It looks like Eric Holder's dogs at the Department of Justice are doing the CME Group a favor by investigating their largest derivatives swaps competitor, LCH.Clearnet, under Federal antitrust provisions. But are they also going after the large banks, and JP Morgan in particular, in roundabout fashion? And just where does the omnipresent MF global connection fit in? From Reuters today:
LCH.Clearnet, the largest clearinghouse in the $400 trillion interest rate derivatives market and also a credit derivatives clearing service, is owned by its members including banks such as JPMorgan Chase, Goldman Sachs and Deutsche Bank. A spokeswoman for the firm declined to comment.
The Justice Department is concerned that a small group of the world's largest banks can use their ownership and influence over key market infrastructure including clearinghouses, trading platforms and data services to impede competition.
Justice Department spokeswoman Alisa Finelli declined to comment on specific details of the probe, or the firms involved. But she did outline three areas the DOJ is focused on.
"The Antitrust Division is investigating the possibility of anticompetitive practices in the credit derivatives clearing, trading and information services industries," she said.
The Role of LCH.Clearnet
As followers of the MF Global saga may recall, it was LCH (among others) who delivered crushing margin calls on MF Global during its final week, $211 million of which in cash and securities was ponied up to LCH alone. However, it was the final $310 million call that sent its UK affiliate into Special Administration (similar to US bankruptcy), since it was also on the hook for collateral calls on these trades. From Trustee Giddens' June 6, 2012 report:
On many occasions, we've thrown out the fact that LCH is owned and operated by the large banks, including JP Morgan, but the DOJ investigation is one of the few media generating stories that highlights this fact. The LCH bank syndicate also participates in revenue streams from its multi-trillion dollar SwapClear platform, as we noted here. Finally, based on court transcripts, JP Morgan seems to have exerted influence over the bankruptcy structure and content of the first day motions.
Lies Before the Bankruptcy Court
As Daniel Collins writes for Futures Mag (disclosure: quoting our own work):
[T]he original sin in the MF Global debacle is how the firm was allowed to be split — the futures commission merchant/broker dealer (FCM/BD) MF Global Inc. (MFGI) into a SIPC liquidation and the parent MF Global Holdings Ltd. (MFGH) into a Chapter 11 proceeding — with a shortfall in customer segregated accounts.
It has been pointed out that this was aided by an attorney for MFGH telling a whopper to Bankruptcy Judge Martin Glenn at the initial hearing on Nov. 1. Attorney Kenneth Ziman of Skadden Arps when asked about press reports of a shortfall told the judge, “I think, to the best knowledge of management, there are no shortfalls, Your Honor. All funds are accounted for, and I’m talking about the broker-dealer. That’s to the best knowledge. All funds can be accounted for.”
No one seemed to jump in to correct the record even though attorneys for the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) attended that hearing and Laurie Ferber, General Counsel for MF Global, acknowledged the day before that indeed there was a shortfall in customer funds.
The Judge asked about this specifically so there is a chance he may have acted differently if he was given an honest answer.
Several interested parties have stated that the appropriate action — one perhaps more likely to have occurred had the facts of the situation been clearly presented — was for a judge to place the entire entity in receivership. A receiver would have more power to pursue leads and claw back money and perhaps more importantly, a company that operated as one entity would not have been able to divorce itself from its responsibility of having to segregate customer funds and the priority of those customers’ property over general creditors would have been maintained. That is what happened in this case with MFGH and its main creditor JP Morgan attempted to jump in front of customers.
Just Who Was the Ultimate Counterparty to the Corzine Trade?
While the broker unit Trustee and prior press reports have cast LCH's role in the repo-to-maturity trades as that of simple clearing agent, a February 2012 London court filing by MF Global UK's Special Administrator, KPMG, gives a tantalizing clue that it might just have been LCH affiliates themselves who were the ultimate counterparties (thus, the trades would have been prop, not flow, as has been assumed [1]). From the filing:
The Repo to Maturity claim (“RTM Claim”)
81 From September 2010 onwards, the Company entered into a number of RTM transactions with MFG Inc involving European sovereign bonds. Under the RTMs, MFG Inc would repo the bonds to the Company [MF Global UK] and the Company would enter into a corresponding repo of the same bonds with a market counterparty of which the most significant were London Clearing House entities. MFG Inc has since submitted a creditor claim for $519,044,608 (£321,569,053) against the Company in connection with the RTM transactions.
It would appear that "entities" denotes affiliation because, had KPMG meant the various hedge funds and banks that conduct clearing business through LCH, it would be more appropriate to call them "members" or "customers."
Soros Profits, Customers Lose
Further, it's instructive to recall that LCH, with permission from KPMG, liquidated the $14.7 billion gross portfolio at reportedly below market prices to George Soros and others. From the Giddens' report:
After the SIPA proceeding commenced, information came to light that LCH had liquidated the positions in European sovereign debt that MFGUK maintained from MFGI. In a November 29, 2011 press release, LCH reported selling “MF Global’s fixed income positions, which had a combined nominal value of [Euro] 14.7 billion . . . with no recourse to the default fund.” According to some press reports, LCH sold the RTM positions at a discount from current market value to George Soros and others. Because these transactions took place at the LCH, the Trustee has not had full transparency into the these transactions or the amounts that might be owing to MFGI. The Trustee continues to pursue a full accounting from the MFGUK Joint Special Administrators on this and other issues.
Yet we know from KPMG reports that the margin that the US broker entity paid, and which ended up at LCH, was used to cover the loss on the firesale of the portfolio, per UK laws that are similar to US bankruptcy laws.
Now that the Department of Justice is involved, we would urge them to consider if LCH.Clearnet, acting under the sizable influence of JP Morgan, was simply a front for a scheme to defraud MF Global customers of their money in the final (and, lest we forget, "chaotic") days of the firm.
* * *
[1] We received a note shortly after original publication by Francine McKenna of ReTheAuditors, who said she had contacted several sources who advised that LCH.Clearnet does not engage in proprietary trading. If that is indeed the case, then KPMG flubbed the disclosure and the ultimate RTM counterparties remain at large. LCH.Clearnet did not respond to McKenna's inquiry regarding ultimate counterparties.
A land grab shrouded in a banking takeover, wrapped in a financial crisis "rescue." As always, insiders get first dibs. (And, yes, there is an MF Global connection.)
Only days ago, we learned from the Financial Times that the 19 largest US banks are $50 billion short of meeting new capital requirements under Basel III accords, with their smaller lending cohorts needing an additional $10 billion. Amazingly (or not), omniscient Fed officials have divined "that most banks should be able to reach the new levels by retaining earnings during the next few years rather than by raising capital in the market" (emphasis ours).
Presumably, this earnings retention would not include most of the aforementioned smaller community banks because Paulson's TARP has trapped them in a Zombiefied state of smothering debt and capital starvation (not unlike what the World Bank and IMF did to its pirated victems circa 1990-2008), aided and abetted by Fed-induced yield starvation .
