MF Global - Beginning of the End?

On Halloween weekend, there was a primary dealer that went bankrupt.  It's been in the news for a while, maybe you've heard of it, maybe not.  It's MF Global, a commodity futures brokerage firm, kind of like TD Ameritrade/Scottrade/Fidelity, only for commodity futures, options and derivatives.
http://en.wikipedia.org/wiki/MF_Global

One thing I've learned from this bankruptcy is that it shows our system of everything is braking, and it may be beyond repair, but we'll see.

But let's back track a little to 2008 during the financial crisis.  Back then, if a company went bankrupt, (i.e. Bear Sterns, Lehman Brothers) the parts of the company would be sold off if possible to other competitiors, customer's money/assets were made whole and transferred to the new company, the remaining assets were divided up to the next stakeholders in line.  These companies going bankrupt damaged the financial system as I've mentioned before leading to the government (tax-payers) bailing out AIG, and a whole bunch of banks from the counter party risk they had with each other.  Most of these banks were foreign banks in Europe if you recall.  So private companies went bankrupt because they were stupid and were betting on highly leveraged collateralized debt obligations (CDO) and mortgage backed securities (MBS) based on sub-prime mortgages (rated AAA for some reason).  The private companies after getting bought out by Barclays and JP Morgan, then had to sell their unsaleable products (CDO and MBS) to the government in the form of the Federal Reserve purchasing these toxic assets (CDO and MBS) and bailing out companies.

How did the government fund this?  Through the sale of it's own bonds to raise the money needed.  They just called it "providing liquidity to the system" or some garbage like that.  (This raised the debt ceiling, and our national debt.)

So that was the first financial crisis where by private sector companies went bankrupt and the burden fell onto the government to fix the problem.  There's a lot of issues involved with the whole financial crisis in 2008, but I'll stop there.

That was then...this is now.

Think of MF Global as a smaller version of what happened in 2008 because, they were smaller, and they didn't have their hands in everything like Bear Sterns and Lehman Brothers.  They weren't investment bankers and securities brokers to that level, but they were similar in their own industry of commodity futures and options.

Now MF Global went bankrupt because they were doing similar things as Bear Sterns and Lehman Brothers by highly leveraging investments in sovereign debt of European countries, instead of CDO's and MBS's.  The thing to take away is that MF Global leveraged (40-1) the amount of their actual assets to purchase the debt of European countries.  This is similar to how a bank can leverage 9-1 (or more) the money you put into the bank to loan to other people, businesses, etc. (This is why bank runs are bad, they only have a small % of the actual assets in the bank, the rest are tied up in other things.  Again, think It's a Wonderful Life).  MF Global did this by borrowing money (very cheap right now w/ historically low rates) and then using that money to purchase government bonds.  Thereby borrowing money at a lower interest rate than the bonds were paying back in interest to create basically free money.  The loans were collateralized by the bonds.  So the only thing that needed to happen, was MF Global needed to maintain their minimum margin (down payment % in a way) to carry the loans.  They couldn't.

That's how the MF Global bankruptcy got started.  But it's after it was started that things started to go really badly...potentially for everyone.

One of the first things that came out was that MF Global had missing customer money.  First it was $633 million that was found to be missing by Interactive Brokers who tried to acquire the company on October 30, 2011 and made the deal fall through.  But now it could be $1.2 billion or more.  This money has still not been "found."

Here's a great link to the MF Global bankruptcy.
http://www.btrtrading.com/Legal/MF%20Global%20White%20Paper%20Revised%20-%2012-1-11.pdf

Well, there's been a lot of talk about this "missing money" and where it went, etc.  The consensus I've seen is that it was rehypothecated. http://en.wikipedia.org/wiki/Hypothecation  Basically, since MF Global didn't have the collateral to maintain the margins on the loans, they pledged their customer's money from the segregated accounts.  This is obviously not a good situation as if you had an account with MF Global to trade in commodities, that was your money you were trading, so you have a claim to that.  Well MF Global used that money as collateral, so JP Morgan (who loaned them the money) also had claim to a portion of the customer's money ($633 million - $1.2 billion+) when they filed bankruptcy.

