“Happy families are all alike; every unhappy family is unhappy in its own way.”
– Leo Tolstoy, Anna Karenina, Chapter 1
In a bull market everyone is happy, the sky is the limit and we all feel like “wunderkinds.” We see cracks, but we disregard them as insignificant; we may notice incompetence and malice but the show must go on.
Then the inevitable moment of reckoning occurs—bull times turn into bears and the sky is suddenly not limitless, but heavy and suffocating. Disasters like the Lehman moment in 2008 happen and great destruction touches society at its core. The only silver lining, you may think, is that something may be learned and that things can only get better from here.
Fast forward to the fall of 2011 and “enjoy” the MF Global moment. The bankruptcy of this once powerful derivative broker may not have, so far, scared markets as much as Lehman, but to the eyes of the careful analyst, it is actually much more dangerous and systemically insidious.
MF Global had been around for more than 200 years facilitating commodity trading around the world; in some exchanges up to 80 percent of the volume was attributed to MF Global. This changed recently when disgraced ex-New Jersey Governor Jon Corzine was chosen to run the firm. Eighteen months later, MF Global is bankrupt thanks to a series of actions that make Lehman look like child’s play.
Corzine levered up the firm’s capital to a ratio as high as 40:1 in risky bets on European sovereign debt. Sounds like 2008 all over again? Weren’t we going to fix the leverage issue with banks? I guess not. Corzine also levered his political capital to intimidate regulators in order to have rules changed or kept in his favor. Doesn’t this sound very familiar also? But additionally, the MF saga really strikes a deadly blow to financial markets: while no formal indictments have been put forward yet, it is clear that $600 million of customer segregated funds have been lost, stolen, vaporized (you pick your favorite). In commodity trading, customer funds are fully segregated from the bank capital to ensure safety in cases like bankruptcy. It is the cornerstone of the brokerage industry. The CFTC, the commodity regulatory body, is supposed to oversee this process and the Chicago Mercantile Exchange (the largest derivative exchange in the U.S.) is responsible for managing this process as well.
Almost three weeks after the filing of MF Global bankruptcy, customers of the bank still have their accounts frozen (only open positions were transferred to new brokers with a percentage of minimum margin needed to hold the exposure) and there are questions whether they will recover 100 percent of their funds.
Even though customers are not part of the bankruptcy dynamic since their funds are outside of the bank’s balance sheet, the Trustee in charge of the process is holding everyone hostage.
If our financial markets cannot guarantee safety of funds deposited with brokers or banks, our economic system will fall into a dark medieval state that will impoverish all. Liquidity will dry up, spreads will widen, prices and volatility will become intolerable. While it is clear that the system of incentives in Wall Street continues to push at best risky behavior and at worst illegal activities, our regulators and legal system continue to abdicate their responsibilities.
This is very serious as people’s faith in financial markets cannot be broken once again.