Daily Archives: November 22, 2011
by Ben Howe
Late Thursday night, American company Hawker Beechcraft was informed by the U.S. Air Force that they were not going to be allowed to compete for an American military aircraft contract.
The Air Force has notified Hawker Beechcraft Corp. that its Beechcraft AT-6 has been excluded from competition to build a light attack aircraft, a contract worth nearly $1 billion, the company said.
The company had been working with the Air Force for two years and spent over $100 million to ensure compliance with the requirements for the plane and says the craft (Beechcraft AT-6) met all requirements as shown through a demonstration actually led by the Air National Guard.
“We have followed the Air Force’s guidance close, and based on what we have seen, we continue to believe that we submitted the most capable, affordable and sustainable light attack aircraft,” the company said.
Keep in mind, this doesn’t appear to be a question of being outbid or outclassed. In fact, this seems to be a classic example of a contract being awarded without any bidding process at all, something you may remember infuriated the left when the recipient of the contract was American company Haliburton.
There’s a big difference this time. The company the no-bid contract went to isn’t an American company. Worse yet, the company it did go to has questionable friends. Namely, Iran.
Embraer, a Brazilian aerospace giant which is currently under investigation for potentially making illegal payments to obtain government contracts, is essentially owned by the Brazilian government. Through their “Golden Share,” Brazil essentially has control over the company’s business operations.
According to Embraer’s website, that Golden Share provision empowers the Brazilian government with veto rights over: “Creation and/or alteration of military programs, whether or not involving the Federative Republic of Brazil;” “Development of third parties´ skills in technology for military programs;” and “Interruption of the supply of maintenance and replacement parts for military aircraft,” among other things.
But Brazil has their own explaining to do regarding their long and sordid history with the rogue country of Iran.
According to the Council on Hemispheric Affairs, “In 1989, Brazil chose to sell Tucanos, Embraer’s relatively low cost and basic military aircraft, to Iran.” Currently, the Islamic Revolutionary Guard Corps Air Force operates around 40 Embraer T-27 Tucanos, according to the Washington Institute. In fact, the Iranians use the Tucano as their primary close air support aircraft.
In recent years, Brazil has continued its troubling friendship with Iran and ruthless leader Mahmoud Ahmadinejad. The Hudson Institute notes that, “Another area of tension between Brazil and the United States relates to Iran. In November 2009, President da Silva invited Iranian President Mahmoud Ahmadinejad to Brazil. In May 2010, da Silva helped broker a deal in which Iran would ship only a portion of its low-enriched uranium to Turkey for reprocessing; the rest would remain in Iranian hands, where it could be further enriched for nuclear weapon production.”
According to the Financial Times, building war planes is actually part of an industry that Embraer is fairly new to as they are only just “venturing into the defence industry.” Yet, the U.S. government has found them to be more capable and trustworthy than an American manufacturer that already builds hundreds of U.S. military aircrafts and would employ as many as 1,400 new workers across 20 states.
To make matters worse, Hawker was already experiencing trouble as a result of the tumultuous economy and had already announced potential layoffs. With news that they won’t be offered the opportunity to compete as the only American manufacturer for the light air craft contract, expect more bad news to come out of their offices.
Of course, the employees of Hawker Beechraft may not be on President Obama’s nice list these days anyway. It turns out that Hawker Beechcraft employees are represented by the International Association of Machinists (IAM). IAM president, Tom Buffenbarger, is one of the few union presidents without direct access to the White House. Here’s why:
For the video impaired, here’s the takeaway:
“Barack so loved his own performance that he made Galesburg part of his presidential stump speech. That’s right, he’s damn proud of his performance. Well I’m not. All he proved is like Janus, the two-faced Roman god of ancient times. He could act like a friend to the workin’ man. Even as he danced to tune dictated by billionaires. Yes, we’ve seen this act before.”
Curious that the Obama administration would push an American manufacturing company who’d been trusted in the past in favor of a company run by a government directly involved in the continuing move towards nuclear capabilities by the nation most hostile to American interests.
- Obama Administration Sends, What the heck? It’s only our national security (whoopsies.wordpress.com)
- Air Force bounces US manufacturer for Brazilian competitor (hotair.com)
- Hawker Beechcraft handing out layoff notices (seattlepi.com)
- Hawker Beechcraft to Showcase Diverse Product Line at Dubai Air Show (linkybird.com)
- LAARA: Beechcraft vs. Embraer (xbradtc.wordpress.com)
The IMF will offer a new credit line program to allow sovereigns to “break the chain of contagion.”
A new “Precautionary Credit Line” would allow governments with sound financials who have made prior agreements with the IMF to access liquidity of 1000% of a member’s quota for 1-2 years. It would also allow them to access up to 500% of their quota in liquidity on a 6-month basis.
