On MF

The MF Global story gets more bizarre by the minute. At this point one has to ask if it could become a systemic problem. At first, I did not think so. I’m rethinking that. There is no definitive information as of yet. The CFTC is suggesting that the missing client money is $633mm. It might be larger than that (Zero Hedge Link). Some thoughts:

I was one of many who tried to stave off the bankruptcy of Drexel Burnham Lambert in 1989. Skadden Arps, (the same law firm who is advising MF today) was involved in the last month as the chess game played out. They were advisers. Their clear advice was to NOT commingle  custody accounts. To commingle funds is potential jail time for any involved. Drexel went down. But client money/assets were returned.

Of course Corzine and all the other seniors at MF knew this. Skadden was giving them the same advice as they gave to DBL 20 years ago. So how can it be that three days after a chapter filing there appears to be a very big hole?

This happened with another big future’s house back in 2005. That was Refco. In that case there were significant client account losses. Of historical interest:

-Phil Bennet, the boss at Refco, went to jail for 12 years.


-Man Group bought what was left of Refco (they were good futures brokers).


-Man became MF Global. Rinse and repeat.

The history is relevant as it is more evidence that Corzine and MF management HAD to know that commingling was the ultimate no-no. It was part of their history.

My guess is that the missing cash was grabbed by one (or more) of the big players in the global bond market. MF did not sign off on the cash grab. The banks moved on them and their customer accounts. MF had no say in the matter.

Given Corzine’s relationship with Goldman I put them high on the list of probable plug pulling bankers. Nomura was a place to go to finance AAA sovereign positions. One of the French or German banks could have been the warehouse for MF’s sovereign exposure. It wouldn’t surprise me if any one of them pulled the plug on the leveraged bets.

It should be noted that all of the big players talk when they are moving on collateral and closing relationships with financial firms.When the SHTF, they act as one.

MF has said that the funding for the sovereign exposure was “locked up” to maturity. That’s complete bullshit. I can tell you from first hand knowledge. When Wall Street is financing positions they always have a MAC (Material Adverse Change) provision that allows them to call the financing. If the debt is not immediately repaid it produces an event of default. That creates a cross default to all other asset positions. When they smell trouble they move first and ask questions later. They always lock up cash.

If you think this sounds far fetched consider what happened at Refco:

Refco’s forex brokerage arm, Refco FX, LLC, was holding over 17,000 retail customer brokerage accounts at the time that Refco declared bankruptcy shortly thereafter. In the bankruptcy proceedings, Bank of America and other large creditors managed to convince the bankruptcy court that Refco’s customers were actually unsecured creditors because of Refco’s failure to segregate its customer accounts from their own general funds, despite telling customers that it had done so.

Most of the broker’s 17,000 customers eventually received little or no compensation.

This is not supposed to happen. FINRA is the watchdog for this. Their words on how “safe” customer accounts are with registered brokers.

In virtually all cases, when a brokerage firm ceases to operate, customer assets are safe and typically are transferred in an orderly fashion to another registered brokerage firm. Even if a firm fails, its customers' assets will be safe.

So much for FINRA.

Where could this go?

I think some drop in confidence by market investors in secondary firms has to happen. Money has to leave those players. With that, will go the flow trading that comes with the accounts. Liquidity across all markets (especially futures) will be affected.

If we go down this road (we will if MF/the Banks actually used/seized clients money) the short-term consequence will be another big ramp up in volatility. Most assets classes will suffer in that environment.

Leveraging of "liquid" assets is a critical component of the global system. The repo markets are already under serious attack. The MF story could take us to a new level.

The absolute craziest outcome would be that we learn that it was Goldman who closed the books and seized the cash last Friday (someone did). It would be even crazier if this leads to a problem that gets out of hand. There’s a decent chance that it plays out along these lines.