Who wins? No less than the Federal Reserve itself, because Treasury has recently been auctioning off its preferred stock in the smaller banks at firesale prices, which guarantees the state regulated banks will be folded into the Fed securitization and rehypothecation cartel. Of course, well-connected former bank regulators, such as a former Comptroller of the Currency, will (and already are) profiting handsomely from these transactions, which we detail below, as well as recently in the second segment on Capital Account with Lauren Lyster:
Who loses? While we're far from an endorsement of the Federal and State banking system in principle, the smaller community banks were the last vestige of the pre-securitization/unlimited moral hazard age, when lending meant "skin in the game" (as opposed to feeding mortgages through the GSE/JPM/Goldman slice-o-matic) and when depositors were seen as an asset (and not only as a balance sheet liability).
While it might be argued that many of these smaller banks would have otherwise been resolved by the FDIC in the 2008 maelstrom, ex-Goldmanite Treasury Secretary Hank Paulson put these mom and pop banks into a shotgun government cartel IPO--preserved in TARP salt, only to have the meat picked off their carcasses years later.
"TARP Provided Lifeline to Community Banks"
So reads a subheading in the most recent SIGTARP report. Yet, what follows is a recitation of what happened when the banks grabbed the money (at the other end of Paulson's bazooka)--they discovered it was tied to an anchor thrown overboard.
"707 [banks] were accepted into CPP [Capital Purchase Program]; 351 small-and medium-sized banks remain, along with 83 financial institutions in CDCI [Community Development Capital Initiative], for a total of 434. Treasury describes CPP as a program to provide emergency support to “viable” banks.623 There are signs that some CPP banks face difficulty in exiting TARP. Despite the dramatic efforts to expedite the exit of the largest banks from TARP, there appears to be no corresponding plan for community banks’ exit from TARP. The only exit strategy for smaller banks that has been announced has been SBLF, through which 137 banks exited TARP. A SIGTARP analysis of the 351 banks that remained in CPP on March 31, 2012, shows one-third had missed five or more dividend payments, and 32% faced formal enforcement actions by their regulators."
Hence the smothering spiral of debt and capital starvation.
Why smaller banks, shut out of the NYC securitization, re-hypothecation Collective, can't compete:
"Community banks’ lending to small businesses has decreased recently while large banks increased loans to small businesses. Small banks — those with assets under $1 billion — have steadily lost market share in small-business lending since 1995, according to an analysis of loan data by information provider SNL Financial LC (“SNL”).613 That group of banks now owns just 34% of commercial and industrial loans of less than $1 million that were secured by collateral other than real estate, down sharply from 51% in 1995, according to SNL. During that same period, bigger banks with more than $10 billion in assets doubled their market share of such loans, SNL reported."
"Once a loan is made to a small business or consumer, a community bank typically holds onto it rather than securitizing or selling it,” Timothy Koch, a professor of banking and finance at the University of South Carolina, said at that conference. 612 “Unlike big banks, community banks generate most of their earnings from net interest income on loans, and rely on core deposits by customers in the same community to fund lending,” he said."
"Community banks need capital to pay off CPP investments, and raising that capital has been a significant challenge along with weakened loan portfolios and slow economic growth."
With long term yields below inflation, government securities are already carry negative for banks who can't wash them at the Fed. Hence, Chairman Bernanke is aiding and abetting the executive branch in the destruction of community banks.
On how the TARP death ray "vaporized" an entire set of market choices whose purpose was to provide an alternative to the government agency known as the Federal Reserve:
"Industry experts say the amount of new capital needed by community banks nationwide is substantial. According to analysts with investment firms Raymond James and Barack Ferrazzano Financial Institutions Group, and consulting firm McGladrey & Pullen, LLP, it will take $23 billion in fresh capital for community banks to repay TARP or SBLF funds; to absorb credit losses and boost loan loss reserves; and to meet higher regulatory capital ratios.614 A higher estimate of $90 billion in community bank capital needs came from StoneCastle Partners, an asset management and investment banking firm. It included $43 billion for healthy institutions to acquire weak and failing banks; $28 billion for banks to clean up their balance sheets; $12 billion to boost loan loss reserves; and $7 billion for internal growth.615"
Why smaller banks cannot access the capital markets:
"Banks with assets under $1.5 billion do not have access to capital from private equity firms, mutual funds, foundations, and other institutional investors, according to some who follow the industry. “Capital offerings for less than $20 million to $30 million are often too small for many institutional investors regardless of structure or investment thesis. Institutional investors have fixed costs to cover and deal size minimums. They simply cannot monitor an unlimited number of small investments, no matter how promising,” the Conference of State Bank Supervisors said in a recent white paper.618 Institutional investors also want a bank to have a business plan that allows the investors to eventually realize gains through a stock offering or by selling the bank to a larger institution."
10% of smaller banks in the US are at risk.
FDIC won't be bailing them out.
They will be assimilated:
"Some industry experts predict a wave of mergers and consolidation among community banks over the next three to five years. “Size matters, and a rule of thumb used by many industry experts is that most banks eventually will need to be $1 billion in assets or greater in order to achieve the scale necessary to operate as an independent entity,” according to a white paper published this year by FJ Capital Management, LLC. “The typical merger can save 20% to 40% in operating costs, thereby creating significant earnings accretion for the combined entity.”620 FJ Capital estimated 413 banks are potential merger candidates because they were trading below tangible book value, and had substandard capital levels and/or elevated asset quality issues.62"
A typical single case: Bank of Hamptoms Road (Norfolk, VA)
According to the American University School of Communication, this bank's Troubled Asset ratio has hovered near 100% since the crisis onset and shows no hope of ever going black. It has $115 million of capital and $72 million in reserves against $185 million of non-performing "assets." Note the $60 million of "other real estate." The best thing that can be said about it is that it has stemmed the bleeding from $(215) million to $(95) million in the last year. It's still losing deposits, capital, reserves, and assets at double-digit percentage rates year-over-year.
As late as July 2009, common shares traded above $200 (1:25 split adjusted). The last trade June 8, 2012 was $1.21 (1:25 split adjusted).
The TARP "rescue" drove the shares down 80% over the first 6 months. Then Treasury converted its $84 million in TARP preferreds into common for a 74% notional loss, the board diluted in September 2010, missed the TARP dividend, diluted again in June of 2011, and has been selling off branches throughout.
The bank's recent 10-Q produced these gems. First, the asset attrition spiral continues:
"The Company reported a net loss of $7.9 million for the quarter, compared to losses of $21.4 million for the fourth quarter of 2011 and $31.6 million for the first quarter of 2011. First quarter 2012 results benefited fromlower provision for loan losses [ew: at exactly the moment when non-performing loans are skyrocketing] due to continued improvements in credit quality and reduced operating expenses due to continued progress from the Company's expense reduction initiatives."