The funds would be offered to sovereigns suffering from “exogenous shocks.”
Markets and the euro spiked immediately on the news.
There are, however, a few big problems with this new proposal.
First, it is unclear whether the IMF actually has access to the amount of funds that would be necessary to bail out a sovereign like Italy.
Italy currently has $2.2 trillion in gross external debt, far exceeding the IMF’s current available resources of about $540 billion. While that would significantly add to the resources the eurozone bailout fund—the European Financial Stability Facility—has available, this still falls short of the estimates for funding necessary to truly stem the crisis. Citi’s Willem Buiter recently suggested about €3 trillion ($4 trillion).
This suggests that the IMF might have to rapidly expand its funding resources to act as an effective bulwark against contagion. But that’s not likely to happen either.
The United States—which provides the largest percentage (17.7%) of IMF funds of any individual country—will also have to approve the plan. Previous bids to expand the IMF’s funding have hit a wall with U.S. opposition, primarily led by the GOP.
This press release from the IMF describes how the new program will work:
IMF Enhances Liquidity and Emergency Lending Windows
Press Release No. 11/424
November 22, 2011
The Executive Board of the International Monetary Fund (IMF) approved on November 21 a set of reforms designed to bolster the flexibility and scope of the Fund’s lending toolkit to provide liquidity and emergency assistance more effectively to the Fund’s global membership. These reforms, which have been under preparation for some time, will enable the Fund to respond better to the diverse liquidity needs of members with sound policies and fundamentals, including those affected during periods of heightened economic or market stress—the crisis-bystanders—and to address urgent financing needs arising in a broader range of circumstances than natural disasters and post-conflict situations previously covered.
“I commend the Executive Board for the expeditious response to support the membership in these difficult times,” said IMF Managing Director Christine Lagarde following the Executive Board meeting. “The Fund has been asked to enhance its lending toolkit to help the membership cope with crises. We have acted quickly, and the new tools will enable us to respond more rapidly and effectively for the benefit of the whole membership.
“The reform enhances the Fund’s ability to provide financing for crisis prevention and resolution. This is another step toward creating an effective global financial safety net to deal with increased global interconnectedness,” she added.
The reform replaces the Precautionary Credit Line (PCL) with the more flexible Precautionary and Liquidity Line (PLL), which can be used under broader circumstances, including as insurance against future shocks and as a short-term liquidity window to address the needs of crisis bystanders during times of heightened regional or global stress and break the chains of contagion. The Fund’s current instruments for emergency assistance (Emergency Natural Disaster Assistance and the Emergency Post-Conflict Assistance) are consolidated under the new Rapid Financing Instrument (RFI), which may be used to support a full range of urgent balance of payments needs, including those arising from exogenous shocks.
The Precautionary and Liquidity Line:
- Qualification criteria remain the same as under the PCL. A member needs to be assessed as having sound economic fundamentals and institutional policy frameworks, having a track record of implementing sound policies, and remaining committed to maintaining such policies in the future. A member can seek support when it has either a potential or actual balance of payments need at the time of approval of the arrangement (rather than only a potential need, as was required under the PCL).
- Can be used as a liquidity window allowing six-month arrangements to meet short-term balance of payments needs. Access under a six-month arrangement would not exceed 250 percent of a member’s quota, which could be augmented to a maximum of 500 percent in exceptional circumstances where the member faces a balance of payments need that is of a short-term nature and results from exogenous shocks, including from heightened regional or global economic stress conditions.
- Can also be used under a 12 to 24-month arrangement with maximum access upon approval equal to 500 percent of a member’s quota for the first year and up to 1000 percent of quota for the second year (the latter of which could also be brought forward to the first year where needed, following a Board review). As under the PCL, arrangements of these durations include Executive Board reviews every six months.
The Rapid Financing Instrument:
- The RFI broadens coverage of urgent balance of payments needs beyond those arising from natural disasters and post-conflict situations, and can also provide a framework for policy support and technical assistance.
- Funds are available immediately to the member in need upon approval with access limited to 50 percent of the member’s quota annually, and to 100 percent on a cumulative basis.
- The member needs to outline its policy plans to address its balance of payments difficulties, and the IMF must assess that the member will cooperate in finding solutions for these difficulties.
Review of Flexible Credit Line and PCL:
The Executive Board also reviewed the FCL and PCL and found that that these instruments have bolstered confidence and moderated balance of payments pressures during a period of heightened risk. The rigorous qualification framework has worked well and access decisions have reflected the evolution of risks facing users of these instruments. The review calls for focusing qualification discussions more on qualitative and forward-looking aspects of policies and policy frameworks, and enhancing the transparency of access decisions.
