Daily Archives: November 8, 2011

MF Global is not the first firm to be done in by bad bets in the casino known as Wall Street, nor will it be the last. With many questions still unanswered – perhaps most importantly what exactly happened to the $630m of customer money that was required to remain in segregated accounts – attempting to divine the meaning of its collapse may be premature. But a first rough draft of the meteoric history of the brokerage company offers a few lessons and timely reminders.

For starters, the financial world has always had, and will continue to have, a regular procession of rogue elephants – individuals who by virtue of bad investment judgement, avarice or dishonesty succeeded in wounding their employers, either mortally (think Barings) or less consequentially (think UBS). Guarding against these kinds of black swan disasters challenges even the most formidable internal controls.

Unusually, of course, MF Global went awry at the very top of the company. But that is also not without precedent. In 1998, the bets of Long Term Capital Management, the hedge fund, almost brought down the American financial system. Protecting against errors of that sort depends heavily on the regulators and their policies.

So this first post-Dodd-Frank failure of a significant financial institution provides an opportunity to assess the quality of regulatory oversight. The conclusion may ultimately confirm the fears of those who doubted the efficacy of the recent reform legislation.

Once again, we appear to be confronted by a company that was supervised by a patchwork of regulators, none fully in charge. Last February, shortly before the arrival of Jon Corzine (full disclosure: a friend of mine) as chief executive, MF Global had been lifted into the pantheon of ‘primary dealers’ by the Federal Reserve. After its bankruptcy, the Fed took pains to emphasise that it was not MF Global’s regulator.

Meanwhile, the Commodities Futures Trading Commission was responsible for overseeing how the accounts of the brokerage’s customers were handled, but did not appear to have authority over MF Global’s balance sheet.

Those that did – the Securities and Exchange Commission and an industry self-regulator – eventually forced it to increase its capital but by then it was too late for the company, which was leveraged around 44 to 1, well in excess of Lehman Brothers levels. (Leverage, of course, is the crack cocaine of Wall Street, amplifying the highs but risking terrifying falls.)

Then there’s the Volcker rule. Even without knowing exactly what happened with customer deposits and whether they were used to purchase risky sovereign debt, it is not hard to see the events at MF Global as confirming the wisdom of the principle that the money of depositors or other customers of financial institutions should not be used in imprudent ways.

Finally, let’s be careful not to see only what we wish in the MF Global collapse. I reject the notion that this is another example of financial industry compensation run amok. Mr Corzine received a salary of $1.5m, a signing bonus of $1.5m and $11m of stock options, very small beer by Wall Street standards.

Nor is this is an example of the unfortunate consequences of an asymmetrical risk-return prospect for the company’s managers. It’s unquestionably true that Mr Corzine had more to gain financially from a success with MF Global than he had to lose in its collapse. But in the end, he lost something far more valuable than his salary, his bonus, or the $23m of severance and stock options that vaporised in the bankruptcy. He lost his reputation at a moment when he was tipped as a possible successor to Treasury Secretary Timothy Geithner. That will haunt him far more than any monetary consequences.

The writer is former counsellor to the US secretary of the Treasury. He contributes a monthly column to the FT and blogs regularly.

Response by Doug Holtz-Eakin

MF Global collapse raises doubts about wisdom of Dodd-Frank reforms

The very public collapse of MF Global is strewn with salacious titbits: a hint of scandal, disgrace for a high-flying leader, and an exemplar of the dangerous state of global finance. But what are the real lessons for financial market policies, especially in the wake of the passage of the contentious Dodd-Frank reforms?

Perhaps the greatest lesson – and greatest relief – is that MF Global was allowed to fail. The Federal Reserve did not step in with an extraordinary lending programme. The Treasury did not stretch the boundaries of existing financial authorities and infuse it with capital. Congress did not tap the American taxpayer for relief. Instead, equity investors were wiped out, the management lost its jobs and reputations, and those who failed to impose and execute adequate internal controls suffered the consequences.

This is all to the good, and in striking contrast to the precedents set during the 2008 financial crisis.

The bankruptcy is a useful reminder that, in the end, the only sound economic buffer is to hold sufficient capital. MF Global did not, and it went bankrupt. It remains unclear whether the Dodd-Frank and Basel processes will create a regime of sensible capital reserves, that provide prudent cushions without overly handicapping the provisions of financial services and incentives for innovation.

It is increasingly becoming obvious that the Dodd-Frank reforms “fixed” things that were not at the roots of the 2008 crisis, and missed the mark completely on some real problems.

There is no indication that confused or overwhelmed consumers were affected by the collapse, and there never was a real need for the Consumer Financial Protection Bureau. There is no hint that proprietary trading was at the root of the bankruptcy, just as there is no evidence that the Volcker Rule would solve any real problem (even if one could figure out how it worked!). But it is another example of the lunacy of continuing to have both the Securities and Exchange Commission and the Commodity Futures Trading Commission when any serious reform would have provided a unified regulator.

MF Global’s collapse is a clear mark against the fundamental conceit of the Dodd-Frank approach where highly-empowered, super-smart regulators are somehow able to conduct extraordinary surveillance; identify institutional, consumer, and systemic risks in a timely fashion; and keep the world safe from financial volatility. Well, MF Global had multiple sets of eyes on its operations, was affected by closely-scrutinised global events, and it still failed.

No amount of regulatory authority will ever substitute for solid internal controls, relentless risk management, and capital market scrutiny and discipline.

The writer is president of the American Action Forum and former senior policy adviser to John McCain

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