Then, yield starvation:
"Net interest income for the first quarter of 2012 was $16.7 million, down from the $17.5 million in the fourth quarter of 2011 and $18.2 million in the first quarter of 2011."
Third, because old habits die hard, unwarranted risk taking:
"Noninterest income was $3.1 million during the first quarter of 2012 compared to ($1.1) million during the fourth quarter of 2011 and $2.1 million in the first quarter of 2011. Noninterest income benefitted fromstrong origination volumes in the Company's mortgage unit which saw revenues increase to $3.3 million from $2.4 million and $1.3 million in the prior year fourth and first quarters, respectively. "
No doubt, someone will spin that as a "housing recovery." The increase in compensation costs related to bonuses to mortgage origination officers is relegated to a footnote.
A week ago, the bank holding company of Hampton Roads sold two of its failing branches to Bank of North Carolina (NASDAQ:BNCN), whose statement on the deal specifically mentioned the all-important $1 billion threshold, "Our goal of having a billion dollar presence in the Triangle will accelerate with this acquisition, and we are excited about offering our diverse product and service opportunities in both of these communities." BNCN itself has a TARP ratio of ~50% and rising.
As usual, it's the insiders who take over
The only money-good asset this dog [with fleas] (NASDAQ:HMPR) really holds is that "other real estate" line item, which is perhaps why the bank holding company is the target of a NY liquidation firm:
CapGen Capital Group VI LP and CapGen Capital Group VI LLC, both of New York, New Yorkto increase their investment up to 49.9 percent of the voting shares of Hampton Roads Bankshares, Inc., Norfolk, Virginia, and thereby indirectly increase their investment in Bank of Hampton Roads, Norfolk, Virginia, and Shore Bank, Onley, Virginia.
This, and all the other TARP takeovers may be found in the Federal Reserve's H.2A report, "Notice of Formation and Mergers of, and Acquisitions by, Bank Holding Companies or Savings and Loan Holding Companies; Change in Bank Control."
Enter Eugene (Gene) Ludwig and the MF Global Connection
CapGen's leader, Mr. Ludwig, is a former primary dealer officer (Deutsche Bank) and Comptroller of the Currency, and whose business is "turnaround specialists." He is also the founder and current CEO of Promontory Financial Group, which has been granted special review and recommendation privileges by various Federal regulators to Bank of America, USBancorp, Wells Fargo. Promontory is also a registered lobbyist for several prominent financial firms, including General Motors Acceptance Corporation (GMAC).
Last, but not least, Promontory was engaged by MF Global after a $110 million rogue trader debacle to provide, in part, "a comprehensive review of MF Global’s risk management and internal controls," according to Trustee Giddens' report of June 4, 2012. The report explains:
"On May 26, 2010, Promontory reported to Holdings’ Audit Committee that MF Global had successfully and effectively implemented most of the Promontory recommendations and the CFTC undertakings and established an enhanced enterprise-wide risk management and compliance program and internal controls framework."
Of course, it would be internal controls that would be the demise of the firm, upon which former Crazy Eddie accountant, Sam Antar, recently commented, "All white collar criminals blame poor internal controls. I tried that trick at Crazy Eddie. The Feds were smarter back then."
While Promontory gave public cover for MF Global, Giddens' report reveals a few pages later that alarm bells were being simultaneously rung internally:
"Similar concerns surfaced in internal audit reviews. A Corporate Governance internal audit issued in May 2010 identified MF Global’s risk policies as not congruent with the changes to its broker-dealer business. Among the specific gaps identified by Internal Audit was liquidity risk reporting. Similarly, an Internal Audit report on Market and Credit Risk Management in October 2010 identified “High Risk” areas arising from the lack of controls over risk reporting. The report also reiterated that market risk policies had not been updated to reflect the current operating environment. The report attributed the failures to remediate gaps to staffing and budget constraints."
A land grab shrouded in a banking takeover, wrapped in a financial crisis "rescue."
The TARP zombie/takeover story is playing out with small variations throughout all the ~300 or so small banks which were trapped in TARP-assisted asset spirals. As stated above, many would have failed outright, further burdening the FDIC fund, perhaps to the point of exhaust, which may be the excuse of record. However, TARP gave Treasury a co-opt entry point to control the flow of equity on this sizeable section of community banking options.
The Fed's merger notices are peppered with former officials using their insider positions and PE headhunters to profit from the "rescue." Whether the net result of killing off a whole tranche of Fed-free banking options was intentional, the combination of forced TARP and negative real interest rates will lead to fewer options and more Fed-centralized control of banking, as the process of slicing, dicing, and consolidating works its way up the food chain, aided and abetted by friends of Treasury.
In future reports, we will detail other small bank merger and acquisition transactions by bank regulatory insiders, as well as develop the role of Promontory in the stress test/internal-policy-failure face-save kabuki that dominates the upper echelons of the extreme moral hazard tranche of the financial sector.
Special thanks to elliswyatt for serving as primary research contributor and TARP wordsmith.
One wonders how the bankruptcy might have progressed differently in those early days had "the best knowledge of management" been truthfully represented. The legal phrase, "known, or should have known," comes to mind.
Ahead of tomorrow's closely watched FOMC Announcement, we would like to pay tribute to a soon-to-be departing VP of the New York Fed--one who was not only an architect of Ben Bernanke's quantitative easing programs, but who ended up its chief implementer over the last three years. When he came back to the New York Fed on June 2, 2009, after taking a break in the private sector, the prior Fed analyst would be charged with the eventual winding down of the largest expansion of the Fed's balance sheet in history (QE1 already being partly underway at the time). Another QE(2) and one Operation Twist later, we know how that worked out (hint: an extra $trillion on the left hand ledger since arrival).
Just why is he throwing in the towel now, scheduled to leave on the last transaction date of Operation Twist at the end of June, 2012? Is he conceding that, in fact, the Fed will never be able to extract itself from balance sheet hyperplasia? We cannot know for sure, but we can offer the following tribute to perhaps the second most influential person in the maddest of monetary experiments in Western central bank history.
His name was Brian Sack.
Over the years, we've written much about Mr. Sack, one of the myriad M.I.T. graduates that run the global central banking cartel. For in 2004, he, along with future Fed Chairman Ben Bernanke and then-Fed economist Vincent Reinhart, wrote the watershed white paper that would become the guide for the Fed's massive monetary experiments--the putative "solution" to what would become the financial crisis of 2008: "Monetary Policy Alternatives at the Zero Bound."
Described by his undergrad alum paper at the University of Vermont (UV), "[Sack] was a math whiz who just happened to take enough economics classes by his senior year to earn a math/economics double major." These math skills would be critical to determining just exactly how many billions in Treasury and MBS securities the Fed would have to buy each day (vis a vis Permanent Open Market Operations "POMOs") to keep the too-big-to-fail banks afloat without causing rampant price inflation for those lucky few who don't eat food or drive.
