Published November 10, 2011
While MF Global’s bankruptcy didn’t trigger the scary chain-reaction that Lehman’s did, the investment portfolios of countless Americans could be impacted by the willingness of regulators and Wall Street executives to learn some harsh lessons from the MF Global episode.
Shockingly, just three years after the 2008 financial crisis, MF Global exposed Wall Street’s continued addiction to leverage and pointed up the perils of what happens when companies fail to prepare for a sudden loss of liquidity and regulators fail to keep tabs on rock-star CEOs.
“It just reinforced the belief that you can’t trust anybody on Wall Street because they’re all greedy bastards looking out for their own wealth,” said Dick Bove, a banking analyst at Rochdale Securities.
Led by former Goldman Sachs (GS) chief Jon Corzine, MF Global collapsed under pressure from a bank run caused by clients and counterparties scared about more than $6 billion in net exposure to the risky bonds of euro-zone nations like Portugal, Italy and Greece.
Hubris Clouds Vision
In many ways, the MF Global collapse proves that at least some Wall Street executives haven’t learned one of the principal lessons from the ’08 disaster: too much leverage -- which magnifies winnings as well as losses -- can kill you.
“Wall Street will always push the envelope. It’s part of the DNA of Wall Street,” said James Gellert, CEO of Rapid Ratings, an independent ratings company.
Just before the euro-zone crisis deepened, Corzine, who was attempting to transform MF Global into a mini-Goldman Sachs, directed his traders to make more than $6.3 billion in bullish bets on these assets.
These positions represented an enormous bet when compared with his company’s relatively small size: With $40 billion in assets and $1.4 billion in equity, MF Global was levered up an alarming 30 to 1. That’s not far from the 38 to 1 level of borrowing at Bear Stearns before it collapsed in 2008.
Corzine “didn’t have the capital, nor the infrastructure in place to take on the risk that he did,” said Sean Egan, founding partner at ratings company Egan-Jones.
Cam Harvey, a professor at Duke University and an advisor to the Man Group, which spun off MF Global in a 2007 IPO, blames management, from Corzine down to the board of directors, which is supposed to oversee the C-Suite.
“It is a gross failure of corporate governance and risk management,” said Harvey. “I have no problem taking risk…However, you do not take undiversified risk. You don’t bet the entire firm on a single trade.”
Corzine’s epic fall from grace has drawn comparisons with that of John DeLorean, Detroit auto czar who was charged with trafficking in cocaine in 1982 in an effort to save his company. DeLorean was later acquitted because the jury found he was the victim of entrapment by the government.
DeLorean was “brought down by his hubris” and “Corzine is following exactly the same path,” said Bove.
Legal questions are mounting on Corzine, who last week resigned and retained a prominent lawyer. While the CFTC searches for $600 million in missing client funds, regulators are investigating whether or not MF Global broke the law by failing to segregate customer accounts or misled investors with their public comments about the company’s financial health.
“If there was one guy that could be trusted, it would be someone who was associated with the U.S. government and associated with the Democratic Party and the rules and regulations they imposed on the industry and yet he broke every one of them,” said Bove.
The MF Global episode also shows that some have quickly forgotten the importance of liquidity during a crisis like the one that struck three years ago.
MF Global didn’t fail because its bets went to zero. It collapsed because the market lost confidence in its ability to continue to operate, leading liquidity to evaporate.
Thanks to more than $165 billion in cash sitting on its balance sheet, BofA successfully beat back an attack earlier this year by buying its own debt, Bove said. Similarly, Morgan Stanley’s $182 billion in liquidity enabled it to thwart an attack in September and October.
“The lesson perhaps from MF to all financial companies is you better have a high level of liquidity the way banks do,” said Bove. “If you’re not liquid, you can be taken apart.”
'Trust Me, I’m a CEO'
Questions have also been raised about the coziness between Corzine, who became CEO in 2010, and regulators. Gary Gensler, the chairman of MF Global’s main regulator, the Commodity Futures Trading Commission, recused himself in a subsequent investigation into MF Global’s collapse due to his ties with Corzine. Gensler worked with Corzine at Goldman and also reportedly donated to Corzine’s run for governor of New Jersey in 2005.
Even though regulators were first aware and alarmed by MF Global’s bullish bet on euro-zone debt in June, Corzine successfully rebuffed their calls for the company to raise more capital for months. Regulatory concerns didn’t emerge in the press until October 17, just two weeks before the bankruptcy.
“I think regulators have got to do formal regulation. They can’t be talked into positions by prominent people simply because they’re prominent,” said Charlie Geisst, a finance professor at Manhattan College.
Geisst compared it with regulators’ willingness to believe Ponzi scheme mastermind Bernie Madoff. Despite numerous warning signs, the Securities and Exchange Commission chose to listen to Madoff’s explanations for his fund’s remarkably consistent returns.
In MF Global’s case, the SEC said responsibility lies with management, not regulators.
“It’s absolutely not a failure of regulation. It’s a failure of the firm to make rationale and intelligent investment decisions and to bear the responsibility for the investment decisions it made,” SEC chairman Mary Schapiro told FOX Business this week.
Still, it’s troubling to some that regulators appear intimidated by big-name CEOs, even in today’s anti-Wall Street environment and armed with the Dodd-Frank financial overhaul laws.
“If regulators don’t have the nerve to do it now, when are they going to?” said Geisst.