InvestSMART

All just a case of history repeating

The MF Global collapse says a lot about a system that lets customers' money disappear so easily.

The MF Global collapse says a lot about a system that lets customers' money disappear so easily.

THE New York Post whipped up a mild frenzy this week by reporting that the Occupy Wall Street movement had plans to stay camped out in Zuccotti Park in downtown Manhattan until 2025. It had found an online calendar on the Occupy website which had "Radical Economics 101" scheduled for 10am on Sunday, October 26, 2025. The notion that the movement would still be teaching the class 14 years after the campaign started should have been enough to ring alarm bells for the newspaper. However, the downfall of futures and derivatives trading house MF Global, the seventh-largest bankruptcy in US history according to Reuters data, may be giving protesters reason to consider laying down some roots.

How MF Global managed to crash and burn in a short-term financing debacle the likes of which brought Lehman Brothers and Bear Stearns to their knees only a few years ago is worth looking at.

Moreover, how MF Global is still unable to locate $US633 million ($A615 million) of clients' money almost two weeks after it filed for bankruptcy is the most troubling indictment on the firm and says a lot about a system that allows customers' money to disappear so easily. MF Global was spun out of Man Financial in 2007. It spent most of its life as a commodity broking house, executing investments on behalf of clients and betting on the future price of everything from stocks to debt. The shares in MF Global, however, had been declining since 2008. Enter Jon Corzine in March last year.

The former chief executive of Wall Street giant Goldman Sachs and New Jersey governor shocked many in the investment community when he agreed to return to Wall Street to revive the fortunes of the company.

But the rock-star reception the Democrat received ended last Friday when he resigned his position, four days after MF Global declared bankruptcy. He was rightly taking the fall for a $US6.3 billion bet he and the board of MF Global authorised when they invested in the sovereign debt of Belgium, Ireland, Italy, Portugal and Spain. Basically, MF Global was banking on Europe being able to dig itself out of its debt crisis a white knuckle gamble. When customers invest in companies such as MF Global their money is supposed to be kept in a "segregated account" separate to the firm's money.

It appears MF Global was driven to use customer assets to provide liquidity and stave off cash demands from counterparties of its investments in the days before its demise.

When ratings agencies downgraded the investment quality of the firm, spooked by the large European debt exposure and a 30-1 leveraging ratio against those bets, there was an understandable "run" on the firm as large clients rushed to pull their money out.

Now, as MF Global wallows in bankruptcy proceedings, there are about 150,000 clients who have been locked out of their accounts. These customers face long delays in accessing their money if it is still there.

There is about $US1 billion in collateral in these clients' accounts that has not been released. This is money that should never have been used for, or by, anyone else.

But the way these investments are structured is to provide high returns based on high risk. The commission structure also gives fund managers incentive to bet big with your money. What bigger bet than expecting the European debt crisis to sort itself out?

Corzine himself stands condemned for his efforts over the past year to stall reforms designed by the Commodity Futures Trading Commission to stop firms from essentially borrowing money from their own customers for these sorts of trades. Questions also have to be levelled at the seven-member board of MF Global. There are two former senior executives from HSBC, a top member of the private equity firm J. C. Flowers & Company and the former chief financial officer of the Aon Corporation. Fellow director Robert Sloan is even a managing partner in a company that specialises in the sort of financing and counterparty risk management that saw MF Global come unstuck.

How were directors left feeling comfortable with a $US6.3 billion bet on European sovereign debt?

Trustee James Giddens, of bankruptcy specialists Hughes Hubbard & Reed, has won court permission to probe the company's directors, as well as investors. Other regulators including the Commodity Futures Trading Commission and the Securities and Exchange Commission are also investigating, as is the FBI. Let's hope they get some answers including whether MF Global exploited customers' segregated accounts and if so why. If so, how was it able to use the funds to stem off its impending insolvency?

While the Dodd-Frank financial reforms, forged out of the global financial crisis, are yet to take full effect, it is unlikely they would have prevented the MF Global collapse.

Perhaps it is time for the second wave of legislative reform and a full assessment of whether the Investment Company Act of 1940, which requires extensive disclosure and independently audited financial statements for these sorts of publicly traded funds, adequately protects mum and dad investors.

At the very least it is time to get our lesson books out and revise the notes we made back in 2008. Investments offering high returns are by their nature high risk.

How much responsibility directors, effectively part-time members of a company, are expected to take for investments should also be examined. Can someone not living and breathing the day-to-day running of a company confidently approve billions of dollars of investment? If boards are to carry this responsibility then there also needs to be greater accountability when things go wrong.

MF Global is said to be the first corporate corpse attributable to the European debt crisis. If more follow it will be hard to ignore the need for a second round of reform.

A crisis is a terrible thing to waste. Particularly a second time.

mathewmurphy81@gmail.com

Twitter: mathewmurphy81


Join the Conversation...

There are comments posted so far.

If you'd like to join this conversation, please login or sign up here

Related Articles