The Fall 2009 UV profile continues:
Given that Sack started his current job after much of this buying by the Fed had already taken place, his biggest task over the coming few years will be to figure out how to best manage or even sell off big chunks of this $2 trillion portfolio of Fed assets without disrupting economic growth. As the Fed never really wanted all this stuff–buying it, essentially, to kick-start the economy–selling it all off may prove more complicated.
Complicated indeed, which speaks to the potential end game for the Fed (and which we will get to in a bit). But far from overseeing a reduction in size of the Fed's balance sheet, Mr. Sack has been an advocate of its expansion vis a vis serial QEn campaigns. As we predicted in October, 2010 (see "Preparing for QE Ad Infinitum"), just ahead of the Fed's QE2 announcement, Mr. Sack would be instrumental in guiding future Fed balance sheet policy.
The Fed would conduct an unscheduled meeting before its November 3, 2010 meeting, in which it would formerly announce QE2. At discussion were the very issues Mr. Sack had brought up in a recent speech, such as whether to bring a bazooka or a machine gun to fight the markets. QE2 would be a mix of both, for the initial announcement size of $600 million was intended to be the bazooka, and the now daily purchases (as opposed to twice weekly) were to be the machine gun. Supposedly, this would result in less market disruption and prevent front running by the Fed's primary dealer purchase partners, a select and highly insider group of the largest banks and brokers (and, at one time, Jon Corzine's MF Global).
Who does the Fed work for?
Yet, as Zero Hedge detailed time and time again, the Fed, under Mr. Sack's supervision, consistently purchased the richest spline in its QE2 operations--meaning it bought the most expensive bonds on a relative basis from its favorite dealers. This amounted to a de facto subsidy to them (see here, here, here, here, here, and here).
Another egregious example occurred on one morning in Spring, 2011, shortly after the Japanese Fukishima nuclear disaster had disrupted the global markets. After an errant comment by a European energy commissioner spiked bond markets just as one of the Fed's daily POMO auctions was closing (meaning the offers by the primary dealers were already in and they were about to face massive losses because of the comments that spooked the markets), Mr. Sack terminated the auction, cancelled the dealer offers and restarted the auction thirty minutes later.
We demonstrated this amounted to a $15.7 million gift to Wall Street that morning. Perhaps not a lot by comparison to the billions in outright purchases by the Fed, but maybe it demonstrates the mentality that pervades the New York Fed's trading room. Yes, the very trading room that has no Bloomberg terminals, but does have a black box algorithm supervised by an NYU intern that spits out the non-market prices at which the largest marginal buyer of Treasury securities in the world should use to pay [subsidize] its primary dealers.
Because the MBS purchases were arranged with primary dealer counterparties directly, there was no auction mechanism to provide a measure of market supply. Instead, the pace of purchases of each class of MBS was adjusted in response to measures of whether that class appeared relatively cheap or expensive. To avoid buying at excessively high prices and to support market functioning, purchases were increased when market liquidity was good and were reduced when liquidity was poor.
This corrects the apparent falsehood on the New York Fed's MBS purchase page FAQ that says, "Outright [MBS] purchases were conducted via competitive bidding to ensure that trades were executed at market rates." Presumably, "market rates" is rounded to the nearest million, which is about the precision that the Fed reported its MBS purchase prices after its arm was twisted by the US Supreme Court in response to Bloomberg's FOIA request.
To be sure, I think it is fair to say that [Fed balance sheet manipulation] is an imperfect policy tool. Even under the estimates noted earlier, the Federal Reserve had to increase its securities holdings considerably to induce the estimated 50 basis point response of longer-term rates. In addition, there is a large degree of uncertainty surrounding the estimates of these effects, given our limited experience with this instrument. Lastly, it is reasonable to assume that the effects of balance sheet expansion would diminish at some point, especially if yields were to move to extremely low levels. Nevertheless, the tool appears to be working, and it is not clear that we have yet reached a point of diminishing effects.
This latter statement begs the question of whether the departing Mr. Sack now sees a point of diminishing effects, a year and a half later. Indeed, to our knowledge, Mr. Sack is the only Fed official to publicly acknowledge the trip wire for what we perceive as the potential end game for the Fed: namely, when (not if) it goes carry negative (though Mr. Sack sees this as a temporary state of affairs).
The risks to the [Fed] portfolio arise because the characteristics of the assets that have been purchased differ from those of the liabilities that have been created by those purchases. The assets held in the SOMA portfolio have fixed coupon rates that reflect longer-term interest rates. However, the purchases of those assets create reserves in the banking system, and the Federal Reserve pays interest on those reserves at a short-term interest rate that it controls. The interest paid on reserves can be thought of as the "funding cost" of the portfolio.
Today, because short-term interest rates are low relative to longer-term interest rates, this mismatch produces a very elevated stream of net income. In particular, the SOMA portfolio has a weighted average coupon yield of about 3.5 percent, which, if applied to a $2.6 trillion portfolio, produces about $90 billion of income at an annualized rate.14 In contrast, the annualized funding cost of the portfolio at this time is only around $4 billion. This cost is relatively low because of the near-zero level of the interest rate paid on reserves. In addition, the private sector holds nearly $1 trillion of currency, which are liabilities of the Federal Reserve that bear no interest.15 Thus, the SOMA portfolio should produce a considerable amount of net income over the near term.16
Beyond the near term, though, the income that will be produced by the SOMA portfolio is uncertain. If short-term interest rates were to rise, the funding cost of the portfolio would increase relative to the fairly steady yield earned on the assets held, reducing the amount of net income from the portfolio. In addition, if longer-term yields were to shift higher, the Federal Reserve could realize capital losses if it were to begin selling assets.
However, even if interest rates did move up abruptly and the SOMA portfolio experienced realized losses, it would have no meaningful operational consequences for the Federal Reserve's ability to implement monetary policy. These losses would not impair the FOMC's ability to control short-term interest rates by paying interest on reserves or by draining reserves as needed. Accordingly, the Federal Reserve would continue to operate in the same manner that it otherwise would have in pursuing its economic mandate.
What would be affected by unexpectedly large realized losses on the SOMA portfolio would be our remittances to the Treasury. All Federal Reserve earnings in excess of those needed to cover operating costs, pay dividends and maintain necessary capital levels are remitted to the U.S. Treasury on a weekly basis. Accordingly, any change to the income on the SOMA portfolio directly affects the amount of funds that the Federal Reserve remits to the Treasury. The unusually large amount of portfolio income realized of late has boosted those remittances considerably. If portfolio income were to decline going forward, whether toward more normal levels or toward unusually low levels, the amount of those remittances would adjust lower.17
Footnote 17:
17 In the most extreme case, the Federal Reserve would have to cease remittances to the Treasury for a time. Of course, one might also want to take into consideration the additional tax revenue to the government that could be generated by the more robust economic recovery supported by the asset purchase programs.
