Latest crisis only of confidence as finance stocks cop a hammering

With MF Global filing for bankruptcy on Monday, investors pummeled many financial stocks, fearful that problems were lurking on the books of other Wall Street firms. It was a crisis of confidence, not unlike in 2008 when the markets punished stocks on mere speculation of trouble.

On Monday, companies with perceived exposure to MF Global bore the brunt of the pain. The Jefferies Group, which issued a statement saying it had a minimal stake in the brokerage, fell by nearly 10 per cent. The Fortress Investment Group, which proactively disclosed that it had "literally zero" exposure, dropped more than 11 per cent.

"Investors across the financial sector are definitely on high alert trying to avoid or minimise these sovereign debt exposures," said Ed Ditmire, an analyst at Macquarie Capital.

MF Global made a risky bet in a tumultuous market. Recently, the firm revealed that it had $6.3 billion of sovereign debt in troubled countries such as Italy and Spain. The position was nearly five times the firm's equity of $1.2 billion. As the sovereign debt crisis reached a peak in October, two rating agencies cut the grades on the company's debt, saying they questioned the firm's risk controls given the size of the position.

The downgrades sent the company into a tailspin. Trading partners asked the firm to post more money against their portfolio. Adding to the jitters, MF Global reported a third-quarter loss, which further eroded its stock and made its capital position even more tenuous. The firm drew down a $1.3 billion credit line as it fought to stay afloat. But it proved insufficient and MF Global was forced to file for bankruptcy.

After the Moody's downgrade last week, MF Global sent a letter to clients trying to reassure them of the firm's strength. On Monday, as some clients called to ask questions and liquidate their accounts, MF Global was not picking up the phone.

Some financial exchanges prevented MF Global employees from entering Monday, while others, including the Chicago Mercantile Exchange and the Intercontinental Exchange, halted the firm's trading in the morning. That forced clients of MF Global to sit tight or liquidate their holdings.

It is difficult to know what other firms could face the same pressure. Most of the small brokerages that clear futures trades like MF Global are private companies, so their capital positions are not as vulnerable to the whims of the public markets. The rest of the industry is dominated by large banks, which analysts say have sufficient capital.

The irony is that MF Global's sovereign debt may turn out to be right eventually. The firm was ostensibly making the wager that Europe would come to the rescue of its troubled economies and the countries would not default on their debt.

In such an event, MF Global's holdings would most likely have paid off. But investors and others just did not have the patience to wait.

"The positions still have not caused any losses to the best of my knowledge," said Richard Repetto, an analyst at Sandler O'Neill. "But this risk-taking is just excessive compared to the size of the balance sheet."