And we’re still at risk of it happening all over againby Adam Taggart Saturday, March 30, 2013, 12:42 PM
Then, when the Fed’s fire hoses started spraying an elephant soup of liquidity injections in every direction and its balance sheet grew by $1.3 trillion in just thirteen weeks compared to $850 billion during its first ninety-four years, I became convinced that the Fed was flying by the seat of its pants, making it up as it went along. It was evident that its aim was to stop the hissy fit on Wall Street and that the thread of a Great Depression 2.0 was just a cover story for a panicked spree of money printing that exceeded any other episode in recorded human history.
David Stockman, The Great Deformation
David Stockman, former director of the OMB under President Reagan, former US Representative, and veteran financier is an insider’s insider. Few people understand the ways in which both Washington DC and Wall Street work and intersect better than he does.
In his upcoming book, The Great Deformation: The Corruption of Capitalism in America, Stockman lays out how we have devolved from a free market economy into a managed one that operates for the benefit of a privileged few. And when trouble arises, these few are bailed out at the expense of the public good.
By manipulating the price of money through sustained and historically low interest rates, Greenspan and Bernanke created an era of asset mis-pricing that inevitably would need to correct. And when market forces attempted to do so in 2008, Paulson et al hoodwinked the world into believing the repercussions would be so calamitous for all that the institutions responsible for the bad actions that instigated the problem needed to be rescued — in full — at all costs.
Of course, history shows that our markets and economy would have been better off had the system been allowed to correct. Most of the “too big to fail” institutions would have survived or been broken into smaller, more resilient, entities. For those that would have failed, smaller, more responsible banks would have stepped up to replace them – as happens as part of the natural course of a free market system:
Essentially there was a cleansing run on the wholesale funding market in the canyons of Wall Street going on. It would have worked its will, just like JP Morgan allowed it to happen in 1907 when we did not have the Fed getting in the way. Because they stopped it in its tracks after the AIG bailout and then all the alphabet soup of different lines that the Fed threw out, and then the enactment of TARP, the last two investment banks standing were rescued, Goldman and Morgan [Stanley], and they should not have been. As a result of being rescued and having the cleansing liquidation of rotten balance sheets stopped, within a few weeks and certainly months they were back to the same old games, such that Goldman Sachs got $10 billion dollars for the fiscal year that started three months later after that check went out, which was October 2008. For the fiscal 2009 year, Goldman Sachs generated what I call a $29 billion surplus – $13 billion of net income after tax, and on top of that $16 billion of salaries and bonuses, 95% of it which was bonuses.
Therefore, the idea that they were on death’s door does not stack up. Even if they had been, it would not make any difference to the health of the financial system. These firms are supposed to come and go, and if people make really bad bets, if they have a trillion dollar balance sheet with six, seven, eight hundred billion dollars worth of hot-money short-term funding, then they ought to take their just reward, because it would create lessons, it would create discipline. So all the new firms that would have been formed out of the remnants of Goldman Sachs where everybody lost their stock values – which for most of these partners is tens of millions, hundreds of millions – when they formed a new firm, I doubt whether they would have gone back to the old game. What happened was the Fed stopped everything in its tracks, kept Goldman Sachs intact, the reckless Goldman Sachs and the reckless Morgan Stanley, everyone quickly recovered their stock value and the game continues. This is one of the evils that comes from this kind of deep intervention in the capital and money markets.
Stockman’s anger at the unnecessary and unfair capital transfer from taxpayer to TBTF bank is matched only by his concern that, even with those bailouts, the banking system is still unacceptably vulnerable to a repeat of the same crime:
The banks quickly worked out their solvency issues because the Fed basically took it out of the hides of Main Street savers and depositors throughout America. When the Fed panicked, it basically destroyed the free-market interest rate – you cannot have capitalism, you cannot have healthy financial markets without an interest rate, which is the price of money, the price of capital that can freely measure and reflect risk and true economic prospects.
Well, once you basically unplug the pricing mechanism of a capital market and make it entirely an administered rate by the Fed, you are going to cause all kinds of deformations as I call them, or mal-investments as some of the Austrians used to call them, that basically pollutes and corrupts the system. Look at the deposit rate right now, it is 50 basis points, maybe 40, for six months. As a result of that, probably $400-500 billion a year is being transferred as a fiscal maneuver by the Fed from savers to the banks. They are collecting the spread, they’ve then booked the profits, they’ve rebuilt their book net worth, and they paid back the TARP basically out of what was thieved from the savers of America.
