Why the MF Global Crisis Matters More Than You Think: 3 Key Lessons
The fall of MF Global doesn't portend doom for the global economy -- at least not yet -- but there are three key lessons that we can learn from it.
Another day, another development in the saga that is the collapse of financial firm MF Global (MF) -- news is out that the troubled firm’s CEO, former Jersey governor Jon Corzine, has stepped down as the head of the firm and will not be seeking severance compensation. It’s small comfort to traders like Minyanville’s John Cassimatis, who’s written extensively about his experience with the company after its fall.
(See: Is This the Second Coming of Bernie Madoff?, Uncertainty Abounds in Continuing MF Global Saga, and Is the MF Global Saga Finally Winding Down?)
We know the story of the collapse of MF Global well by now: Corzine took big, risky bets on European sovereign debt, expecting that stronger EU nations like Germany and France would not let weaker ones like Greece and Portugal fail. As the sovereign bonds continued to plunge, MF Global got downgraded by Fitch, leading to margin calls on the firm’s $6.3 billion in bets. The overleveraged firm ran out of cash to put up and imploded.
The fall of MF Global doesn’t portend doom for the global economy -- at least not yet -- but there are some key lessons that we can learn from it. Here are three of them.
1. There's no such thing as an "isolated" case.
“I believe it was an idiosyncratic case,” said Federal Reserve Chairman Ben Bernanke when he was asked about the failure of MF Global on Wednesday. It is true that so far, the troubles at MF Global have not infected other US financial institutions with the same magnitude that the collapse of Lehman Brothers did. And the big banks here have learned some lessons from 2008. Morgan Stanley (MS), for example, made it a point to release their European exposures in their latest quarterly filing, which states that the bank has $287 million of exposure to Greece, $1.8 billion of exposure to Italy and even negative exposure to Portugal and France, because of the hedging they have taken on. So the banks are safe then, we’re supposed to think.
But we’ve seen this story before, back in 2007. As Minyanville’s Kevin Depew offered at the time, Bernanke said that the subprime market collapse was an isolated case that would not affect the broader housing market. We also saw similar assurances from analysts and commentators that the hedge fund failures at Bear Stearns did not signify a wider issue at the firm.
John Carney at CNBC recently said, “We don’t really know very much about the exposure of bigger Wall Street firms to Europe, except that they say that they aren’t very exposed and that their exposure has been reduced or hedged. Only we don’t know how they reduced that exposure or hedged it, so we just have to cross our fingers and trust the brilliant minds who brought us 2008.” Indeed, it’s not exactly very comforting to hear that US banks are minimizing exposure to bad European sovereign debt by way of counterparty hedging and credit default swaps.
Reuters blogger Felix Salmon pointed out that it's very difficult to calculate an exact figure for country exposure. For example, during Argentina’s debt crisis in 2001, analysts had predicted that Citigroup’s (C) would lose only about $200 million if the Latin American country went bankrupt. It turned out at the end that Citi lost over $2 billion in Argentina.
It could be that MF Global’s collapse is simply an isolated case of excessive risk-taking, but with the specter of the European sovereign debt crisis looming in the broader picture, the fall of the derivatives broker could potentially be the first in a series of falling dominoes.
2. Always take the words of CEOs and experts with a huge grain of salt.
In a wonderfully snarky take on MF Global, David Weirdner of the Wall Street Journal draws attention to the wildly inaccurate statements on the health of the firm by Jon Corzine in the months before it became bankrupt.
“Reflecting the stressed markets in the quarter, we deliberately chose to reduce overall market exposure in most principal trading activities and focused on preserving capital and liquidity. We also used the dislocation in the markets to add quality people for strategic roles, as well as expand our client relationships across our businesses," said Corzine just over a week ago, on Oct. 25.
"We were particularly pleased with the repositioning of our mortgage, credit and foreign exchange businesses, the performance of our commodities group and the common alignment of our brand to strategy. These efforts reflect positively on our ability to execute and deliver competitive returns to shareholders in the quarters ahead," he added.
It’s perhaps understandable that a CEO with his firm’s interests at heart would make misleading statements like the ones above. However, expert analysts from investment banks also gave their thumbs up to MF Global.
“Our read is that MF has dialed back its risk appetite," Sandler O'Neill + Partners told its investors on Oct. 17. JPMorgan (JPM) gave the thumbs up to MF Global’s principal-trading arm in August, saying it was “getting traction” and “gaining momentum” even though its primary bets were on European debt (JPMorgan, as Weirdner notes, is a lender to MF Global). Analysts and ratings agencies go off public information, which as of October was still Jun. 30 filings and occasional press releases, so it’s not surprising that their calls were wildly off base. It’s safe to say that these experts aren’t infallible.
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