- IMF to rescue eurozone from debt crisis? (cbsnews.com)
- G20 asks IMF for solutions to eurozone crisis (thestar.com)
- Steen’s Chronicle: Wrestling with a lack of liquidity (tradingfloor.com)
- IMF Playing Larger Role In Addressing Europe Debt Crisis (huffingtonpost.com)
- ECB in talks to lend to IMF Quantitative Easing by the back door to save the Euro (politics.ie)
- IMF’s Largarde: IMF to Propose New Crisis Management Tools (forexlive.com)
- What lies beneath the IMF’s (liquid) blanket (ftalphaville.ft.com)
Heads should roll. Don’t bet on it.
He also was one of legions of corrupt politicians as US senator and New Jersey governor. His extreme, longstanding criminality warrants putting him in prison for life. No restitution can reverse his harm. It’s true also for many others like him.
Before its collapse, MF Global (MFG) faced a run on its holdings. On October 31, it filed for Chapter 11 bankruptcy protection.
On November 19, Reuters said the firm “moved hundreds of millions of dollars in customer money from its US brokerage unit to Bank of New York Mellon Corp. in August, just months before filing for bankruptcy….”
In other words, MFG lawlessly looted customer accounts. It used client money for its own purposes to speculate, as well as cover debt obligations and losses. At issue is grand theft.
In fact, it’s one of the most brazen acts in memory in a business notorious for outrageous criminality. What ever’s gotten away with incentivizes Wall Street crooks to steal more. Why not! At most, they’re slap on the wrist punishments mock rule of law justice.
On November 19 on the Kaiser Report, Barry Ritholtz commented on the big lie, hyper-leveraged banks, the MFG scandal, and congressional political whores, saying:
People responsible for creating these problems shift blame to others. Facts say otherwise. Wall Street speculators take big risks. They use hyper-leverage that’s only effective when it works.
“Their models were wildly optimistic. Banking is supposed to be very boring.” Decisions are supposed to be made about who’s credit worthy and who isn’t. Instead, reckless speculation replaced investing and sound lending policies.
Wall Street’s ideology is bankrupt, “and it’s causing global damage to the economy. For investment banks, the five biggest houses got waivers on leverage rules.”
SEC collaborators rigged the system for them. These banks also “happen to be the five biggest donors to Congress,” or among the largest. Over time, successful lobbying removed everything affecting profits, no matter the risk. The SEC, Fed, FDIC and CME rigged the system for them.
Brazen fraud became standard practice. Criminals deserving prison keep stealing. The dirty game involves grabbing “whatever the hell you want and run for the hills. No one will prosecute you.”
“MF Global is another order of magnitude. If anyone is going to jail over this whole period, it has to be” their top officials. Don’t bet on it, especially a power broker like Corzine.
He’s directly responsible for stealing $1.2 billion in client funds. He looted them brazenly. According to Bloomberg:
“Examiners from CME Group Inc., the world’s largest futures exchange, found unexplained wire transfers” and $1.2 billion “during the weekend the failing broker was talking with possible buyers, a person briefed on the matter said.”
Multiple investigations began, including by Justice Department lawyers. The Commodity Futures Trading Commission (CFTC) and Chicago Mercantile Exchange (CME) were responsible for overseeing MFG. They knew what went on but did nothing.
Huffington Post writer Daniel Dicker said the Koch Brothers were tipped off in time to get out safely. Others weren’t as lucky.
MFG is America’s eighth largest bankruptcy, the first major one the Eurozone crisis caused. Expect more ahead.
Practices cratering economies in 2008 continue. Nations teeter on bankruptcy. Corzine bet heavily that Spanish and Italian debt wouldn’t collapse.
Using 40 to 1 leverage, he bet massively the wrong way. His second quarter $190 million loss drove investors away. Those remaining lost everything. Corzine and top executives pocketed millions.
In 1999, he was worth an estimated $400 million when he left Goldman Sachs. Perhaps its double that now, including funds looted from MFG. We may know more later on.
From 1994 – 1994, Corzine headed Goldman Sachs during the time banking became deregulated. Carter began it late in his tenure. Reagan did much more. Clinton completed unfinished business. James Petras calls the 1990s “the golden age of pillage,” the decade of anything goes.
It persists in the new millennium because political Washington and regulators look the other way, profiting handsomely by doing it. Everyone feathers nests belonging to others. Self-sustaining corruption continues. Only little people and unknowing investors get scammed. Power brokers make out like bandits.
After losing his 2009 gubernatorial reelection bid, government regulators welcomed Corzine back on Wall Street. New York Fed president William Dudley (a fellow Goldman alumnus) made MFG a “primary dealer.” Despite its size and a former trading scandal $10 million fine, it became one of a handful of firms marketing US Treasuries.