Now they go down and pound the table and whine and pout like JP Morgan and the rest of them, you have to let us do stock buy backs, you have to let us pay out dividends so we can ramp our stock and collect our stock option winnings. It is outrageous that the authorities, after the so-called “near death experience” of 2008 and this massive fiscal safety net and monetary safety net was put out there, is allowing them to pay dividends and to go into the market and buy back their stock. They should be under house arrest in a sense that every dime they are making from this artificial yield group being delivered by the Fed out of the hides of savers should be put on their balance sheet to build up retained earnings, to build up a cushion. I do not care whether it is fifteen or twenty or twenty-five percent common equity and retained earnings-to-assets or not, that is what we should be doing if we are going to protect the system from another raid by these people the next time we get a meltdown, which can happen at any time.
You can see why I talk about corruption, why crony capitalism is so bad. I mean, the Basel capital standards, they are a joke. We are just allowing the banks to go back into the same old game they were playing before. Everybody said the banks in late 2007 were the greatest thing since sliced bread. The market cap of the ten largest banks in America, including from Bear Stearns all the way to Citibank and JP Morgan and Goldman and so forth, was $1.25 trillion. That was up thirty times from where the predecessors of those institutions had been. Only in 1987, when Greenspan took over and began the era of bubble finance – slowly at first then rapidly, eventually, to have the market cap grow thirty times – and then on the eve of the great meltdown see the $1.25 trillion to market cap disappear, vanish, vaporize in panic in September 2008. Only a few months later, $1 trillion of that market cap disappeared in to the abyss and panic, and Bear Stearns is going down, and all the rest.
This tells you the system is dramatically unstable. In a healthy financial system and a free capital market, if I can put it that way, you are not going to have stuff going from nowhere to @1.2 trillion and then back to a trillion practically at the drop of a hat. That is instability; that is a case of a medicated market that is essentially very dangerous and is one of the many adverse consequences and deformations that result from the central-bank dominated, corrupt monetary system that has slowly built up ever since Nixon closed the gold window, but really as I say in my book, going back to 1933 in April when Roosevelt took all the private gold. So we are in a big dead-end trap, and they are digging deeper every time you get a new maneuver.
Those farmers, traders, and other assorted customers of busted trading firm MF Global probably won’t like hearing the news that JP Morgan got money it was owed, on the day before it filed for bankruptcy, The New York Times reports. And even worse in the hunt for the missing $1 billion in customer funds after the collapse of former New Jersey governor and Goldman Sachs CEO Jon Corzine‘s trading firm, The Times reports that the “roughly $200 million that JPMorgan Chase received is said to be entirely customer money.” There were other transfers to other, unspecified trading partners on October 28, the day before MF Global filed its bankruptcy papers, as well, the paper reports. Meanwhile, customers have only gotten back a third of their money and are short roughly $1.2 billion. For its part, JP Morgan apparently questioned the source of the money itself, asking for assurances that it wasn’t coming from customers (which it didn’t get).
- MF Global Customers Target JP Morgan (forbes.com)
- NOW IT GETS INTERESTING: JP Morgan’s Role In MF Global Will Be Investigated (JPM) (businessinsider.com)
- JP Morgan Fires Up Maxeler FPGA Super (insidehpc.com)
- JP Morgan Stock Breaks Down On News Company’s Role As MF Global Lender To Be Probed (zerohedge.com)
- Who Gave Permission To A Bankrupt MF Global To Sell Italian Bonds To JPM At A 5% Discount To Market Value? (zerohedge.com)
- Corzine: No, I really didn’t know about customer-fund transfers (hotair.com)
- Rancher Discusses Losing Money With MF Global (npr.org)
- The Woman Corzine Mentioned In His Testimony Also Pops Up In Some Illuminating MF Global E-Mails (businessinsider.com)
- Tough Questions for MF Global, Conflicted Trustee Giddens & SIPC President Harbeck (zerohedge.com)
by Eric Platt
The dark clouds in the Federal Reserve’s 2012 annual stress test are keeping bankers up at night, as banks are being asked to imagine their balance sheet situation under some horrible economic scenarios.
