Last Days at MF Global
Board: Macro Economics
In the last decade, I have personally seen one “black swan” event, that was so outlandish, I do not know of a single person that forecast it well in advance. You are probably thinking that the housing crash, credit crisis, AIG bailout all might be black swan events, but I am not referring to any of those. The one event, that I consider a “black swan” event is MG Global customers losing money in their bankruptcy. I must admit that I did NOT think that was possible in US markets by a Federal Reserve approved “primary dealer” in 2011. Luckily none of the widows and orphans accounts I manage were with MF Global. However, a lot of normal investors, particularly farmers hedging their crops were MF Global customers. They have suffered mightily.
List most of you, I did not really understand how this could happen. Earlier this month, Fortune published a very lengthy article entitled “The last days of MF Global”  written by Peter Elkind and Doris Burke. Peter was the co-author of the book on Enron entitled “The Smartest Guys in the Room” so he has good experience in chronically failed companies.
The short story is OUTSTANDING IMO. It is based on over 70 interviews with regulators, industry executives, legislators, lawyers, friends and family of Corzine, and people at all levels of MF Global. It is presented in a matter of fact style, with little right/wrong judgment applied. It is a much easier read than the 275 page report issued by the bankruptcy trustee, James Giddens. Here are the significant points that I learned from the article.;
1. The Fed “Killed” MF Global with ZIRP. Pre-ZIRP, the majority of MF Global’s profits came from the interest rate spread they made on customer accounts. They were strictly a brokerage with NO proprietary trading for their own account.
2. After the Fed ZIRP’ed them, they lost money for four consecutive quarters before Corzine became CEO. They went through two different CEO’s but the flight trajectory was still headed down. They did NOT have a viable business model as long as ZIRP continued. Their only hope was for increased short term US interest rates.
3. Corzine’s solution: Add proprietary trading and turn MF Global in the second coming of Goldman Sachs. (Corzine was CEO of Goldman from 1994 through 1999)
4. MF Global was built up with 17 acquisitions, had 262 different websites, and more than a dozen brand names. Stated differently, it was a hodgepodge of poorly integrated businesses scattered across the world.
5. Corzine and the two previous CEO’s were clueless about how to properly integrate all of the scattered pieces into a single, coherent organization.
6. The company used word of mouth and manually entered data on spreadsheets to determine critical funding issues EVERY DAY. Their US business had 48 different accounts at 8 different banks that had to be manually combined in a spreadsheet.
7. Corzine took it on himself to literally do a lot of the proprietary trades. During meetings, he would regularly stop listening and look to see how his trades were doing in real-time. He would often interrupt the meeting to call his trading desk. Yoda’s comment: This is not exactly what you want your CEO to be doing. He should have been doing big picture kind of tasks.
8. The deal that eventually killed MF Global was a “repo to maturity” aka RTM involving foreign, sovereign bonds from Italy, Spain, Greece etc. The reason they chose RTM’s was twofold:
a) Did NOT require “marking to market” the bonds as prices changed that would show up on MF Global’s balance sheet. Stated differently if the market price of Greek bonds dropped in half, it was NOT reflected on MF Global’s balance sheet. This means that it also did NOT show up in their earnings.
b) MF Global was legally allowed to “book” the forecasted profits for entirety of the trade, the day the trade was consummated. They did NOT have to wait until the trade closed, months to years later to recognize the earnings.
9. RTM’s allowed MF Global to show a profit. Corzine was praised.
10. The board 100% knew about the RTM’s, regularly reviewed them and approved them. The board had many very sophisticated investment professionals on it. Yoda’s comment: this is as opposed to the boards of many other companies where the directors are 100% clueless about the underlying business.
11. The RTM trade was to have a third party buy a short term sovereign bond with a yield to maturity of say 10% on MARGIN using low, ZIRP like margin rates. The profit was the interest rate spread, assuming that the sovereign bond did NOT default.
12. Regulators and credit rating agencies did NOT know about the RTM trades. MF Global portrayed them as having the same risk as owning US treasuries.
13. What started the downfall was when the middleman that owned the sovereign bonds started demanding more collateral, i.e. a margin call. This occurred when the market started downgrading the sovereign bonds. Note that the bonds did NOT have to fail, they only had to require a larger margin
14. In the end, MF Global used customer “segregated” funds to meet the RTM margin calls.
15. Today, customers are still short $ 1.6 billion.
YODA comments, as opposed to facts presented in the article:
1. Corzine and MF Global had NO intention of doing anything wrong, immoral, illegal until possibly the last week of MF Global’s life. Stated differently, they were different from a lot of the other large bankruptcies like Enron and Worldcom where widespread criminal activity went on for a long time.
2. Corzine is guilty of hubris for thinking that the RTM trades he put on, could NOT turn out badly. There was NO plan B if they started turning bad. He had literally bet the house on these trades with the full knowledge and approval of the board. Several high level employees recognized this risk and left the firm.
3. Corzine is certainly guilty of managerial incompetence for NOT having the correct infrastructure in place before he started proprietary trading. He is NOT the only CEO that is guilt y of this. Managerial incompetence is not against the law and matter of fact, many CEO’s have been handsomely rewarded for it. Dick Fuld, Anthony Mozillo, Dick Parsons to name a few.
4. Corzine MIGHT have crossed the line and committed a crime literally in the last few days of the company. He MIGHT have understood and directed customer “segregated” funds be used to meet margin calls. If so, he fully expected the funds to be repaid in literally a matter of days. MF Global had a rational and possibly credible plan to get the funds replenished on short order.
5. I have NO idea if Corzine will ever be criminally charged or not. If you put a gun to my head and made me commit, I would say he WOULD NOT be convicted if you tried him.
6. Interesting to note the MF Global was NOT a TBTF bank. The Fed could have easily saved them and they would still be in business today. All the Fed would have to do would be open up the discount window like they did to everybody and their brother back in 2008. MF Global could have survived.
7. All of the bonds that Corzine picked out have been money good so far. NONE of them have defaulted. So if they could have met the margin calls, all would be OK.
8. All of the regulators failed 100%, but they had a lot of help in that MF Global was not forthright in disclosing these trades until it was too late.
BOTTOM LINE for me is that I still literally stay awake some nights wondering if this can happen again to US investors. And I am NOT kidding, as opposed to my usual tongue in cheek, staying awake at night comments. The investors that owned “securities” were apparently made whole, but those owning futures are the ones that were short changed. I sure hope another black swan from the same flock does not land in the US, but I have NO rational reason to be confident it will NOT occur again. I have not seen and/or heard anything that would prevent this the next time. I guess that makes it a white swan since we have been forewarned . . .
I have condensed the article down and left out many smaller points. You might come to different conclusions that I did if you read the article.
 Fortune Magazine, The Last Days of MF Global
 Report of the Trustee’s Investigation and Recommendations