At the behest of Corzine and other power brokers, CFTC head Gary Gensler suspended implementation of new rules imposing limits on broker-dealer use of client funds, especially for foreign sovereign debt. In other words, they were freed to commit grand theft. MFG took full advantage.
Wall Street Journal Money & Investing editor Francesco Guerrera wrote about “Three Lessons From the Collapse.” He quoted University of San Diego Professor Frank Partnoy, saying:
MFG’s “failure illustrates how much financial markets are about trust and confidence. Once you lose those, you are done.”
Guerrera’s three lessons include:
- closing accounting loopholes and strengthening oversight;
- establishing lead regulators for nonbank financial firms; and
- writing new rules for “nonsystemic” firms as well as “too big to fail” ones.
Dodd-Frank financial reform left a broken system in place. The entire law needs rewriting. Better still, scrap it and start over. Stiff regulations with teeth are needed, including mandatory prosecution of crooks, especially those highest up to let others know invulnerability days are over.
When culpable CEO heads roll, it’ll be a good start. However, game-changer differences won’t happen until all high level Wall Street swindlers wear numbered striped suits.
Trends forecaster Gerald Celente lost $100,000 in an MF Global gold futures account. He told Russia Today:
“I really got burned. I got a call,” saying “I needed to have a margin call. (W)hat are you talking about,” he asked? “I’ve got a ton of money in my account. They responded, oh no you don’t. That money’s with a trustee now.”
His advice for everyone holding gold ETFs is cash out because “they are going to steal all our money.” Angry about MF Global’s theft, he called Corzine a “cheap SOB.” He’s that and much more.
“How come he’s not in Jail,” railed Celente. It’s “because he’s one of the white shoe boys from the Goldman Sachs crowd.” He added that “the merger of state and corporate power” brought “fascism” to America.
The entire system’s too corrupted to fix. Only tearing it down and starting over can work. It’s high time the process started. Hopefully, OWS protests began it.
Rumor has it that JPMorgan Chase and perhaps other Wall Street banks are involved. Judge Martin Glenn is handling MFG’s bankruptcy. HL Camp, Proprietor of HL Camp Futures , wrote him as follows:
“Our firm is a registered introducing broker with the CFTC. I have written to you previously on behalf of our customers.”
“Here is a comment this morning from one of our former customers in Europe,” saying:
“I will never do business in the United States of America again.”
According to Camp, “(t)he system is to protect futures accounts is broken. And the whole world knows it.”
“What started as a failure of one FCM (Futures Commission Merchant) that quickly gave a black eye to the CFTC and especially the CME has now made our United States of America a very bad joke to commodity futures traders all over the world.”
“The problem this morning is not just excess margin equity.”
“The problem this morning is the reputation of the United States of America.”
“Thank you very much for your time and for listening.”
Forbes staff writer Robert Lenzner said traders and clients didn’t know about MFG’s unscrupulousness. He said a CFTC loophole lets firms speculate with segregated client accounts. Few know it without carefully reading contract fine print or getting sound legal advice.
Lenzner’s lesson one is CFTC Rule 1.29 must be scraped. It lets futures commission merchants gamble with client funds.
Lesson two is knowing personal funds aren’t safe in futures metals, energy, precious metals, or agricultural
Lesson three is resolving which regulator oversees firms like MFG – the CFTC or CME. One should have primary responsibility and be held accountable for fraud.
Lenzner added that Justice Department attorneys are determining whether federal crimes occurred. He expects a lengthy process because MFG’s books “are in a state of chaos,” deliberately no doubt.
Whether anyone ends up indicted isn’t sure. At most perhaps, expect lower level patsies hung out to dry to let crime bosses like Corzine stay free to steal more. It’s how it always works.
- MF Global trustee doubles estimates of shortfall (mb50.wordpress.com)
- MF Global Revelations Keep Getting Worse (mb50.wordpress.com)
- Janet Tavakoli: MF Global Revelations Keep Getting Worse (huffingtonpost.com)
- MF Global may be missing $1.2-billion (business.financialpost.com)
Asia still needs international oil companies to continue to play a large and essential role in the oil and gas industry’s research and development activity, despite the rise of national oil companies, a group of the region’s oil and gas industry leaders has stated during the round table discussion event organized by GL Noble Denton in order to to generate research information for a forthcoming Economist Intelligence Unit (EIU) report on the outlook for the oil and gas industry in 2012 and beyond.
A mix of senior representatives from international oil companies, technical suppliers and industry associations attended the event and offered their opinions on where the industry is going and the challenges and obstacles that await it in the future.
