Saturday, November 5, 2011

MF Global Bankruptcy Proves Need for Privatization of Financial Regulation

Here we go again. After all of the public outcry to rein in Wall Street, the eighth largest commodities trading firm in the United States has declared bankruptcy, three short years after the Lehman Bankruptcy.  This bankruptcy comes with a twist - $593 million of customer money is missing. The FBI, as well as the securities regulators, is now camped out the firm's headquarters. Will we ever learn?

I have been arguing for privatization of financial regulation for some time. This bankruptcy proves that we need to find a new paradigm for regulation. The regulations and regulators that we have now in place are not working. After the last financial crisis, it seems incredible that there were no rules in place to limit the leverage and concentration of trades done with firm's money. Once again, one trader has bankrupted an entire firm by taking outsized risks without any fear of a clawback of his earning.

My new paradigm for securities regulations is to empower outside lawyers, with a vote by the commissioners, with the ability to investigate securities and commodities firm, prosecute violators and pocket the fines imposed. I am working on this with the community reporting news site, Spot. us. More details here. 

Regulators are always Johnny Come Lately if they arrive at all. The CFTC did not detect the lack of controls over the segregation of client money. Exactly when MF Global clients  need his insight and wisdom the most, the head of the CFTC, Gary Gensler, has withdrawn from any involvement in the case due to his close relationship with the firm's former CEO Jon Corzine, his former boss at Goldman Sachs.  Funny, that close relationship never seemed to be a problem when Corzine was lobbying for what he wanted.

MF Global clients may lose as much as 40% of the capital in their personal accounts. Some of these losses could have prevented if regulators were paying attention,  Many institutional investors, having their ear to the ground, rushed to withdraw their money last week. A money manager in Chicago told the New York Times that his firm, hearing the rumors, pulled out $5 million last week. The CTFC gave sophisticated investors an advantage by not blocking last week's hastily arranged withdrawals. Maybe, the withdrawals can be clawed back like they are in a Ponzi scheme.

Corzine, who should have known better, was using the commodities firm, which was also a registered broker-dealer, as his own private casino. He was making huge bets, leveraged 40 to 1, on European sovereign debt with the firm's money.  If he won, he would become richer. If he lost, he would walk away as he has done.

The Financial Industry Regulatory Authority, a private organization, first raised the alarm about MF Global's risky bet. Then the panic spread. MF Global tried to sell itself to Interactive Brokers but the missing client money precluded a deal. The firm may not have been properly segregating customer money.; It  may have been using the money to shore up their under the water positions.

We might be able to write this off this speculative use of firm money as a one time incident except that Corzine and the CEOs of other commodity firms were lobbying the CTFC  to even further relax the rules surrounding commodity firms' uses of customers' money. Gensler wanted to tighten the rules, but apparently was unable to stand up to the bulldozer that is Corzine. The Republican commissioners were also against more regulation. Gensler isn't perfect. When he served in the Clinton White House, he was against additional regulation of derivatives.

The coziness of Gensler and Corzine may be unseemly but probably had very little effect on the final result. When I was at Wharton, Gensler and his twin brother were the most intelligent and best prepared students in every class I attended. If Gensler was blindsided by Corzine's actions, then probably no one could have seen it. When traders leave Wall Street and become Washington regulators, something appears to happen to them. It must be the brand of cool aid they serve in Washington.

While many treat Elizabeth Warren as a hero for dreaming up the Consumer Financial Protection Bureau, this bureau also would not have prevented the MF Global disaster.  More regulations and regulators are not the answer. Smart people in the private sector must be given tools by which they can protect the consumer. Regulators are not up to the job.

There may be one good thing to come out of the MF Global bankruptcy. While it is a commodity firm and not a bank, the bankruptcy should shore up support for the Volcker Rule, which is meant to curtail speculative investments by the banks.


  1. Dear Congressman

    I am writing to you to ask for your immediate help and intervention to ensure the integrity of the US Financial markets in lieu of the MF Global debacle. The integrity of the markets are at stake as well as the integrity of the USA in the eyes of the financial world.

    Segregated client accounts of MF Global are missing upwards of $600 million USD. This money just does not disappear or then according to news reports show up at JP Morgan and then to disappear once again. JP Morgan was a custodial bank for MF Global. JP Morgan had repurchase agreements with MF Global. Were funds sequestered from MF Global Clients by JP Morgan to make up in short falls? Does the US Financial system allow stealing of segregated funds at one institution by another?

    These segregated accounts are no different than personal or corporate bank accounts or even stock market accounts. These accounts were (possibly) violated and a large amount of assets are missing.

    What is worse is the violation of the Commodity Exchange Act, which states that in the event of a FCM bankruptcy client funds are to be handled separately from the firm assets and given priority. It is questionable what transpired, however 50,000 customer accounts have been frozen and hundreds of millions of dollars are unaccounted for. The analogy is very simple. It is as if a bank makes bad loans and then pillages their customer’s accounts to remedy the situation or if a Stock brokerage company makes bad investments and then withdraws monies from their client’s accounts. If this is allowed to continue there will be NO Trust in the markets. Nothing will be safe!

    The implications are severe to farmers to hedgers of virtually aspect of our human existence. This is not just a group of commodity trading speculators. This is the basis of the US economy.

    The fact is that the regulators were not regulating nor are they acting now in order to protect the integrity of the financial markets. I implore you to take a stand to protect the financial markets. I implore you to

    1.Demand that the trustees of the MF Global release at least partial of the frozen cash
    2.Open immediately investigations of JP Morgan and how segregated accounts & money supposedly appear and disappear.
    3. Open immediately an investigation of the regulators who failed their task in regulating the markets.

    This can spin out of control very quickly. Myself and countless others are counting on you to protect the integrity of the US Financial markets.

    Andrew Abraham
    Abraham Investment Management

  2. Smart people in the private sector are not there to protect the consumer. They are there to make money for their firm. To say the financial industry can self regulate after the mess we have seen is either the height of hypocrisy or extreme naivete.