MF Global: Too Small to Save

Not the same impact as Lehman

Late last month the world of finance, brokerage and trading experienced a hiccup--beyond the daily eruptions from Europe.  It wasn't yet another day of market swoons or showdowns in Europe.  It wasn't yet another day of a nose-dive in the Dow or headline disagreements on how the economy should recover.

MF Global, the futures brokerage firm, filed for bankruptcy.  It was deemed too small to save. MF Global was not a household name (but so wasn't Bernard Madoff before the world found out about that fraud). Few outside the industry knew much about MF Global. Some knew that former New Jersey Governor Jon Corzine was its CEO. And they knew Corzine had been the head at Goldman Sachs in the 1990s.

MF Global was known as a major player in futures and commodities brokerage. It had institutional client accounts with hedge funds, pension funds, corporations, banks, other brokerages, and other trading firms. It facilitated futures and commodities trading on all the important derivatives exchanges around the world and special trading over the counter.

For the most part, it acted in intermediary roles, a broker for clients who wished to engage in futures and commodities trading for hedging purposes or for taking a bet or view on interest rates, crude oil, foreign currencies, or stock indices.  Clients deposited funds at the firm, and the firm facilitated trading at futures and commodities exchanges or "over the counter." It earned commissions (or "mark-ups"). Client funds not yet deployed for transaction purposes were supposed to be deemed "safe" and "segregated."

MF Global was supposed to be somewhat insulated from virulent swings in markets, as long as there was some activity or some transaction for which it could charge a commission. While clients try to hedge against market swings, MF Global is supposed to thrive in market volatility, not suffer inexplicable trading losses that lead to bankruptcy.

Entered Corzine, recovering from a devastating loss for reelection for a gubernatorial term in New Jersey and perhaps hoping to write a thrilling second chapter to his career on Wall Street.  He felt he could be the catalyst to wake up a sleeping MF Global, which had stumbled through a few performance and risk-management issues before he arrived.

To provide earnings spark and improve performance, Corzine felt he needed to reinvent MF Global. It wouldn't move away from its core brokerage expertise, but it needed to be more daring. It would take risks in the same way Goldman evolved to become a trading powerhouse under his helm in the 1990s.

MF's demise has caused ripples in markets, not a Lehman-like thunderous roar. Its disappearance won't be a threat to the global financial system. But many market participants wonder whether other medium-sized brokerage houses are similarly vulnerable or could be next. Who could be next? Unfortunately, too, at MF Global, regulators are scrambling to locate hundreds of millions of dollars of missing customer funds. Many experienced brokerage personnel at the firm must look elsewhere for work. (Over 900 were let go this week.)

What happened at MF? What hastened its demise?

1.  Corzine likely tried to hard too fast to replicate parts of Goldman and had a stubborn belief in his old, successful ways. About a year after Corzine had settled in, MF Global started to suffer substantial losses from leveraged bets on Europe sovereign debt this year (exploiting its access to "repo" markets and credit-default swaps, but stumbling soon thereafter).

2.  Risk management lacked a voice or authority to restrain the trading and the firm's piling up of risks. It certainly lacked authority to second-guess Corzine. He presided over a risk-management structure that didn't allow risk managers to say "no" or "slow down."

3.  MF was non-responsive to regulators' persistent requests to increase its capital base.  Capital might have been adequate for a pure-brokerage role, but it wasn't when it began to engage in proprietary trading on a large scale. Instead of boosting capital to comply with requests, Corzine and team would lead arguments for why it felt new capital wasn't necessary.

Are there lessons to be learned from the MF Global mini-crisis?

1.  Leveraged trading is still risky, even if it involves trading government securities.

2.  Risk management within financial institutions must have an authoritative voice to be effective.

3.  Old, successful ways of making money in trading may not be magical and profitable at a different firm in a different era in apparently different market scenarios.

4.  Plain-vanilla brokerage and banking businesses may not always lead to stellar returns, but can help ensure long-term survival.

What happens over the next year or two?

1. The bankruptcy will run its course. It will continue to be a business headline, because customer funds and deposits are missing and can't be accounted for. Regulators, market watchers, and business media will persist in asking how that could happen. They will blame woefully inadequate operations, and some will suspect fraud.

2.  Exchanges and regulators will ponder rules changes to discourage futures brokerages from taking big proprietary-trading risks. As with other financial reform, new rules will be thoroughly discussed, but won't be implemented soon.

3.  MF Global will become a broker/dealer-industry footnote like Rothshild, Hutton, Refco, and Drexel. That it will become a footnote in the history of finance is probably good. It meant it was too small to save, just a market ripple.


Tracy Williams