One of the key findings is that the rise of Asia’s national oil companies (NOCs) does not mean international oil companies (IOCs) will be marginalized in the region. State-owned oil companies have played a leading role in developing Asia’s growing profile in the international energy market over the past decade. Overall, NOCs now control about 80% of the world’s oil reserves. Research gathered for the EIU 2012 report shows that just 15% of respondents expect to see a more favorable approach to working with international companies from governments and NOCs, a 10% drop on last year’s figure. However, according to the energy industry leaders participating in the GL Noble Denton event, Asia will continue to count on global players to provide the innovation that is critical to the safe and efficient exploration of more challenging environments.
The growth of China’s oil and gas industry
China’s place in the Asian energy market remains difficult to predict, leading the Singapore round-table attendees to offer conflicting opinions on how heavily its neighbors will be impacted by China’s growth. Some believed that the rise of China’s prominence in the Asian oil and gas industry was likely to have a significant commercial impact on other countries, once issues of quality have been overcome. Others, however, felt that China’s interests in oil and gas projects outside of the Asian region will mean its growth was less likely to impact upon other countries in the market.
Concerns over skill shortages
The Asian energy market is at particular risk of under-resourcing itself over the next decade. Concern over skills shortages in the region reflect similar anxieties across the oil and gas industry. However the rapid growth in energy demand across the region, means the need to address this problem is particularly acute. Sustaining this growth will require unprecedented numbers of oil and gas professionals. Participants at the round table suggested that companies broaden the pool of candidates that they could draw upon by requiring fewer years of technical experience.
The discussions raised around the tables at this event have confirmed the underlying concerns felt within Asia’s oil and gas industry, many of which are linked to the rapid expansion the region is experiencing,” said Richard Bailey, GL Noble Denton’s Executive Vice President for the Asia Pacific,who hosted the event.
“The Asian oil and gas industry is clearly focused on its future challenges, and the opportunities that lie ahead, and GL Noble Denton continues to support its key players in developing the innovative solutions they need to meet the region’s evolving energy demands, “ he said.
- Shortfall estimated at $1.2 billion or more (up from $600 million)
- “Repo-to-Maturity” is a “Total Return Swap-to-Maturity,” a Type of Credit Derivative
- Probable Shortfalls Throughout 2011
- Jon Corzine to Credit Derivatives Head: Next Time “Double Up”
JT Note: Subsequent to this report Jim Parascandola told me that he was never
told to increase the size of any position, albeit his trades were profitable.
- Regulators Waive Required Tests for Jon Corzine
- Questions About How MF Global Became a Primary Dealer
- MF Global Wrote Rubber Checks for some Electronic Checks for Others
- Tip-Offs for Some Customers?
- CFTC’s Gary Gensler Didn’t Act
- MF Global Debacle Damages a Key Global Market
When MF Global collapsed on October 21, it was the biggest financial firm to collapse since Lehman in September 2008. Then Chairman and CEO Jon Corzine is connected to the head of one of his key regulators, the Commodity Futures Trading Commission (CFTC), through his former protÃ©gÃ© at Goldman Sachs, Gary Gensler. He also knows the Fed’s William Dudley, a key member of the Fed’s Open Market Committee, from their days at Goldman Sachs. The Fed approved MF Global’s status as a primary dealer, a participant in the Fed’s Open Market Operations, just before Jon Corzine took its helm and beached it on a reef called leveraged credit risk.
MF Global’s officers admitted to federal regulators that before the collapse, the firm diverted cash from customers’ accounts that were supposed to be segregated:
MF Global Holdings LTD. “violated requirements that it keep clients’ collateral separate from its own accounts…Craig Donohue, CME Group‘s chief executive officer, said on a conference call with analysts today that MF Global isn’t in compliance with the rules of the exchange and the Commodity Futures Trading Commission.”
“MF Global Probe May Involve Hundreds of Millions in Funds,” Bloomberg News – November 1, 2001 by Silia Brush and Matthew Leising
Cash in customers’ accounts may be invested in allowable transactions, and MF was allowed to make extra revenue from the income. But what isn’t allowed, and what MF Global apparently admitted to doing, is to commingle customers’ money with its own and take money from customers’ accounts to meet margin calls on MF Global’s own allowable transactions. Even if all of the money is eventually clawed back and recovered, this remains an impermissible act. Moreover, full recovery–even if it is possible–is not the same as restitution. People have been denied access to their money, and businesses and reputations have been tarnished.
In layman’s terms, you may buy a Rolls Royce with customers’ excess cash, sell it at a profit, and pocket part of the profits. You may buy a Rolls Royce and try to resell it at a profit with your firm’s cash. But you aren’t allowed to take customers’ money to make the car payments on your firm’s Rolls Royce. If one engages in this impermissible activity, it becomes almost impossible to cover up if you have an accident driving your Rolls Royce.
