My take on the MF Global debacle: It could have been a customer
As you may or may not know, I was a futures broker for 7 years. Both of the firms I worked for during that time, through various mergers, are now a part of MF Global. This means I have a lot of friends, clients and former co-workers that are struggling to make sense of what is happening with their accounts, positions, and cash on deposit with the defunct firm.
Here is my take:
When a client opens a futures account, they are assured that their money will be kept in a ‘segregated account’, meaning that their funds and positions will remain separate from all other monies within the firm. Their cash will not be pooled with other clients money, nor does the firm have access to their account to finance it’s own operations. Accounts are ‘marked to the market’ at the close of each day, and a client is to have access to those funds, at any time, without penalty for withdrawal. Those are the rules as set by the CFTC.* (Please read footnote for explanation)
As a broker, this is what you tell your clients, and this is what you trust to be true.
At MF Global, SOMEBODY OR SOME GROUP with the firm had placed large bets on European bonds.** (Please read footnote for explanation)
SO, when Greece, for example, ran into financial trouble, the liklihood of default began to rise, so the yields on their ‘government’ bonds rose, prices fell. The assets became more ‘risky’ therefor trade at a higher yield. Some dope at MF Global, thought they were a good investment at the now higher yield, and bought a truckload of them. In fact, he/she bought more than was reasonably ‘affordable’ based on the risk and cash balance of the account. This dope could even have been a customer of the firm.
This is when the trouble began.
As these bonds continued to lose value, the account balance dropped, in fact, the balance dropped so far, that more money was needed in the account to finance the trades. IF the money is not available, the positions should be liquidated.
As a former broker, I have made many a phone call to clients telling them that they need to add more money to the account to finance a trade that is under water. If they refuse, don’t have the money, or are unreachable after several attempts, I have the right to liquidate their position at the close or intra-day if need be. It’s written in the contract they signed to open the account.
OK. Now let’s say this is a very good customer of mine, someone with whom I worked for several years. And this customer assures me that he/she will wire the money by the end of the day. It’s risky, but I may accept, and let the trade remain. The money doesn’t arrive. The next day, the customer is further underwater, to the point where the account is deeply in the red. The customer either doesn’t have the money or is nowhere to be found. This account now becomes the risk of me and my firm.
I contact the manager of my department and share the bad news. The account is now down millions of dollars. There is an emergency meeting whereby all management and even the CEO (Jon Corzine) are called in to assess the situation. After careful consideration, the group decides to hold the positions and wait for a more ‘opportune’ time to liquidate. UH OH. The next day, as situations in Europe worsen, the trade is now down many millions if not billions. Worse yet, the loss exceeds the risk capital of the firm.
This is when MF Global breaks the rules.
In an effort to ‘float’ the position and wait for a rebound, money from OTHER CUSTOMER ACCOUNTS is transferred to the bad account in order to hide the losses from the regulators and exchange.
The losses keep growing.
MF Global moves more and more money from other accounts until the losses grow so large that they are no longer able to hide them. REGULATORS FREEZE ALL ASSETS AND SHUT THEM DOWN.
MF Global reportedly lost 633 million dollars of customer money trying to cover up a bad trade.
The news is reporting that it was MF Global itself that ‘invested’ in these bad bonds. It is possible, however, that the trade began as a customer position.
This leaves me with one question: WHO WAS THE CUSTOMER?
EDIT: Someone at MF Global is going to jail for this, irregardless of how the trade got started.
See these links for more info:
http://www.bloomberg.com/news/2011-11-02/mf-brokerage-has-commodity-customer-shortfall-of-600-million-cftc-says.html
http://www.bloomberg.com/news/2011-11-03/corzine-lived-up-to-risk-taking-reputation-at-mf-global-before-bankruptcy.html
* Bank deposits: Think ‘It’s a Wonderful Life’, where George was begging people not to take all of their money out of his savings and loan, because he didn’t really have the cash on hand, it was distributed as loans to finance mortgages, etc. This is different than, say, a mutual fund, which pools assets together to make large purchases of stocks or bonds. It is also different than a bank, which uses customer deposits to make loans to other clients.
**If you have been a follower of my blog, you know that the formation of the Euro set off a ticking time bomb: Individual nations (Spain, Italy, Greece etc..) were now offering ‘government bonds’ based in a currency which is not their own. Greece, for example, does not have the power to ‘print’ Euros, they do not have the power spend Euros or finance government operations without having the deposits to do so. They cannot run a deficit without eventual default. In contrast, the U.S. DOES have the power to ‘print’ their own currency, therefor can make payments on all government debt issued in dollars regardless of the deficit. (This is why we have 10 year Treasury yields at 2 percent… because the investment is safe from default.) It’s possible for STATES to default on their individual debt (municipal bonds, etc.) because they are reliant on tax income and cannot ‘print’ dollars.
All countries that joined the Euro gave up their financial power as a sovereign nation. They turned themselves into a ‘state.’