What Mr. Sack is saying is that when interest rates inevitably rise, the Fed could experience operational losses that would cease the payment of billions in annual remittances to the US Treasury. What Mr. Sack alludes to when he says, "These losses would not impair the FOMC's ability to control short-term interest rates by paying interest on reserves or by draining reserves as needed"--but fails to outright disclose, is that the Fed has devised a fraudulent accounting scheme that will let the banks keep the money that should rightly be repatriated to the Treasury and, hence, taxpayers.
After the Fed massively expanded its balance sheet through the creation of reserves (printing digital money), it has attempted to mitigate price inflation by encouraging banks to keep such reserves parked at the Fed. This program, accelerated by you, Congress, in October, 2008, approved the payment of interest on reserves. As long as short term rates are exceptionally low (and Mr. Bernanke said they would be through mid-[2014]), this is a minor expense. Meanwhile, the Fed is earning higher interest rates on the $2 trillion+ in securities it bought as part of its so-called QE programs. It is the spread between what it earns and what it must pay that allows the Fed to remit funds to the Treasury, and by extension the taxpayers.
When (and not if) short term interest rates rise (and the markets might force this in a violent fashion long before Mr. Bernanke would prefer), the Fed could easily go cash flow (or carry) negative. That is when the cost of paying banks interest on reserves (to reign in price inflation) exceeds the Fed's interest income it receives on the securities it holds. Consider that just under three decades ago, short term rates quickly reached nearly 20%.
In response, the Fed could outright sell assets that it holds, but I urge you to consider what happens when the world's largest holder of Treasury securities switches from being a net buyer to a net seller of Treasurys and what it would do to the United States' long term borrowing rates. Mr. Bernanke [and (by extension) Mr. Sack believe] that [they] can blissfully guide the Fed to a graceful exit from its $2 trillion+ balance sheet expansion. You might not wish to give [them] the benefit of the doubt.
This scenario is not lost on the Fed, which is why in March, 2009, its Board of Governors concocted a fraudulent accounting scheme (implemented retroactively to include the year 2008), which allows it to operate with negative income. It also prevents its member banks from having to pony up the difference, which was the case prior to the accounting change. Instead, in this scenario, the interest that the Treasury pays on securities held by the Fed will go to the banks, instead of back to the Treasury.
It's beyond the scope of this response to discuss all the details. However, in brief, the Fed allows a line item on the liability side of its balance sheet (specifically, the one that covers remittances to the US Treasury) to go negative. It creates a deferred asset from a hypothetical amount it will be remitting to the Treasury at some non-specified time in the future.
The heads of anyone with accounting knowledge ought to be spinning right now. For everyone else, it's as though you or I could log into our bank account and increase our balance in any given month in which expenses exceed income, with the promise that we will correspondingly lower our balance the next time we have a surplus.Only, there is no guarantee that you or I would ever again generate a surplus--meaning, we would have printed ourselves money not to be repaid. Similarly, there is not any reason to believe that once the Fed goes cash flow negative that it will ever again generate a surplus.
This creates the absurd scenario that the Fed could end up printing money as a tightening measure to reign in price inflation. Welcome to the grave that Mr. Bernanke [and Mr. Sack continue] to dig deeper for us. [They assure] us there will be nothing but an orderly withdrawal from this unprecedented activity. However, markets have a way of punishing central banker hubris.
A curious resignation announcement by the New York Fed.
The actual press release regarding Mr. Sack's resignation reveals a curious exit structure:
Mr. Sack will step down as head of the Markets Group and SOMA Manager on June 29, 2012. He will then be placed on leaveuntil September 14, 2012, during which he will have limited contact with the Bank and no access to Bank information, including FOMC and supervisory materials.
As mentioned at the top, June 29, 2012 is the last day of the Fed's latest balance sheet experiment, so-called Operation Twist. It would be only natural he would see it out to the end. A friend from the banking industry also pointed out to us:
If that is a year-anniversary, it may satisfy his third complete year, possibly completing the checkbox for comps to give him the summer off paid. I've never met a public employee who did not know, to two decimals, the exact countdown to some comp deadline. The FED's benefits list runs to three pages. He's a relatively young man. No one ever went broke over-estimating the self interest of publicly paid servants.
Indeed, but why then the two and a half month leave period wherein he is operationally and informationally shut out of the Fed, yet presumably still on the payroll (or at least on the official registrar)? Based on our research of the New York Fed's website, this leave period appears unusual for the end of someone's career at the Fed. On the other hand, the September 14 exit date (a Friday) is two days after a September 12 FOMC meeting.
A spokesman for the New York Fed said, "[Mr. Sack] will continue in his current role 'until June 29, 2012, to help ensure a smooth transition'. He is being placed on leave to establish a reasonable time period between his cessation of work and any potential future outside commitment."
It appears our friend, Mr. Brian Sack, likely has something else big lined up--perhaps, a job of import that might be influenced by future FOMC meetings, including the two during his leave period? Will it be the World Bank, the IMF, or something more lucrative with BlackRock or Citi? We'll have to wait to see, but in the meantime, here's to the [relatively] unsung soldier who helped design and deliver quantitative easing and all its yet-to-be-experienced [side] effects to the US [and, by extension, World].
* * *
Special thanks to Ellis Wyatt for carrying the torch.
Ahead of Tuesday's Senate Banking Committee hearing on MF Global, we present the April 20 installment of Capital Account with Lauren Lyster, featuring futures industry veteran guest, Mark Melin. Ms. Lyster pulls no punches in the opener:
Has the case really gone cold?Or, are those who are in charge of the investigation, the "regulators" and the trustees, simply spraying teflon on every piece of sticky evidence that could lead to criminal prosecutions--and, ultimately--the recovery of stolen customer money?
We wish that MF Global were just a one-off affair--a bad apple, if you will. Unfortunately, it seems more likely to us that this is another milestone in the history of what we see as criminality, which has swept through the financial services industry, like some sort of Medieval Black Plague--the Black Death for capital formation. It seems the only time people are held accountable anymore, is when they commit crimes that affect the super-rich.
Bernie Madoff is a prime example...Madoff is securely behind bars, but Jon "Teflon Don" Corzine is busy ordering carmel-Frappuchinos at the local Starbucks as he goes to shop for office space in New York...bothered only by the low din of discontent emanating from the blogosphere (and shows like this, Capital Account). What a nuiscance we must be to the new God-fellas of Wall Street...
Nuiscance, indeed, to which we hope we are part. Below is the entire episode, in which Ms. Lyster and Mr. Melin cover the following salient points, all pointing to a criminal intent to commit fraud, as well as the role of regulators and investigators aiding and abetting the criminals:
Why was the MF Global back office cleared out with three top personnel allowed to leave, just as the firm was exeriencing its most serious liquidity (ahem solvency) crisis in its soon-to-be-terminated existence?
