End the Lie

Collapse of MF Global proves we need a hard limit on leverage

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By End the Lie

Jon Corzine of MF Global (Credit: Mario Tama/GETTY IMAGES)

On Monday the New York-based financial firm MF Global run by former governor of New Jersey and Goldman Sachs executive Jon S. Corzine filed for bankruptcy.

This collapse is not just a symptom of the economic crisis or the eurozone’s sovereign debt collapse, indeed this is a sign of a much larger problem that has plagued the world’s financial system.

It is arguable that the problem exemplified by the MF Global meltdown is indeed a causal factor in the rest of the global economic crisis although concretely identifying the direction of the causal arrow is more difficult.

A quite astounding and disturbing revelation has come to the fore today: Corzine’s bets were leveraged at a mind blowing 40 to 1 ratio.

As co-founder and co-editor of The American Prospect magazine and distinguished journalist Robert Kuttner points out, “This is like playing poker and borrowing 97 percent of your stake. If you guess wrong on a big bet (as Corzine did), you are wiped out (as he was).”

However, unlike the “too big to fail” gambling houses that received trillions in funds from the corrupt private Federal Reserve System which was thus passed on to the taxpayer as a liability, Corzine’s operation actually felt the economic justice of how capitalism is supposed to work.

If the taxpayer wasn’t being put on the line for these gambling operations, then I would have no problem allowing them to leverage their bets to astronomical proportions, but that is far from the case.

MF Global seems to be an exception to the precedent set by the Federal Reserve and the financial industry in which every possible move is made in order to remove all liability from the actual investors in favor of passing it on to the average American taxpayer.

This can be seen in the criminal collusion between Bank of America and the Federal Reserve where the Fed (despite the rules preventing such) are allowing absurd amounts of derivative exposure to be transferred to the FDIC-insured branch from Merrill Lynch.

This will effectively remove any and all financial risk from the highly unstable financial assets and instead put that on the taxpayer.

To use the gambling analogy, this is like if you went to a poker game playing with someone else’s money. If you lose, they lose all of their money and if you win, you get to keep all of their money.

It makes just about as much sense in the real world as it does in the gambling analogy. That is, none at all.

As Kuttner points out, it is good news that Corzine’s operation MF Global paled in comparison to the largest financial institutions out there with a relatively paltry $8 billion.

If MF Global was the size of say, Goldman Sachs or the other Wall Street powerhouses, it could have indeed massively impacted the entire financial system which could then be used by the bought-and-paid-for politicians in Washington as justification for yet another bailout.

MF Global is a microcosmic example of what could happen in the larger financial institutions if a regulatory overhaul isn’t mandated, and fast.

Leveraging bets 40 to 1 is simply absurd and when it is a highly risky asset, that number gets even more ridiculous.

To make matters worse for Corzine and MF Global’s legacy, it recently emerged that federal regulators are investigating MF Global due to hundreds of millions in customer funds disappearing into thin air.

Originally $950 million was thought to be lost but as MF Global processed its bankruptcy the number dropped to less than $700 million as of late Monday, according to individuals briefed on the issue cited by The New York Times’ Deal Book.

As of now, it is unclear where the money went or where it is now, meaning it could either be something as innocuous as “sloppy internal controls” or “something more intentional and troubling.”

Kuttner writes,

“As a regulatory matter, it would not be difficult to limit all kinds of leverage for any financial institution to, say, 10 to 1. And the more risky the kind of institution and its strategy, the more leverage should be limited.
“You could require all financial institutions to make real-time filings to the SEC of how much money they are borrowing compared to their own capital, and any one that goes over the ratio of ten to one is shut down.”

It seems all too simple when Kuttner lays it out like this but apparently the regulators would rather opt for ludicrously opaque and purposefully complicated regulatory instruments like the woefully inadequate Dodd-Frank Wall Street Reform and Consumer Protection Act.

Instead of this type of needlessly complex regulation, I agree with Kuttner in putting forth much more simple rules like significantly limiting leveraging, forbidding any and all forms of investment banking among commercial banks, and banning credit-default swaps which are “inherently subject to abuse”.

It remains to be seen what exactly was going on at MF Global but we must keep in mind that there are indeed steps we can take from preventing incidents like this in the future that would likely be much larger in scale and thus be passed on to the taxpayer and the world economy as a whole.

One Response to Collapse of MF Global proves we need a hard limit on leverage

  1. Anon November 2, 2011 at 6:06 PM

    Wall street is like Vegas except you can bet money you don’t even have. It’s criminal is what it is.


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