Implausible Denial and an Ugly Surprise
On November 1, Kenneth Ziman, a lawyer for MF Global, relayed information from MF Global to U.S. Bankruptcy judge Martin Glenn in Manhattan: “To the best knowledge of management, there is no shortfall.” If that sounded like a cover-up, it was, unless of course you prefer to believe that the “best knowledge” of management is actually no knowledge at all.
How long does it take to find more than $600 million to $1.2 billion of customers’ money? MF Global’s books seem so messed up that one person couldn’t have created this chaos alone. A lot of people had to agree to throw away controls, standards, and procedures. I doubt this happened just in the final week or two before MF Global blew itself up.
“According to a U.S. official, MF Global admitted to federal regulators early Monday [October 31, 2011] that money was missing from customer accounts. MF Global acknowledged a shortfall in a phone call amid mounting questions from regulators as they went through the firm’s books.”
The initial bankruptcy estimate was a shortfall of around $600 million. As of Monday November 21, MF Global’s liquidating trustee believes the shortfall may be as much as $1.2 billion and possibly even more
“Repo-to-Maturity” is a “Total Return Swap-to-Maturity,” A Type of Credit Derivative
If you call a total return swap-to-maturity a “repo-to-maturity,” you are much less likely to freak out regulators. Many regulators still remember that Long Term Capital Management (LTCM) used total return swaps (among other things). Jon Corzine should remember, too, since he was closely involved with LTCM when he headed Goldman Sachs. In September of 2011, FINRA seemed to catch on that MF Global’s transactions were riskier than it previously thought and asked for more capital against these trades.
Part of AIG’s acute distress in 2008 was due to credit default swaps, another type of credit derivative, linked to the risk of shady overrated collateralized debt obligations. The basic problem was risk on fixed income assets that could only go down in value combined with lots of leverage.
I’d like to interject a side note. I understand that some pundits tried to say that the New York Times’s Gretchen Morgenson was incorrect when she wrote MF Global was felled by derivative bets. She is correct. The pundits leaped to the conclusion that when she referred to credit derivatives and “swaps” that she meant credit default swaps, but she was referring to total return swaps, a type of credit derivative. (Later in the article she discussed a different topic, lack of transparency in credit default swaps, another type of credit derivative.)
MF Global’s problematic trades were different from AIG’s, but they were also derivatives, in fact, they were a form of credit derivative. The “repo-to-maturity” transaction was just a form over substance gimmick to disguise this fact. Specifically the transactions are total return swaps, a type of credit derivative, and the chief purpose of these transactions is leverage.
A total return swap-to-maturity includes a type of credit derivative. It allows you to sell a bond you own and get off-balance sheet financing in the form of a total return swap. Alternatively, you can get off-balance sheet financing on a bond with risk you want (but do not currently own so there is no need to sell anything) and take the risk of the default and price risk. (Price risk can be due both to credit risk and/or interest rate risk.) This is an off-balance sheet transaction in which the total return receiver (MF Global) has both the price risk and the default risk of the reference bonds. In this case, MF Global had the price risk and the default risk of $6.3 billion of the sovereign debt of Belgium, Italy, Spain, Portugal, and Ireland. As it happened, the price fluctuations of this debt in 2011 weren’t due to a general rise in interest rates, they were due to a general increase in the perceived credit risk of this debt.
Repo transactions are on balance sheet transactions, but they don’t draw as much scrutiny from regulators. There was just one little problem. MF Global wanted the off-balance sheet treatment of a derivative, a total return swap, but it didn’t want to call it a total return swap, so it used smoke and mirrors. Even if MF Global engaged in a wash trade at the end (if there is no default in the meantime) to buy back the bonds, MF Global would receive par on the bonds from the maturing bonds. The repurchase trade at maturity is a formality with no real (or material) economic consequence.
In other words, the “repo-to-maturity” exploits a form-over-substance trick to avoid calling this transaction a total return swap. Accountants paid by the form-over-substance seekers and asleep-at-the-switch regulators will sometimes, at least temporarily, go along with this sort of relabeling.
The fact that MF Global was exposed in a leveraged way to default risk and liquidity risk because of these transactions and that the risk was- linked to European sovereign debt was disclosed in MF Global’s 10K for the year ending March 31, 2011, a required financial statement filed with the SEC. The CFTC and other regulators had the information right under their noses, but it appears they didn’t understand that they were looking at a leveraged credit derivative transaction that could lead to margin calls that MF Global would be unable to meet.