Why were C-level executives, far from being sequestered by investigators and being placed in an information silo, allowed to run the company for six weeks (prior to Mr. Freeh being installed as Trustee of the Holdings company)?
Why did Freeh wait until early March to have MF Global Holdings USA declare bankruptcy, the very entity that retained the few remaining executives and employees and may have been cash-rich?
Why did Federal cops and investigators fail to so much as question Mr. Corzine nearly six months after the crime?
Why were large counterparties paid with wire transfers, when requests from lowly customers for wires were converted to checks (which ultimately bounced)? "Sloppy is when you don't do things consistently. Sending all checks to customers and all wires to counterparties--that's consistent." See here for details published by John Roe of the Commodity Customer Coalition.
Why were the final days characterized as so "chaotic" when a properly programmed iPhone or Android smart phone (sorry, RIMM) should have been able to handle what amounts to maybe a few dozen megabytes of transfer instructions?
Just what were the details surrounding the successful lobbying effort by top level MF Global execs that effectively postponed reforms on rules that would limit use of customer funds (coincidentally, or not perhaps, just ahead of a $325 million bond offering by MF Global)? [For more details, see our prior piece from this week, which includes exclusive CFTC emails on the issue.]
Only on Wall Street can you bankrupt a company; misplace $1.6 billion of customers’ money; lose 75 percent of shareholders’ money in two weeks; speed dial a high priced criminal attorney and get a court to authorize the payment of your multi-million dollar legal tab from the failed company’s insurance policies; have regulators waive your requirements to take licensing exams required to work in the securities and commodities industry; have your Board of Directors waive your loyalty to the firm; run a bucket shop out of the UK; and still have the word “Honorable” affixed to your name in a Congressional investigations hearing.
One of the few to question the role of JC Flowers in the MF debacle, Martens continues:
But wearing the three incompatible hats was not the only fatal flaw in Corzine’s management model: he contractually did not owe his total loyalty to MF Global. The August 11, 2011 proxy issued to shareholders and filed with the SEC carried this caveat:
“During the term of Mr. Corzine’s employment agreement with the Company, Mr. Corzine will spend substantially all of his business time and attention on Company matters, except that he may serve as an operating partner of J.C. Flowers. Pursuant to his contract with J.C. Flowers, Mr. Corzine will not receive any salary from J.C. Flowers as long as he is serving as Chief Executive Officer of the Company, but he will have a financial interest as a limited partner in certain of J.C. Flowers’s investment management entities. Mr. Corzine’s employment agreement with the Company contains a provision regarding corporate opportunities. In general, this provision provides that, if Mr. Corzine acquires knowledge from J.C. Flowers (and not the Company) of a potential transaction or other business opportunity that may be a business opportunity for the Company he will have no duty to communicate or present such opportunity to the Company…”
We would point out to MF Global customers pursuing redress against Mr. Corzine, individually, that it is not always the case that simply by disclosing something, one waives his or her responsibility under the rule of law for it.
And, how the CATO institute founders, the Koch Brothers (see this EPJ exclusive), got out of Dodge early:
Compared to Corzine’s former employer, Goldman Sachs, MF Global was a flea on an elephant’s back. It had experienced a string of quarterly losses since 2007, was predominantly a Futures Commission Merchant (FCM) holding retail and institutional commodity and futures trading accounts, and had 80 regulatory actions against it since 1997. It had a securities brokerage unit with 300 to 400 U.S. accounts according to the trustee. How big those accounts were is unknown. If they were all institutional or hedge fund accounts, it could have been a sizeable operation. One known account, which presciently moved out before the bankruptcy, belonged to the $100 billion private energy firm, Koch Industries, majority owned by Charles and David Koch, financial backers to numerous corporate front groups.
More on the role of "the other JC," who, we note, was not only instrumental in securing Mr. Corzine's hire, but that of fellow ex-Goldmanite Laurie Ferber, who was MF Global's go-to reguatory fixer:
JC Flowers was the namesake of J. Christopher Flowers, a former colleague of Corzine’s at Goldman Sachs. Flowers had acquired a stake in MF Global to help shore it up in 2008 after a trader blew up $141 million of the firm’s money overnight in what the firm called an unauthorized trade. It was Flowers who invited Corzine to become CEO of MF Global. Corzine left MF Global on November 4, four days after its bankruptcy filing, at the request of the Board.
Why Corzine, a man of great wealth and political stature, would join an obscure brokerage firm is a mystery worthy of pursuit by the FBI, which is investigating the missing customer funds according to Congressional sources. One avenue worthy of pursuit according to Wall Street veterans, is whether Jon Corzine turned MF Global into a giant parking lot for other Wall Street firms’ bad bets on sovereign debt.Fueling that speculation is the fact that JPMorgan, Citigroup and Bank of America were part of a syndicate of 22 banks that provided MF Global with an unsecured $1.2 billion revolving credit line that required no posting of collateral, despite the company’sstring of losses and weak credit rating. The firm heavily tapped this line of credit in its last days.
And on the beleaguered trustee of the MF Global Holdings estate in Chapter 11 (who, incidentally is still under investigation by the Treasury department for allegedly accepting funds from a designated Iranian terrorist group):
The trustee of the Chapter 11 proceeding for the parent holding company is Louis J. Freeh, a former FBI director. On April 19, Freeh asked the court for an expedited hearing to grant him the ability to issue subpoenas to “the Debtors’ affiliates and subsidiaries, the Debtors’ former employees, current and former officers, directors and employees of the Debtors’ affiliates and subsidiaries, lenders, investors, creditors and counterparties to transactions with the Debtors…”
The court is allowing Freeh’s own firm, Freeh Group International Solutions, to perform the accounting work. Four docket entries show that Freeh has asked for and received four extensions by the court to file a list of assets of the holding company.
We would add that Mr. Freeh and his firm(s) have exactly ZERO experience in bankruptcy prior to MF Global, and even Judge Glenn has expressed concern about the work he has been forced to outsource to a plethora of other law firms.
Then, there is the other trustee of the broker unit, Mr. James W. Giddens, who is statutorily designated under SIPA as the customers' advocate. Ahead of the Senate hearings, we would like to remind that just over one year ago, the Office of Inspector General at the SEC released a scathing report of SIPC (the private corporation created by SIPA statutes), which is supposed to oversee failing securities broker dealers for the protection of customers and that now by-gone relic, "market integrity."
Liquidations are similar to ordinary bankruptcy cases, it does not provide any limit on the amount of trustee fees in SIPA liquidations, unlike bankruptcy cases. Second, under SIPA, where payments are made out of the SIPC fund, courts have no discretion whatsoever to limit fees that SIPC has recommended for trustees or their counsel. Thus, even if a court finds the amount of fees awarded to the trustee to be excessive, it is required to approve such excessive fees if SIPC determines that the fees are reasonable. We found that in one case, a Southern District of New York bankruptcy judge deemed fees to be awarded to the trustee in a liquidation to be excessive, but found that he had no choice but to approve the fees.
