Conditions Apply

Christopher Elias at Thomson Reuters describes how MF Global used its client’s money to make their own bets. They took assets which were restricted in one jurisdiction and by legal hocus-pocus transferred it to London — another jurisdiction where no such encumbrances applied. Thus at a stroke the monies were theirs to handle.

MF Global’s bankruptcy revelations concerning missing client money suggest that funds were not inadvertently misplaced or gobbled up in MF’s dying hours, but were instead appropriated as part of a mass Wall St manipulation of brokerage rules that allowed for the wholesale acquisition and sale of client funds through re-hypothecation. A loophole appears to have allowed MF Global, and many others, to use its own clients’ funds to finance an enormous $6.2 billion Eurozone repo bet.

There was no act of desperation. It was how business was done. It was how perhaps $1.2 billion was lost.

Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. … But in the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated. In fact, brokers are free to re-hypothecate all and even more than the assets deposited by clients. Instead it is up to clients to negotiate a limit or prohibition on re-hypothecation. On the above example a UK broker could, and frequently would, re-hypothecate 100% of the pledged securities ($500).

Things were fast and loose in Old Blighty, but that is how London operates; and doubtless had MF Global’s clients wanted to play in such a heady atmosphere they could have taken positions in London themselves. But having put their money in New York they probably expected it would be handled by New York rules, which only goes to such that you can never take anything for granted unless you read all the fine print, check the telephone line for bugs, inspect the space behind the curtain for lurking assassins and look under the carpet for venomous spiders.

The problem was simply this: there’s the corner bank and there’s Las Vegas, and each is upstanding it’s own sphere. What might be horribly wrong is if your local banker takes your savings and goes to Las Vegas. You might not expect that. How did MF Global pull of this stunt? Well they put the pea under a shell and away it went.

Keen to get in on the action, U.S. prime brokers have been making judicious use of European subsidiaries. Because re-hypothecation is so profitable for prime brokers, many prime brokerage agreements provide for a U.S. client’s assets to be transferred to the prime broker’s UK subsidiary to circumvent U.S. rehypothecation rules. …

In fact this is exactly what Lehman Brothers did through Lehman Brothers International (Europe) (LBIE), an English subsidiary to which most U.S. hedge fund assets were transferred. Once transferred to the UK based company, assets were re-hypothecated many times over, meaning that when the debt carousel stopped, and Lehman Brothers collapsed, many U.S. funds found that their assets had simply vanished.

Vanished. As in “Gone With the Wind” and “Now You See It, Now You Don’t”.

But don’t expect Jon Corzine, a former CEO of Goldman Sachs, Democratic Governor of New Jersey and a former US Senator to share the secrets of this impressive act of legerdemain. Lawyers awaiting his appearance at a Congressional investigation into MF Global believe Corzine will remain silent as the tomb — take the Fifth in fact — before he educates the public for free.

Attorneys who specialize in congressional investigations said they expect Corzine’s silence will continue.

“Given the pending criminal inquiries, I’d advise him to take the Fifth,” said Mark Paoletta, former chief counsel for the House Energy and Commerce Committee who is now a partner at the Dickstein Shapiro law firm in Washington. “There’s too much potential downside to testifying.” …

Lawmakers, federal regulators and the Justice Department are all investigating MF Global’s demise and trying to find as much as $1.2 billion in customer funds that have gone missing.

You wouldn’t expect to lose money with the former Governor. Corzine knew all the best people. Men of unimpeachable characater. MF Global was represented in public by the topnotch public relations firm Teneo, which counted in its ranks Bill Clinton and Tony Blair. “Teneo served as a personal p.r. firm and political consultant for then-MF Global CEO Corzine, the former governor and senator from New Jersey. It also offered advice on European financial investments — like the ones that ultimately led to MF’s collapse in October.”

But that should only prove Corzine’s good intentions, because if Bill Clinton couldn’t see the Euro collapse coming, then who could? Mischance may happen to anyone. But was it mischance? David Beatty, battlecruiser commander at Jutland, suspected something out of the ordinary when he watched his battlecruisers blow up, one after the other, like giant firecrackers. “Chatfield,” he said, “there seems to be something wrong with our bloody ships today.”

Might there be something wrong with the financial system today?

Apart from the specific damage caused by the MF Global collapse, the debacle must raise some doubts in the minds of investors as to the probity and integrity of some parts of the financial industry. The “loophole appears to have allowed MF Global, and many others, to use its own clients’ funds to finance an enormous $6.2 billion Eurozone repo bet” is worrisome in toto, but one phrase, the “many others” is more worrying than the whole. With financial skeletons rising from the graveyards in every direction the hapless investor must feel a little like Bruce Campbell, who in a horror movie, tries to escape the clutches of malevolent forces without much success. There are just too many of them.

But thankfully, those things happen only in the movies. In real life things are so much better.