Here are some of the key metrics, complete with headline numbers, for what would happen in the Fed’s worst scenario:
U.S. Real GDP:
- 4Q11: -4.84%
- 1Q12: -7.98%
- 2Q12: -4.23%
- 3Q12: -3.51%
- 4Q12: +0.00%
- 1Q13: +0.72%
- 2Q13: +2.21%
- 3Q13: +2.32%
- 4Q13: +3.45%
- 4Q11: 9.68%
- 1Q12: 10.58%
- 2Q12: 11.40%
- 3Q12: 12.16%
- 4Q12: 12.76%
- 1Q13: 13.00%
- 2Q13: 13.05%
- 3Q13: 12.96%
- 4Q13: 12.76%
U.S. 10-Year Treasury Yield:
- 4Q11: 2.07%
- 1Q12: 1.94%
- 2Q12: 1.76%
- 3Q12: 1.67%
- 4Q12: 1.76%
- 1Q13: 1.74%
- 2Q13: 1.84%
- 3Q13: 1.98%
- 4Q13: 1.97%
Dow Jones Industrial Average Price:
- 4Q11: 9,504.48
- 1Q12: 7,576.38
- 2Q12: 7,089.87
- 3Q12: 5,705.55
- 4Q12: 5,668.34
- 1Q13: 6,082.47
- 2Q13: 6,384.32
- 3Q13: 7,084.65
- 4Q13: 7,618.89
EU Real GDP:
- 4Q11: -1.03%
- 1Q12: -3.49%
- 2Q12: -5.40%
- 3Q12: -6.91%
- 4Q12: -4.92%
- 1Q13: -0.88%
- 2Q13: +0.35%
- 3Q13: +1.11%
- 4Q13: +1.50%
Remember, banks have less than two months to stress test their portfolios against these, and 21 other metrics. For a full list of scenario inputs visit the Federal Reserve’s site.
- The doomsday scenarios the Fed wants banks to test (business.financialpost.com)
- Fed Sets Jan 9 for New Round of Fin Inst Stress Tests (forexlive.com)
- The Fed’s Stress Tests: Too Little, Too Late (247wallst.com)
- Federal Reserve Board issues final rule on annual capital plans, launches 2012 review (bespacific.com)
- Top U.S. banks told to stress test against severe recession (business.financialpost.com)
- Federal Reserve Will Force 31 Banks To Stress Test Portfolios (GS, BAC, JPM, MS, WFC, MET, AXP) (businessinsider.com)
- Fed FAQ Re Fin Institution Stress Tests (forexlive.com)
- Fed Tells Top U.S. Banks to Submit Capital Plans (businessweek.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)
- 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)
- MF Global Trustee Says Commingling Shortfall May Be Double Previous Estimate, Could Reach “$1.2 Billion Or More” (zerohedge.com)
- CME May Face Liability Related to MF Global (forexlive.com)
- Trustee: Up to $1.2 billion missing from MF Global customers’ accounts (mercurynews.com)
- Janet Tavakoli: MF Global Revelations Keep Getting Worse (huffingtonpost.com)
By Nick Brown and David Sheppard
(Reuters) – The shortfall of commodity customer funds at MF Global Holdings Ltd (MFGLQ.PK) may be around $1.2 billion, about double initial estimates from regulators, the trustee liquidating the company said on Monday.
The news was a blow to customers still hoping to get more of their cash out of frozen broker accounts and raised new questions about why the authorities managed to locate only about 60 percent of the segregated customer funds three weeks after the parent firm’s October 31 bankruptcy.
“I’m flabbergasted,” said Tom Ward, a retired Chicago Board of Trade member whose two sons cleared their futures trades through MF Global and have been blocked from accessing their money. “The bottom line is, there’s going to be a haircut involved. It’s devastating, what this has done to the industry.”
Monday’s announcement was trustee James Giddens’ first public statement on the size of the shortfall, which regulators initially said was about $600 million.
Regulators are investigating what happened to the money and whether MF Global may have improperly mixed customer money with its own — a major violation of industry rules. No charges have been filed.
Hours after the statement, the bankrupt MF Global parent filed court papers along with JPMorgan Chase & Co (JPM.N), one of its key lenders, seeking the rare appointment of a separate trustee to take over the company’s assets in bankruptcy.
Such appointments are reserved for cases in which a company’s executives are accused of wrongdoing or when it may otherwise be in the estate’s best interest. JPMorgan, which pledged $8 million of its collateral to keep MF Global afloat during bankruptcy, agreed to increase that pledge to $26 million if a trustee were appointed, according to the filing.
The request is on the agenda for a hearing tomorrow afternoon in U.S. Bankruptcy Court in Manhattan.
An MFGlobal spokeswomen declined to comment on the case.
