Here’s A Good Question For Analysts and Ratings Agencies

Posted by Jeff Carter
on November 2nd, 2011

The MF Global ($MF) melt down in less than a week has caused a lot of people to scratch their heads over the business decisions made by the company. Who in the brokerage business puts their excess cash into European debt? Absolute stupidity. Overnight cash should always go into US Treasuries, no questions asked.

However, what are we relying on ratings agencies like S&P for? Or, what were MF Global analysts thinking? On conference calls, no one ever asks a company, “What are you investing in with your short term investments?” After this debacle, don’t you want a full accounting of where companies are putting their money? At least investors would have a better idea of balance sheet risk.

The short term investments line on the balance sheet was the cause of the fall for MF. If they had invested in US Treasuries, they’d still be in business. They would have had some quarters of losing money, or missing estimates, but they would probably still be a going concern. Traders all over the world wouldn’t be in a pickle.

Of course, that assumes that they had some ethical standards, which they didn’t, because they co-mingled segregated customer cash and their own. But at least you could point to the track record of the former Goldman, Democratic Senator/NJ Governor CEO for a hint on ethics.

Another pertinent question is where was the Commodity Futures Trading Commission(CFTC)? According to testimony over the past three years by Gary Gensler and Bart Chilton, they are all knowing and should have been able to see this coming. Especially with Dodd-Frank legislation, and certainly with Sarbanes-Oxley legislation that made corporate officers more accountable. Tell me, is this the outcome we should expect with all the rules and regulations we have written over the past several years? Big government is asleep at the switch again!

Also from Jeremy Grant’s article at the Financial Times, “Why was MF allowed to operate at a 40-1 leverage?” Did regulators look the other way because of who was in charge?

Yesterday in bankruptcy court the MF attorney said, “MF Global Holdings Ltd. has accounted for all its assets, which have “substantial value,” said Kenneth Ziman, a lawyer for MF Global, at a bankruptcy court hearing in Manhattan. “To the best knowledge of management, there is no shortfall,” Ziman said U.S. Bankruptcy court judge Martin Glenn, who inquired about whether a shortfall in customer accounts would affect the case, citing media reports that hundreds of millions were missing.

In lawyer speak I believe the attorney said management was innocent, but he didn’t say they could actually account for every dollar. Word on the street is traders have had checks bounce. They can’t get their money. This attorney knows there is going to be a flood of fraud litigation and some in MF could go to jail.

In the aftermath, the FT had a good summary.

The loss of one of their most aggressive competitors will also benefit the few large commodities brokers who are independent of banks, such as ($INTL) FCStone, RJ O’Brien, OTC Global, Marex Spectron, GFI and PVM. One of these groups could certainly be in the running to kick start their expansion plans by buying part of MF Global out of bankruptcy; but even if they do not, they are likely to gain from its demise.
MF Global’s approach to brokerage was to win market share by competing aggressively on brokerage fees, competitors say. As such, its bankruptcy should mean higher fees – as well as higher market share – for other brokers.
Moreover, its relatively orderly collapse appears to have highlighted the benefits of central clearing, and so could accelerate a move towards exchange-traded contracts that began with the Lehman Brothers bankruptcy and is being pushed by regulators.
Ultimately, the end of MF Global may be a boon for both commodities brokers and exchanges.

As far as independent traders go, it might drive some that are large enough to self clear. It should drive others to more boutique clearing operations that put them closer to their money. Global traders that need a big balance sheet to trade will be forced to go to the five or six big banks left. Dodd-Frank legislation has made it impossible to compete with them.

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