See Also: “Credit Derivatives and Leverage Sank Jon Corzine’s MF Global,” by Janet Tavkaoli, Huffington Post, November 4, 2011,
The result is that yet another large financial institution has been felled when it couldn’t meet margin calls due to the credit risk of fixed income assets combined with high leverage in an off-balance sheet transaction. The ugliest part of this story, however, isn’t that MF Global got in over its head, it’s that the bankruptcy trustee estimates customers’ money to the tune of $1.2 billion or more is still missing.
Probable Shortfalls Throughout 2011
MF Global reportedly employed 35:1 leverage–some reports are 40:1–against a portfolio comprised around 20% of European Sovereign risks including Belgium, Italy, Spain, Portugal, and Ireland. MF Global would have had several trading days in 2011 with moves of 5% to 10% on this sovereign risk. MF Global was so thinly capitalized that this trade alone could eat up half of its capital. Any of MF Global’s other asset positions moving the same way in 2011’s highly correlated markets would have put MF Global in a position of negative equity. From a risk management point of view, examiners have to consider the very strong possibility that MF Global had several negative equity days throughout 2011.
How did MF Global meet margin calls throughout 2011? It seems an investigation into money flows throughout 2011 is in order.
By the end of October, the combination of a $90 million August legal settlement against MF Global coming due, increased capital calls by FINRA, and margin hikes from counterparties worried about MF Global’s credit made it impossible for MF Global to cover up its shortfall.
Regulators Waive Required Tests for Jon Corzine
Jon Corzine resigned as Chairman and CEO of MF Global on November 4, just days after the October 31 bankruptcy announcement. As a matter of corporate governance, holding the position of Chairman and CEO meant that Corzine had a lot of concentrated power with little oversight. Many question the wisdom of a corporate structure that allows officers to hold this dual position. (Ken Lewis, the former Chairman and CEO that merged Bank of America into the poorhouse held this dual role, too. Lewis defended this practice at the Federal Reserve Bank of Chicago’s Bank Structure Conference in 2003.) Corzine was the former governor of New Jersey and had been out of the active markets for twelve years. Prior to that, until 1999 he had been the CEO of Goldman Sachs.
The Financial Industry Regulatory Authority Inc. (FINRA) gave Jon Corzine a waiver from his Series 7 and Series 24 exams when he took the helm of MF Global in March 2010. The former is required for anyone involved in the investment banking or securities business including supervision, solicitation, or training of persons associated with MF Global, and that included Corzine. As an officer of MF Global the latter was required for Corzine, since he had been out of the business for around 12 years or more than six times the 2 year expiration date for reactivating these qualifications.
Jon Corzine to Credit Derivatives Head: Next Time “Double Up” (See note below)
The test waiver by regulators seems to be blatant cronyism, because Corzine not only hadn’t been involved in the day-to-day markets for more than a decade, his responsibilities at MF Global included active decision making. The waiver wasn’t justified. Corzine reportedly authored the strategy for the MF Global killing trades, and he also had authority on the trading floor.
Jon Corzine pushed traders to increase their risk. According to an MF Global employee, Corzine knelt down beside Jim Parascandola, head of credit derivatives trading, and told him that next time he should “double up” on his winning protection bets on brokerages. Traders loved Corzine, because he pushed them to increase risk. Now the traders aren’t lifting offers, they’re pounding the pavement.
Update: Subsequent to this report Jim Parascandola told me that he was never told to increase the size of any position, albeit his trades were profitable.
MF Global Becomes a Primary Dealer Unregulated by the Fed: How Did That Happen?
MF Global’s financials were shaky ever since Man Group spun it off in 2005 and saddled it with a lot of debt. Yet MF Global was added to the Fed’s list of 22 primary dealers in February 2011, just before former Goldman CEO Jon Corzine officially came on board. Primary dealers buy and sell U.S. treasuries at auction and are a counterparty to the Fed’s Open Market operations.
William C. Dudley is the president and chief executive officer of the FRBNY. He is also vice chairman of the Federal Open Market Committee (FOMC) and VP of the Markets Group, which oversees open market and foreign exchange trading operations and provisions of account services to foreign central banks and manages the System Open Market Account. Dudley is a former partner at Goldman Sachs (1986-2007), and he was Goldman’s chief economist.
David Kotok of Cumberland Advisors has raised important questions about the fact that the Fed has dropped its role of surveillance of primary dealers, and his commentaries are available here.
Besides trading treasuries, the big benefit to primary dealers is the perception that the Fed will provide funding to primary dealers during a systemic liquidity crunch. Just before Bear Stearns imploded, the Fed changed the rules so that non-U.S. banks, along with brokers that were primary dealers (as MF Global later became), were allowed to borrow through a program called a Term Securities Lending Facility (TSLF) to finance mortgage backed securities, asset backed securities, and more. TSLF’s start date was too late to help Bear Stearns, and the program has now been discontinued, but the perception of a Fed safety net has precedence.