In Monday’s statement, Giddens said he currently controls about $1.6 billion of the brokerage’s funds that he can use to pay back customers. His plans to pay back 60 percent of customer funds by early December would nearly exhaust that amount.
The sharply higher estimate of the shortfall raises questions about the investigation, said Tim Butler, an attorney for a group of customers demanding a fuller payback.
“What did the CFTC know three weeks ago and what do they know now?” Butler said. “If the amount has changed that much over three weeks, where did the money go? What were (regulators) looking at before?”
Leaders on Capitol Hill have entered the fray with calls for hearings and accountability.
Sen. Chuck Grassley, R-Iowa, said the CFTC should “do everything possible” to get more information to customers on the status of their funds. The call comes as angry farmers and ranchers across the country begin to reconsider a livelihood in the market and how they hedge future crops and livestocks.
“Unlike the big banks, the average farmer who lost money in this fiasco can’t afford to hire an attorney and attend proceedings in a Manhattan courtroom,” Grassley said in a statement.
MF Global was run by former Goldman Sachs & Co Inc (GS.N) chief and New Jersey governor Jon Corzine before its bankruptcy. The Chapter 11 filing came after the New York-based company revealed it made a $6.3 billion bet on European sovereign debt. Corzine resigned on November 4.
On Sunday, Reuters reported that, based on initial reports of what was supposed to be segregated for customers, the trustee appeared to be keeping about $3 billion on hand to cover the shortfall.
Customers had been clamoring for more specifics, saying that was too large of a cushion — a notion Giddens rejected.
“Restoring 60 percent of what is in segregated customer accounts … would require approximately $1.3 to $1.6 billion to implement,” or nearly all the money at the trustee’s disposal, he said.
Giddens previously transferred more than $2 billion to other brokers, giving most customers access to a portion of their funds.
Sen. Pat Roberts, R-Kan., said legislators should call on Corzine to testify about his former company’s actions. Roberts said in a statement on Monday that the Senate Committee on Agriculture, Nutrition and Forestry should hold a special hearing on the matter.
If the trustee does exhaust the funds he now controls, his focus would shift to going after monies that may belong to the brokerage, but may be tied up in foreign depositories, or may be part of the shortfall, Giddens spokesman Kent Jarrell said.
“We can’t distribute money we don’t have, but we do have legal means for going after other assets,” Jarrell said.
The Commodity Futures Trading Commission and other regulators are investigating MF Global.
CFTC Commissioner Jill Sommers refused to speculate on how the $1.2 billion figure might compare with earlier estimates.
“From the very beginning we have tried as much as possible to never use a figure, out of fear that it’s not right,” said Sommers, who has been leading the agency’s investigation into MF Global after Chairman Gary Gensler recused himself from the probe because of his ties to Corzine.
“Until the final reconciliation (of accounts) is done, you don’t know what the shortfall is.”
Commodity customers say they have more questions than answers about MF Global’s collapse and the safety of their money.
Sean McGillivray, vice president of Great Pacific Wealth Management, still has about $5 million tied up in MF Global for his customers. He was aware of the latest estimates of the shortfall, but wants exact figures.
“It would be in the best interest of all clients, brokers and anyone else caught in this mess to know just how much has been transferred … and how much is supposed to be there,” he said. “You could do this with an abacus and it would take less (time).”
A spokesman for the Commodity Customer Coalition in Chicago, which represents more than 7,000 former MF Global customers, said it was unclear how much of the trustee’s estimate related to possible co-mingling of customer money.
Some of the missing money could be tied up overseas, said spokesman John L. Roe.
“We’re hopeful given what was accounted for initially that more of the money will be found and that the trustee will work with us on an expedited claims process for customers,” he said.
In a sign that even distressed investors are losing faith in a decent return, MF Global’s bonds fell to an all-time low below 30 cents on the dollar, according to Tradeweb, down more than 5 cents on the day. The $325 million in 6.25 percent notes were issued at par in August.
Some investors have targeted other financial institutions. Two pension funds have sued seven banks, including Bank of America Corp (BAC.N), JPMorgan and Goldman Sachs, over prospectuses that allegedly concealed the problems that led to MF’s collapse.
The trustee’s case is In re MF Global Inc, U.S. Bankruptcy Court, Southern District of New York, No. 11-2790.
The MF Global bankruptcy is In Re MF Global Holdings Ltd, in the same court, No. 11-15059.