According to the latest published report, the fees paid to the trustee and his counsels processing the Lehman claims for the period from September 2008 to September 2010 (24 months) totaled approximately $108 million. According to the fourth interim fee application, as of September 30, 2010, the entire administrative fees, including fees for accountants, consultants, etc., totaled approximately $420 million.
MFGFacts.com comments, "We hadn’t see anything yet. October 24th Bloomberg reported that LBH had spent “642 million on its liquidation, with most of the money going for professional and consulting fees. Trustee James Giddens and his law firm, Hughes Hubbard & Reed LLP, have earned about $169 million.”
Not to fear, there has been commissioned a SIPC Modernization Taks Force to implement reforms, on which no lesser than MF Global Trustee (and former price-gouging Lehman Trustee), James W. Giddens is a member.
Speaking of Mr. Giddens' firm, Hughes Hubbard & Reed, Ms. Martens also had something to say about them in her aforementioned MF Global article:
Hughes Hubbard and Reed is the same law firm handling the bankruptcy of Lehman Brothers. After more than three years, customers have yet to be made whole. There are over 7600 law firms in New York City according to the legal web site, Martindale.com. Why SIPC has selected the same firm for two of the largest Wall Street collapses in history is noteworthy.
Hughes Hubbard and Reed hired the same public relations firm to handle both the Lehman and MF Global matters, APCO Worldwide. APCO was originally formed as a subsidiary of Arnold & Porter, the law firm aligned with spin for Big Tobacco in the 90s. [EB: Arnold & Porter was also heavily involved in lobbying the CFTC with respect to DF implementation, including CFTC Rule 1.25, investment of customer funds.]
According to Wendell Potter, an insurance company public relations insider and whistleblower, writing in his book Deadly Spin, "One of the deceptive practices of which APCO has a long history is setting up and running front groups for its clients. In 1993, Philip Morris hired APCO to organize a front group called the Advancement of Sound Science Coalition in response to the U.S. Environmental Protection Agency's ruling that secondhand tobacco smoke was a carcinogen. Philip Morris also hired APCO to manage what it called a 'massive national effort aimed at altering the American judicial system to be more hostile toward product liability suits' and to build a coalition to advocate for tort reform. According to the Center for Media and Democracy, the tobacco industry paid APCO almost a million dollars in 1995 to implement behind-the-scenes tort reform efforts and specifically to create chapters of 'grassroots' citizens' groups called Citizens Against Lawsuit Abuse."
In the same month that Corzine was hired by MF Global, March 2010, there were confirmed news reports that APCO Worldwide had been hired by the Financial Services Roundtable, a Wall Street trade group, to promote the image of Wall Street as trustworthy. An APCO spokeswoman says they no longer represent the account.
Lets not forget that, according to the New York Post, MF Global was also paying Bill Clinton and Tony Blair's consulting firm, Teneo Holdings, betwen $50,000 and $125,000 per month for "public relations and investment advice."
Coming full circle, we will finally get back to the arcane bankruptcy structure of the MF Global entities that ought to be questioned in detail at Tuesday's Senate hearings. In particular, the SEC Director of Trading and Markets, Robert Cook, should be held accountable for what was ultimately his decision (though with no protest by the toothless CFTC) to subject 38,000 futures customers to a SIPA liquidation, which offers no insurance protection and that places futures customer claims to MF Global estate assets in legal limbo. For, as we have pointed out previously, it was his predecessor, at the then-styled position of Director of Market Regulation, who exercised authority to put Lehman in a SIPA liquidation (at least Lehman was primarily a securities firm, not a futures firm).
Even Chuck Grassley, the sponsor of the now-widely criticized 2005 bankruptcy reform act, has stated, "The bankruptcy laws are written to ensure that company executives who were involved in the demise of a company because of fraud or mismanagement shouldn't be eligible for bonuses," Mr. Grassley said.
More broadly, MF Global customers have an absolute right to clawback of questionable margin payments and asset transfers from the broker unit that occurred in the weeks leading up to the firm's demise because there was a clear pattern of intentto deceive investors and customers alike--from manipulating regulators and the regulatory process to changing business practices in the final wee--all of which ensured that customers would be last in line for the remaining morsels of the MF Global carcass. (And, as we have pointed out since early November, 2011, the very nature of the Corzine Trade from Day One was such that all the risk was put in the customer brokerage house, while profits were diverted to an offshore business unit).
"Fraud" is the operative word here. There is no dispute that the Commodity Exchange Act (sic, the law) has been broken, but until fraud is investigated, customers are at the mercy of a very fuzzy and opaque legal process.
It's time for Congress to put pressure on those in charge of this investigation and oversight to break their own glass of silence and dare them to utter the magic "F" word.
The MF Global circus continues, as only yesterday, the Senate Banking Committee announced it will hold a hearing next Tuesday, April 24, 2012, in which a few old and a few new faces will grace Congressional Chambers. We can only hope that some of the Committee members will pursue the panelists with the same zeal that certain members of the House Financial Services Oversight & Investigations Subcommittee did in their three hearings.
According to a press release that arrived in our email box this morning, next week is Money Smart Week at the Chicago Fed. The awkward phrasing sure sounds smart. The National Futures Association, the CFTC and AARP will hold a seminar entitled "Avoiding Fraud is Your Best Money Strategy." No kidding. Tell that to Mr. Corzine and the MF Global customers. The always pithy CFTC Chairman Gensler had a few choice words as well: "When making important financial decisions, even simple actions like asking a few smart questions can help set people on the right course." Right...and where were your smart questions, Mr. Gensler, when you let the SEC steamroll the CFTC into accepting a bankruptcy and liquidation structure of MF Global and its broker unit such that the customers ended up on equal footing with creditors?
Maybe the SEC's Director of the Division of Trading and Markets, Mr. Robert Cook, can shed some light at next week's Senate Banking Committee hearing on why he ordered a firm with 388 securities accounts and 38,000 futures accounts to be put into a SIPC liquidation, where there is no insurance fund for futures customers and where the liquidation Trustee has no clear right to assets in the parent company's Chapter 11 estate.
And, if Mr. Gensler truly believes that the "CFTC exists to protect Americans in financial markets and to ensure the integrity of the marketplace for investors," perhaps CFTC Commissioner Jill Sommers can enlighten the Senate and public as to why the CFTC delayed implementing reforms to Rule 1.25 governing investment of customer funds, conveniently around the time when Mr. Corzine and his fellow ex-Goldmanite general counsel, Laurie Ferber, were meeting with Chairman Gensler, CFTC Commissioners and other high level CFTC officials in July. Only after MF Global's demise did it become imperative to finally implement the changes, now dubbed appropriately, the "MF Global Rule."
