TOPICS > Economy

MF Global’s Risky Bets on Europe Backfire on Investors

November 1, 2011 at 12:00 AM EDT
Major securities firm MF Global, Inc., run by former New Jersey Gov. Jon Corzine, filed for bankruptcy protection Monday. Ray Suarez speaks with New York Times columnist Joe Nocera about the story and the investor money at stake.
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TRANSCRIPT

JEFFREY BROWN: And we turn to the fall of a major securities firm and its well-known leader.

Ray Suarez has the story.

RAY SUAREZ: MF Global Holdings is not the kind of financial firm most Americans are familiar with. But when the giant trading company filed for bankruptcy yesterday, it became the largest failure by a U.S. securities firm since the collapse of Lehman Brothers in 2008. And some of the reasons behind its fall may sound familiar, from the failures earlier in the financial crisis.

MF’s chief executive, former New Jersey governor and U.S. senator, Jon Corzine, bet heavily on European debt, and the company reportedly put clients’ money at risk as its troubles grew.

Here to fill in the picture for us is Joe Nocera, a reporter and financial columnist for The New York Times.

And, Joe, let’s begin by explaining just what MF Global was doing that got it the scrutiny, the trouble and eventually bankruptcy.

JOE NOCERA, The New York Times: Well, to start with, you know, it wasn’t — it used to be an old-fashioned broker/dealer. So all it did was match buyers and sellers who wanted to buy derivatives or trade derivatives, but that business was becoming increasingly less profitable.

So when Corzine took it over in March of 2010, he decided he wanted to bet some of the firm’s own money, which is riskier, but it’s also potentially more profitable, on European sovereign debt. And his theory was that European governments were never going to let this debt fail and that ultimately this would be a big winner, a big contrary bet.

And, ultimately, they built up a gigantic $6.3 billion position, and the bet, you know, it just turned out to be wrong. It’s as simple as that. What we have discovered since is more troubling in the last — really in the last 24 hours, with the possibility of customer money being missing.

RAY SUAREZ: Well, we spent much of the beginning of tonight’s program talking about things unraveling in Europe with perhaps a Greek referendum turning back the deal.

But did it, in fact, turn out to be a bad bet? Have those MF Global purchases, those bonds, actually lost their value?

JOE NOCERA: Well, not ultimately, Ray. But that actually doesn’t matter. That’s like AIG saying, you know back in 2008, well, these mortgage-backed securities will ultimately pay off.

That is not what the question is. The question is, what does the market value it at a particular moment? And most of these bond purchases usually have collateral calls attached to them, so if the value decreases in the marketplace, if the market value decreases, you know, counterparties can call for more collateral.

And this sort of thing feeds on itself. As the collateral calls come, the have less money, investors get jittery. Their customers get jittery. And then they can’t get the loans they need to run the business on an overnight basis. And once they lose that, they’re dead.

And in effect, it’s a kind of — it’s a modern version of the run on the bank. And that’s what happened in this case.

RAY SUAREZ: In addition to it ending up being a bad bet, as you say, was this more than just a business decision that didn’t work out? Is there allegations of — are there allegations of wrongdoing that may hint at something much more sinister going on?

JOE NOCERA: Well, that is certainly a possibility. And we don’t want to get ahead of ourselves because we don’t really know what the story is here.

But, really, within the last day, it now appears that the reason that Corzine was unable to sell the firm over the weekend, as he had expected to be able to do, was because the potential buyer found a discrepancy in the customer accounts, millions — billions, literally billions of dollars of — excuse me — not billions of dollars — $600 million or $700 million that has been missing.

Subsequent to that, regulators have been investigating, and there does appear that the company commingled customer assets with its own assets, which is a huge regulatory violation. And if that turns out to be the case, they could be in a lot of trouble.

RAY SUAREZ: What’s the problem with the commingling? Don’t customers give their money to firms like MF Global to have it invested?

JOE NOCERA: No.

Most of their customers, please remember, were parking their money as part of a broker/dealer, in the same way, Ray, that you and I might have our stocks parked with our broker. And in those situations, the customer’s assets are supposed to be absolutely segregated from the customers’ own cash.

So this intermingling is absolutely a violation of regulation, if in fact that is what happened. The general theory is — I mean, it’s just totally a theory and is a rumor — is that perhaps as the company was getting more and more desperate, it began to use customer money to help shore up its own capital position. I really don’t know if that’s true or not. But that’s certainly the rumor that one has been hearing in the last I would say four or five hours.

RAY SUAREZ: And The Wall Street Journal is reporting that $600 million to $700 million, as you say, is perhaps missing from those customer accounts.

JOE NOCERA: Yes.

RAY SUAREZ: In your column… yes, go ahead.

JOE NOCERA: I was just going to say, for the record, The New York Times is reporting the same thing.

RAY SUAREZ: Ah, OK.

In your column, you suggested that this was a very retro kind of crisis, that this was the kind of thing that we were having hear about during the bad days of 2008.

JOE NOCERA: I think that’s absolutely true.

One of the things that’s really striking about this is that MF Global’s cap — excuse me — leverage ratio was 40-to-1. That meant they had $40 of debt for every dollar of equity. Those numbers compare — I mean, those are crazy numbers. Those are numbers of — Lehman Brothers was 35-1. Bear Stearns was 30-1.

Those are numbers that absolutely reflect the mind-set of 2007, 2006, 2008, not the mind-set of 2011. And you really do have to wonder what was Corzine thinking to create that much debt, that much leverage in an environment that is pretty risk-averse now?

RAY SUAREZ: But before everything started to unravel in the last decade, there were people on Wall Street making very big fortunes with bets just like that one, weren’t there?

JOE NOCERA: Well, sure they were. There were also fortunes that were being lost the same way. Think about Long-Term Capital Management a decade ago.

So, yes, I mean, the whole point of the exercise is the more risk you take, the more reward you can gain. But by — the opposite is, if the risk turns out to be wrong, you can lose everything. And that appears to be what happened in this case.

RAY SUAREZ: Joe Nocera of The New York Times — thanks for joining us, Joe.

JOE NOCERA: Thanks for having me, Ray.