MF Global declared bankruptcy this month. The once trusted brokerage with roots dating back to the 1700s filed the eighth-largest ever U.S. bankruptcy after a wrong-way $6.3 billion trade on its own behalf on bonds of some of Europe's most indebted nations. "While most people would have never heard of MF Global, its bankruptcy may be seen as the first shoe dropping in the European financial crisis and as a clear indicator that the regulatory infrastructure of 2011 may not be sufficiently more solid than the structure that failed so miserably in 2008."
MF Global's CEO Jon Corzine, former CEO of Goldman Sachs as well as former governor and Senator from New Jersey, expanded the companies reach in recent years from its brokerage base by making an aggressive move into proprietary trading. Many believe that this move into proprietary trading spelled its downfall.
According to Eric Lewis writing for CNN: "MF Global's Company Overview and Financial Overview, both dated October 2011, tell a story quite different from that of a company about to plunge into insolvency. At the end of September, it touted $41.05 billion in net assets, $3.7 billion in available liquidity and $2.5 billion in total capital. It was able to sell $325 million in unsecured notes in August. It claimed 'solid risk management,' a 'strong capital position,' 'strong liquidity' and an 'extremely liquid and high quality balance sheet.'
Its balance sheet was huge but terribly fragile. While it had lots of assets on its books, it also had a huge amount of borrowing. For every dollar of its own capital on its books, it had borrowed $40, a leverage even greater than that of Lehman Brothers at the time of its collapse.
Why is that a problem in a time when near-zero interest rates extend as far as the eye can see? Because leverage is always treacherous and 40-to-1 leverage is madness. Even when interest rates are low, lenders demand security. When the value of that security goes down, the demand for margin -- additional collateral to secure the debt -- goes up."
Lewis argues that too-tepid "leverage requirements" in the wake of Dodd-Frank are to blame for MF Global's downfall. "Many will view the demise of MF Capital as just another bit of the 'creative destruction' of capitalism. The Republican candidates complain that Dodd-Frank, last year's financial reform bill passed in response to the credit crisis, is stifling healthy risk-taking. The reality is that Dodd-Frank does not do enough to prevent financial institutions from taking excessive risks with investors' money. While it imposes leverage requirements on banks, those requirements are still quite limited, and institutions not regulated by federal banking agencies are not restricted in their risk-taking in any meaningful way."
As described, Corzine and his traders made very aggressive bets on European debt which would have resulted in spectacular profits had the bonds moved favorably for MF Global, even just slightly. They did not. As Lewis concludes: "Leverage is the steroid of modern finance that creates the hazardous incentives to bet big, keep the winnings and dump the losses onto others. What MF Global shows is that the problem is not too much regulation but too little. Without meaningful leverage restrictions on borrowers and meaningful lending restrictions on those who are willing to underwrite this steroidal debt expansion, MF Global is likely to be the tip of yet another iceberg. And we have yet to recover from the last financial Titanic."
Finally, as reported by Leah McGrath Goodman for CNN/Money yesterday, the MF Global mess keeps getting messier as the bankruptcy trustee announced perhaps as much as $1.2 billion may be missing from customer's accounts, indicating potential misappropriation.