CFTC discloses new emails regarding top level meetings with Gensler, Corzine and Ferber
This gets to another event that transpired yesterday, wherein the CFTC finally responded to a five month old FOIA request regarding those very meetings on July 20, 2011. EconomicPolicyJournal.com has exclusively obtained a smattering of emails from such figures as Ms. Ferber, Chairman Gensler and Amanda Radhakrishnan, Director of Clearing and Risk for the CFTC.
In one email from Ms. Ferber to Ms. Radhakrishnan on the morning of the 20th, she pleads "I know you must be truly swamped, but I also know that we are having calls with some commissioners today...I continue to believe that you and your team are the most important to be speaking with on 1.25 and I know Jon [Corzine] would appreciate the opportunity to speak with you."
In another series of emails, we learn that Chairman Gensler initially turned down a request on July 11, 2011 from Mr. Ferber to meet with Corzine, [ex-Refco exec] Dennis Klejna and others on either the 20th or 21st, citing scheduling conflicts. (See Francine McKenna's article for background on Klejna and JP Morgan's inside track to MF Global here). Yet, Mr. Gensler would eventually make a point to chat by telephone with Corzine and others on a 1:00 pm call on July 20. Such was the former Senator and Governor's clout, or the zeal and persistence of Ms. Ferber.
Certain details of these meetings were already public, having been posted on the CFTC's website. (We first wrote about them in detail on November 9, 2011.) But we now know exactly who pushed for them (Ferber) and just how badly Corzine needed to wield his starpower in front of the regulators. After all, MF Global was about to float a $325 million bond offering (now practically worthless) that would close just days later on August 2, 2011, and any threat to MF's revenue model would have likely derailed it.
Regulatory Capture Kept the Corzine Trade Alive
According to a Bloomberg piece by William Cohen, Corzine himself said that the repo transactions pursuant to 1.25 made with customer funds with other broker-dealers as counterparties should be permitted “because such transactions could be beneficial to” firms like MF Global. Without the extra income from investing customer funds (and they need not have been necessarily invested directly in the sovereign bonds), the Corzine Trade would be toast.
This was also a time when FINRA was about to push for a regulatory capital hike (eventually stalled by Corzine at the SEC, but not ultimately defeated), and a time when the SEC decided to sit on the annual audit of the broker unit for over three months instead of making it public right away as it customarily does. This was the only document that would have been public at the time that disclosed the true risk of the Corzine trade to MF Global customers, wherein all of the risk was saddled in the broker unit and the bulk of the profits were sent overseas.
But we digress. Back to those July 20 CFTC/MF Global meetings, what was the outcome? According to the Federal Register, the CFTC filed on July 22, 2011 a notice effective July 20, 2011 regarding other rulemaking, and provided a footnote disclosing that "The amendments [to Rule 1.25 and 30.7] proposed in those Notices are not addressed herein and may be subject to future Commission rulemaking." Apparently, Corzine and Ferber won...at least for the time being.
MF Global's long standing push against Rule 1.25 reform
But July, 2011 was not the first time that MF Global had pushed against Rule 1.25 reform. Only months after it put on the Corzine Trade in September, 2010 (and lying about its existence to FINRA that same month), Ms. Ferber and a representative from Newedge penned a letter on December 2, 2010 to the CFTC. As we quoted on November 9, 2011:
The ironic, if not prophetic, introduction:
As a general matter, we applaud the CFTC for seeking new ways to ensure the safety and liquidity of investments made by futures commission merchants under CFTC Rules 1.25 and 30.7. However, as we set forth below, we believe the specific amendments being proposed: (a) are unnecessary, considering that the current permissible investments under Rule 1.25 have not, to our knowledge, resulted in any FCM's inability to provide customers their segregated funds upon request or to continue as a solvent entity, (b) will, in many cases, create new investment risks and logistical difficulties for FCMs, and (c) may well change the pricing dynamics for customers and the industry at large. Recognizing the CFTC's concerns, however, we have set forth our own proposed amendments which we believe satisfy the CFTC's desire for the enhanced security of customer segregated funds without the risk of significantly increasing costs to customers.
On fixing something that is not broken (until it is):
B. The Investments Currently Permitted Under Rule 1.25 Have Not Put Customer
Funds at Risk.
We believe strongly that the CFTC's proposed amendments endeavor to "fix something that is not broken." Indeed, the evidence is clear that the investments permitted and safeguards required under Rule 1.25 have met the CFTC's stated "objectives of preserving principal and maintaining liquidity" of customer segregated funds. Sec Rule 1.25(b). Among other things, since the CFTC's 2004 expansion of permissible investments under RuIe 1.25, we are not aware of any FCM that has been unable to liquidate and provide to their customers upon request any segregated funds invested under Rule 1.25 (or under Regulation 30.7 either, for that matter).4
Further, since this expansion, no FCM to our knowledge has failed or otherwise been unable to meet any other of its financial obligations as a result of investments made under Rule 1.25.5 In short, we believe the current investment criteria set forth under Rule 1.25 have worked, including over the past two years of market instability and uncertainty - the ultimate stress test. Nevertheless, the Commission has proposed changes so sweeping that they may in fact increase systemic risk by imposing new burdens on otherwise effective, efficient and liquid settlement processes. Such a radical overhaul, in our view, is unnecessary considering the Rule's stellar track record. At most, the CFTC should be adjusting only slightly the products, counterparties and concentration percentages currently permitted. 6
Need for a fraud investigation and lawsuits against the execs
Mr. Corzine and Ms. Ferber, apparently operating under an end-justifies-the-means ethics, did not get their desired end, and now face a greatly undesired one. They need to be held personally accountable, both criminally and civily, for their actions, should the facts warrant (which we believe they do). The case, far from being cold, is just getting warmed up. We hope the SIPC Trustee, James W. Giddens, keeps his word when he said last week he would go after MF Global personnel who broke the law by dipping into segregated funds. We have also hopefully established enough intent to justify a fraud investigation by the DOJ, not that intent is a prerequisite to clawing back missing customer funds, which are statutorily required to be sacrosanct at all times.
Using his former Congressional chambers as a stage, Mr. Corzine has theatrically attempted to set up a MF Global back office worker, one Edith O'Brien, to take the fall for it all. While she may or may not have some culpability as firm Treasurer, she appears to hold the key to unraveling the mystery that has always been exposed in plain day. If anyone deserves immunity, it is she.
A video explains it all
Explaining the situation in simple terms with some great background is Mark Melin of Opalesque TV. Feel free to forward to anyone who might not be up to speed on MF Global, as this first part in a series of three is an excellent primer. Mark will also appear on RT's Capital Account with Lauren Lyster [Friday] to discuss these latest developments.