Why did the Fed award prestigious primary dealer status to a shaky operation like MF Global, an entity it does not regulate?
MF Global Stalled and Wrote Rubber Checks: Did Some Customers Get Better Treatment?
The week before the bankruptcy, when customers asked for excess cash from their accounts, MF Global stalled. According to a commodity fund manager I spoke with, MF Global’s first stall tactic was to claim it lost wire transfer instructions. Instead of issuing an electronic check or sending an overnight check, MF Global sent paper checks via snail mail, including checks for hundreds of thousands of dollars. The checks bounced. After the checks bounced, the amounts were still debited from customer accounts, and no one at MF Global could or would reverse the check entries. The manager has had to intervene to get MF Global to correct this, and still hasn’t gotten the entries corrected. Reuters’s Matthew Goldstein reported more in “MF Global and the Rubber Check.”
I thought that was bad enough, but on November 10 I was a guest on Stocks & Jocks, a Chicago radio show, when Jon Najarian said that a large broker he knows got a $400,000 electronic check from MF Global the Friday before that bankruptcy, and the check cleared. If that’s accurate, MF Global treated some customers differently than others.
Tip-Offs for Some Customers?
In August, customers started pulling billions of dollars out of their segregated accounts with MF Global. It was the biggest outflow of funds since January 2009. The bankruptcy trustee may clawback transfers of funds from MF Global as it was teetering, because it is likely that employees within MF Global were well aware of the problems and tipped off key customers.
Yet Gary Gensler, head of the CFTC, did not investigate or begin transferring accounts out of MF Global before the bankruptcy, and that is unprecedented for the CFTC. Given that Gary Gensler was a protÃ©gÃ© of Jon Corzine at Goldman Sachs, one should question why Gary Gensler didn’t act and why he should be allowed to remain head of the CFTC.
CFTC’s Gary Gensler Didn’t Act
Gary Gensler, Jon Corzine’s former Goldman Sachs colleague and current head of the Commodities Futures Trading Commission (CFTC), had reason to be concerned about MF Global’s risk management. In early 2008, a rogue trader racked up $141.5 million in losses in unauthorized trades that exceeded his trading limits. It seems he accomplished this in under seven hours. In August of this year, MF Global and the underwriters of its 2007 initial public stock offering (IPO) agreed to pay around $90 million to settle claims by investors that they were misled about MF Global’s risk management prior to the rogue trader’s actions. Since 2008, MF Global’s financial condition has been nothing to brag about. Now the settlement is in jeopardy due to the bankruptcy. [Michael Stockman, the chief risk officer of MF Global as of January 2011 (after the previous mentioned incident) was in my Liar’s Poker training class lampooned by another classmate, Michael Lewis.]
In the past, the exchanges and CFTC “always” moved customer positions before a Futures Commission Merchant (FCM) declared bankruptcy. The CFTC had ample reason to have contingency plans for MF Global based on publicly available information. Yet the Gensler-led CFTC hasn’t followed this historical precedent when an FCM led by his former Goldman colleague teetered on the edge of bankruptcy. Gensler has recused himself from the CFTC’s probe of MF Global.
The exchange-traded futures markets have been shaken to the core. The Bankruptcy Code apparently conflicts with the Commodity Exchange Act, so customers of MF Global have less protection than one might expect. The Securities Investor Protection Corporation (SIPC) is not the FDIC. Account holders have no idea how long it will take to get back all of their money, if it is there to be recovered, and right now, it appears a lot of it cannot be found. This is why many traders sweep all of the excess cash out of their accounts each day, and only put in cash when required.
MF Global Debacle Damages a Key Global Market
The “risk wizards” of Goldman Sachs once again look like market wrecking balls. The futures market is a globally connected market and it is a key mechanism for farmers, metals miners, and metals fabricators (among others) to hedge their risk. Confidence in the futures market has been shaken. No one knows if their money is safe, but what is more disturbing is the appearance of crony capitalism once again giving favored treatment, lax regulation, and absent oversight to a crony capitalist that abused all of these perks to blow up a large financial firm and damage a key global market.
This commentary is available in pdf form by clicking this link.
Read more posts on Tavakoli Structured Finance »
- MF Global may be missing $1.2-billion (business.financialpost.com)
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- Trustee: Up to $1.2 billion missing from MF Global customers’ accounts (mercurynews.com)
- Janet Tavakoli: MF Global Revelations Keep Getting Worse (huffingtonpost.com)