MF Global is MF Kaput

Posted by Jeff Carter
on October 31st, 2011

There are a few sides to the futures business. I was always a “local” trader, and never had customers, filled orders, tried to get retail accounts or anything like that. Locals had different needs and wants from a clearing house than a customer, a broker, an introducing broker or some operation like that.

I continue to clear any trades I do at Shepard International Trading. I pay more in commissions there, but everything is clean. I never have a problem with my account. I don’t have to worry about the positions being leaked out of it, and the people that run the company play straight.

One of the great fears of a local trader is that one day some idiot bankrupts the clearing firm, your assets get frozen, access to trading is denied and you are stuck. If your clearing firm has a good risk manager, that shouldn’t happen.

However, that happened to a bunch of people today with the bankruptcy of MF Global ($MF). Traders couldn’t access their accounts and the trading MF did was liquidation only, meaning closing positions. I feel bad for the employees of MF Global. They didn’t have a hand in running the company into the ground.

This dislocation is only a short term operational problem. Money in clearing firms is segregated away from the assets of the firm itself. Traders don’t worry about that. But when assets get frozen up and you need to post margin on positions it’s a royal pain in the you know what.

The market decline today wasn’t about MF Global. It was about continued worry in Europe. The Europeans papered over their problems by throwing more money at it. Do you really think the Italians can continue to auction of debt at 6% interest rates and pay for it? Not a chance. The broader market isn’t affected by one futures firm. The only reason it’s a big story is they are led by a former Goldman CEO, and former government official (Senator, Governor) that was rumored to become a Treasury secretary.

MF Global went bankrupt for the same reason a lot of clearing firms go under. They chase yield. All the guys like me that have excess money in their account after their positions are margined give firms a chance at some cash flow. The firms that go bankrupt use that money to buy overnight treasuries and earn some interest on it. The problem today, no one is paying any overnight interest so that cash flow stinks.

When you are an operation like MF Global, you might do some financial budgeting based on earning a certain return on assets. When you don’t earn that return, you need to bump up the risk you take to earn more yield. In MF’s case, instead of buying US Treasuries, they decided to buy European securities. What could go wrong?

A haircut that’s what.

Boom went their balance sheet. Now they are done. Refco and MF Global followed a similar strategy. They rolled up IB’s and then tried to sell a lot of value add products and generate cash flow from deposits and commissions. In Refco’s case, fraud brought them down. MF just made some really poor business decisions.

Those of us in the know in the futures industry never thought MF was a particularly clean house anyway. My friend Dan Dicker from New York can tell you chapter and verse about their reputation on the NYMEX/COMEX floor. It wasn’t very good.

I mean, what did you expect? Their CEO ran the state of New Jersey into the ground. His claim to fame was front running customer business at Goldman before he became a US Senator. All you have to do is read “When Genius Failed”. Goldman downloaded the positions of LTCM before they lent them the money, then pressed the positions and caused them to go bankrupt. They took the other side as they blew out and made a ton of dough. Karma sucks. What did Corzine run better? MF or NJ?

One thing to note, just like when Stotler, Refco, Bear Stearns and Lehman went bust, none of the commodity clearing houses ($CME, $ICE, $NYX) were affected. The markets ran efficiently and on time.

Anyway, if you are a futures customer, or considering trading futures it’s sometimes important to check out your firm. Like I said, I use Shepard. For S&P execution, I also know a guy named Charles Reynolds that is pretty sharp. He runs his operation through FC Stone($INTL). Happy to put you in touch with either of them if you desire.

UPDATE

To clarify on the MF reputation-it was far before Corzine showed up. There are conflicting stories on my “chasing yield” meme. Thestreet.com says that isn’t the case.

It’s ugly for the customers and the employees that had nothing to do with it. But, let’s see what the forensic accountants say when they go through bankruptcy. We learned a lot about Enron after the fact.

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