This is where things start to show why our system is breaking, if not already broken.

When MF Global filed for bankruptcy Chapter 7, they were not listed under Sub Chapter IV (Commodity Broker Liquidation).  They were listed under Sub Chapter III (Stockbroker Liquidation).  When that happened, that basically put the customers way down the list of stakeholders, and put JP Morgan to the top of the list.  Why this was done, I could only guess.  The fact is, MF Global was a Commodity Broker with $5.4 billion in assets on over 50,000 accounts for commodities, vs. $100 million and 400 or so contracts for securities.  http://uscode.house.gov/download/pls/11C7.txt

But the point is, that decision has just changed our legal system, and puts into question it's viability.  This also should put questions about our financial system's viability if JP Morgan had to steal (with the help of the legal system and bankruptcy courts) $600 million to potentially over $1.2 billion of customer's money.  If they didn't do that, would JP Morgan have gone bankrupt due to leverage on their own books?  Would that have collapsed the whole financial system in a worse way than 2008?  I don't know for sure, but it's definitely unprecedented actions that have taken place during this bankruptcy.  So I would have to imagine there would have been unprecedented re-actions if things did not happen this way.

So what does all of this mean?

Some would say that nobody's money is safe...any where.  After all, it was because of this bankruptcy that Ann Barnhardt closed her commodity futures brokerage company.  She said she could no longer guarantee her customer's funds.  Maybe she's a little nutty, but she had her own company in this industry, and that's more than anyone I know has.  http://www.zerohedge.com/news/entire-system-has-been-utterly-destroyed-mf-global-collapse-presenting-first-mf-global-casualty

But what's the difference between some commodity brokerage's company with their accounts and say TD Ameritrade and a stock trading account, Fidelity and a 401k/IRA, Charles Schwab investments, Insurance annuities, or your bank account even?  Well, that's up to you to decide.  It could be that everything is different and if something happened to the company the accounts would be made whole.  Or maybe nothing is different and your money could be stolen as well at any time, and replaced with 65% of what you originally had.

The one thing I can guarantee, the problems that caused this situation are similar.  Companies, governments, banks, individuals all leveraging their assets (your home is a leveraged asset when you made your down payment of 3-20%, and you leveraged the other amount in a loan to actually purchase the house).  These are being collateralized as well, mostly by the assets backing the leveraged loans.  But more importantly, banks are also collateralizing leverage of assets with customer money (just like MF Global did)...see Bank of America.  They are currently leveraging and collateralizing the $53 Trillion of derivatives with $1 Trillion of customer bank accounts.  Luckily, those are FDIC insured, up to $250k.  But the actions are the same, and the result could potentially be the same, so be forewarned.


http://www.bloomberg.com/news/2011-10-18/bofa-said-to-split-regulators-over-moving-merrill-derivatives-to-bank-unit.html
http://www.zerohedge.com/news/bank-america-forces-depositors-backstop-its-53-trillion-derivative-book-prevent-few-clients-dep


So, is this the beginning of the end?  Who knows?  Maybe the next financial crisis like 2008 started with MF Global on Halloween.  Maybe instead of the governments bailing out the banks and putting it on your shoulders, they'll just take your money directly instead.  One way or the other, your money is being taken from you.  Whether it's through direct stealing like with MF Global, or Government inflation...all of the debt has to be paid, one way or another.  And it doesn't help when the national debt just keeps getting larger.  It's already clear that companies will steal your money.  And at some point, inflation won't be an option for governments to increase and pay their debts.  So the question is, then what?


A couple other good articles to read from which I have gained knowledge about this bankruptcy and have included in the above...
http://gonzalolira.blogspot.com/2011/12/run-on-global-banking-systemhow-close.html

http://www.washingtonpost.com/the-systemic-risk-revealed-by-mf-globals-collapse/2011/12/14/gIQAtrTI1O_story.html