcing regulatory requirements on John Corzine, shouldn’t the board should be liable for their failure to properly supervise him? The financial services industry is supposed to have a fiduciary responsibility to its clients, lenders and depositors. Unfortunately, the responsibility seems to be to its own wallets. (See Goldman Sachs Prospers at Taxpayers Expense).
When these businesses used to be operated as partnerships, executive’s bad bets only resulted in the loss of their own personal fortunes, not customers or clients. This was a very efficient manner of checking stupid betting. This is much better than the policy of “too big to fail.”
The raw material for this corruption was created by the removal of key sections of the Glass-Steagall Act in 1999. This law was established in 1933 to keep commercial banks and investment banks from doing business with and owning each other. With its repeal in 1999, the resulting mega-banks borrowed unprecedented amounts of other people’s money from each other to make massive bets on securitized mortgages and commodities. This, more than anything else, led to the 2008 financial collapse. In prior financial catastrophes, borrowers went broke. In 2008, the lenders went broke from lending to each other so that they could make huge “bad bets.” And remember that from MF Global’s financial statements, it would have only taken a .001% decline in the value of their assets to erase one year’s worth of net interest income on $504 million.
It is little coincidence that the leader of the charge to repeal the heart of the Glass-Steagall Act was another former chief executive of Goldman Sachs, Robert Rubin. The former Secretary of the Treasury was helping his friend Sandy Weil. Weil wanted to merge his Traveler’s Group with Citicorp. So, on November 12, 1999, President Clinton stated, “Glass-Steagall is no longer appropriate for our economy.”
The most unexpected and incredulous if not outrageous development in the MF Global matter is about another institution, the New York Federal Reserve Bank. Here is a quote from MF Global’s bankruptcy petition:
…As of October 30, 2011, MF Global is one of 20 primary dealers authorized to trade U.S. government securities with the Federal Reserve Bank of New York….
And what is a primary dealer? It is a very unique status within financial institutions. Only the best of the best can qualify. From Wikipedia:
In the United States, a primary dealer is a bank or securities broker-dealer that is permitted to trade directly with the Federal Reserve System (‘the Fed’). Such firms are required to make bids or offers when the Fed conducts open market operations, provide information to the Fed’s open market trading desk, and to participate actively in U.S. Treasury securities auctions….
Primary dealers purchase the vast majority of the U.S. Treasury securities (T-bills, T-notes, and T-bonds) sold at auction, and resell them to the public. Their activities extend well beyond the Treasury market…all of the top ten dealers in the foreign exchange market are also primary dealers…. Arguably, this group’s members are the most influential and powerful non-governmental institutions in global financial markets. Group membership changes slowly….
In response to the subprime mortgage crisis and to the collapse of Bear Stearns, on March 19, 2008, the Federal Reserve set up the Primary Dealers Credit Facility (PDCF), whereby primary dealers can borrow at the Fed’s discount window using several forms of collateral including mortgage backed loans.
Here, then, was a ragtag company that never made a profit since being taken over in June of 2007. It was having problems with regulators and all that are have seen above was ongoing. And in the end its top management blew it up.
One only can wonder what unseen corruption occurred and how the New York Federal Reserve Bank qualified MF Global as a Primary Dealer. This would get them at least indirect access to Federal Reserve financing perhaps to buy European bonds.
The only linkage that an outsider can see is the President of the New York Federal Reserve Bank: William C. Dudley. According to Wikipedia:
William C. Dudley (born 1952) is the president of Federal Reserve Bank of New York and vice-chairman of the Federal Open Market Committee. He was appointed to the position on January 27, 2009, following the confirmation of his predecessor, Timothy F. Geithner, as United States Secretary of the Treasury….
Dudley worked at Goldman Sachs from 1986 to 2007, holding the position of chief economist for ten years before he was hired by then-president of the New York Federal Reserve Timothy Geithner to oversee the department in charge of buying and selling government securities.
According to salary figures released in 2010, Dudley is paid ‘more than $410,000 per year,’ making him one of the two highest-paid of the twelve presidents of the Federal Reserve Banks.
What a coincidence. John Corzine left Goldman Sachs after 24 years in 1999. William Dudley started at Goldman Sachs in 1986 and left after 2007, a period of 21 years. Could it be that this trio of former Goldman Sachs executives – Corzine, Gensler and Dudley – were co-conspirators against the customers of MF Global?
-Fred N. Sauer is an NLPC Associate Fellow, St. Louis resident, and businessman whose blog can be found at www.fredsauermatrix.com. You can also buy his book at www.americasculturalstudies.com.