After reading this article, people also read:
- MF Global Missing Money May Double, Exceed $1.2 Billion (businessweek.com)
- MF Global Trustee Says Shortfall Could Exceed $1.2 Billion (dealbook.nytimes.com)
- MF Global Trustee Says $1.2 Billion Missing, twice original amount (colonel6.com)
- MF Global Trustee: Company Shortfall Could Be Double Original Estimate (michellemalkin.com)
- MF Global Trustee Says Commingling Shortfall May Be Double Previous Estimate, Could Reach “$1.2 Billion Or More” (zerohedge.com)
Real resources are always a true constraint for any economy. This has become an increasingly important point over the last 10 years as commodity prices have surged. But the debate over the cause of this surge and the lack and real resources is still very much up in the air. Some say it is due to an insatiable demand from China. Some blame the decline of the dollar due to irresponsible government action. Others say Wall Street is cornering the commodities markets and turning it into another profit making casino. The truth, in all likelihood, lies somewhere inbetween.
One of the more important themes I’ve discussed over the years here has been the financialization of our economy. Financialization has seeped into many facets of our economy in order to help the big banks maximize profits. This has led to massive deregulation, increasing reliance on the FIRE industry, a concentration of power in this industry and an economy that is increasingly volatile and dependent on this industry which produces little, but takes much. This financialization has been nowhere more apparent than it has been in the commodities markets.
A few weeks ago I wrote a piece about the continual imbalance in the commodities markets and a veteran of the energy market happened to be reading. Dan Dicker reached out through the comments section and offered to send me a free copy of his book, Oil’s Endless Bid (see here to buy a copy). I had heard of Dan’s book and had been meaning to read it for some time. Now, I get a lot of free books from financial people. A LOT. They all want me to promote their books on the site. 95% of the books never get mentioned on the site. As you’ve noticed, I don’t just crank out content for the sake of cranking out content and the “payment” of a free 300 page book is not really incentive enough for me to write about a book. So, a lot of books end up in my fireplace (I’m an energy conservationist obviously). This one is different because I think Dan is conquering an incredibly important subject and he does so from the position of an informed insider.
His perspective is very much in-line with the positions of Michael Masters who has been one of the more vocal proponents of this financialziation of the commodities markets. Dan Dicker is a 20+ year veteran of the oil markets and a long-time seat holder at the NYMEX. Dan’s book is a frighteningly eye opening perspective from someone who has been in the trenches and has witnessed the massive changes in real-time. Dan highlights the massive changes that occurred over the years as the industry has morphed from one that was dominated by big oil into an industry that is dominated by big banks (from the book):
“In the mid-1990′s, the participants and performance of oil trading slowly started to change, and by 2003, the dominating forces in oil trader were no longer with the oil companies. The list of NYMEX seat owners again shows just how deep the change was. Right before going public in 2006, only 22 seats remained in the hands of the oil companies that had direct involvement in the buying and selling of oil and oil products. But a much more significant percentage of seats were owned by companies that ostensibly had nothing to do with the buying and selling of physical oil.
That’s a total of 56 seats owned by investment banks! (And yes, I include AIG, which was an enormous booker of bets on oil too, not just in famously bad mortgage swaps.)
Of course, the most important purpose for some of these firms to own seats was to execute orders for clients, some retail, but many commercial clients who were being sold on the importance of risk management of energy costs. And during the years from the mid-1990′s though 2005, this made for a legitimate increase in the volume of crude. But commercial growth of risk management programs was a happy appetizer for the quick rise of the investment banks in the trade of oil. Oil companies that tried to maintain a presence and dominance in trading began to be overshadowed by the volume and influence of trading from these banks and their clients.”
These firms aren’t dominating the trading pits at these exchanges because they want to buy and sell commodities for real economic purposes. They are dominating the exchanges because they know there is big money in financializing the asset class of commodities. And they’re succeeding. They’ve sold the asset class as an investment and the investing public has eaten it up hook, line and sinker. Dan goes into much more detail about this destructive trend and its impact on the economy and ultimately concludes that massive change is needed. We need to get control of our economy again and wrangle it back from these big banks who are looking out for the interest of their shareholders and not the US economy. Dan Dicker’s book is one of the most important ones I have read in a long time. It should be required reading for the US Congress.
- Oil, gold keep losses after manufacturing data (marketwatch.com)
- Review 145: Griftopia (thelablib.org)
- Yergin, D. “The Prize” Chapter 35 (iranrevolt.wordpress.com)
- How US Banks Are Lying About Their European Exposure; Or How Bilateral Netting Ends With A Bang, Not A Whimper (zerohedge.com)