MF Global’s exposure to European sovereign debt was not done through straightforward purchases of bonds. Instead, CEO Jon Corzine used a transaction known as repurchase-to-maturity (RTM). The RTMs allowed MF Global to, in essence, buy the bonds on margin, yet classify the purchase as a sale, with the bond and the repurchase liability removed from MF Global’s balance sheet, thereby concealing the risk. (“A Romance With Risk That Brought On a Panic,” New York Times, Dealbook).
Corzine started his career as a trader at Goldman Sachs and remained a trader (i.e. risk taker) at heart. “His obsession with trading was apparent to MF Global insiders over his 19-month tenure.” When he joined MF Global as CEO, he intended to turn the struggling firm into a mini-Goldman through proprietary trading largely directed by himself, according to the article. To that end, “[h]e pushed through a $6.3 billion bet on European debt ? a wager big enough to wipe out the firm five times over if it went bad ? despite concerns from other executives and board members” (which approved the transactions, according to Corzine).
The European wager went bad despite the fact that the bond trades were ultimately profitable! In his testimony before Congress, Corzine said: “As of today, none of the foreign debt securities that MF Global used has defaulted or been restructured. ‘ There actually were no losses.” How could MF Global have fallen into bankruptcy when there were no losses? The exposure of the previously hidden risks led to a run on the firm.
In his testimony before Congress, Corzine described the RTMs as follows: “MF Global would purchase a debt security (such as sovereign debt) from a seller and would sell the same security to another party (the “Counterparty”) with an agreement to repurchase the security from the Counterparty at a later date [in this case, on the maturity date]. The agreement between MF Global and the Counterparty to sell and buy back the debt security was the repurchase agreement, and it served, in effect, as a loan from the Counterparty to MF Global. The Counterparty would hold the debt security as collateral for the loan.” Under applicable accounting rules, according to Corzine, the bonds and the money owed by MF Global to the Counterparty “must be ‘derecognized,’ i.e., removed from MF Global’s balance sheet.”
Thus the risks were initially (apparently legally) concealed by the RTM structure, and the exposure of it caused regulators and creditors to demand that MF Global put up more net capital and collateral that MF Global did not have to cover the trades in case of losses ? essentially a run on the firm.
This is (in part) a story about how a trader who bets the firm can ultimately be right but still lose the firm. Another part of the story is whether and how $1.2 billion of investors’ money was misappropriated to fend off creditors.
Still another part of the story, according to the article, is how MF Global’s executives had for months explained the firm’s European bet to Moody’s and Standard & Poors, and those ratings agencies applauded it. “We consider the most recent strategic plan of the new C.E.O. Jon Corzine to be sound,” Standard & Poors said in 2010, at the same time conceding that the plan “will incrementally increase the firm’s risk profile.” But a week after FINRA made MF Global increase its net capital, Moody’s cut the firm’s rating to one level above junk, which caused the stock to plummet.
The case raises more questions about the ratings system, questions about how risky transactions are accounted for and disclosed to the public, as well as questions surrounding the missing $1.2 billion of investors’ money.
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