MF Global

A question has been raised as to if the clients of MF Global are insured on their losses as a client of a bank or securities firm would be under FDIC or SIPC? The answer is maybe. While there is no regulatory insurance agency to cover the losses of MF Global clients, the CME itself has a guarantee fund for losses. This fund is financed by the other Primary Clearing members. So all FCMs bear some burden of MF Global’s indiscretions. We believe it amounts to a $4BB Clearing Member “error Account” The answer depends on legal questions and accounting details: For example, are the segregated funds of a Clearing member’s clients guaranteed if those funds were lost due to fraudulent actions by that clearing member? In other words, do the other Clearing Members at CME have to pony up the lost money if MF Global lost it fraudulently as opposed to though market events and poor in-house risk management. If MF Global is found to be in violation of some CME rules, fraud, delinquency or otherwise, we believe CME’s other Clearing Members will put their collective political collateral into finding a way to not pay the money lost.

Here is video outlining precisely how MF would collapse due to Fed policy, made at the beginning of the year! This wasn't hard to see coming. How many of you are willing to bet that MF Global will NOT be the Lehman of 2011? Let me rundown a few hard, painful and accurate observations that you guys who fell for that rough ass bear market rally might have overlooked.

Say you are the head back office guy at MF Global, it is the close of trading on Thursday, the firm has already completely drawn down on its revolver, and all the resulting cash in addition to all the firm's cash at your disposal in affiliated bank accounts, up to and including petty cash, has been used to satisfy margin demands due to declining collateral value, yet the collateral calls just won't stop, and impatient voices on the other side of the phone line demand you transfer even more cash over immediately or else risk default proceedings commenced against you within minutes. What do you do? Do you go ahead and tell your superior that the firm is broke even though the co-opted media is trumpeting every 5 minutes that "MF Global is fine", knowing full well you will be immediately fired for being the bearer of bad news, or do you assume that courtesy of your uber-boss being the former head of the Vampire Squid, and thanks to infinite moral hazard which after Lehman made sure nobody would ever fail ever again, that there is simply no way that you will be left without some miraculous rescue, if only you can last one more day, and as a result proceed to "commingle" some client funds with the firm's cash. It turns out that at MF Global you do the latter... over and over... until you have literally stolen hundreds of millions from the firm's client accounts in hopes that the miracle rescue will come on Friday... then over the weekend... and then you realize no miracle is coming, partly because your actions have been exposed, partly because miracles only exist in fairy tales. The next thing you know, your firm is bankrupt and hundreds of clients are about to learn that all their money is gone. Poof. This is not a fictional tale. This is precisely what very likely happened at MF Global in the past 72 hours. And someone has to go to jail. That someone, if indeed this criminal act is proven to have taken place, should be none other than Jon Corzine himself.

More from our Bank Exec friend, this time on MF Global after we tried to lay blame on Rubin, Thain and Corzine for blowing up their firms: "MF Global. They named that company right. You probably didn't see it first hand but Lehman, Bear and Merrill were doing the dumbest real estate deals "ever" in the run up to the implosion. Every real estate veteran saw it, and while AIG's CDS exposure gets airplay, bad real estate lending is at the center of the disaster. So, Merrill was toast before Thain showed up. He was just the funeral director. Citi (with its 14 off balance sheet SIV's @ $1 trillion) was an abomination in progress before Rubin arrived, the Enron of banking and each and every officer and board member should go to jail. But they won't because they are all too powerful and very politically connected."

Reaching for yield (and prospectively capital appreciation) while shortening duration had become the new 'smart money' trade as we saw HY credit curves steepen earlier in the year (only to become the pain trade very quickly). The attraction of those incredible yields on short-dated sovereigns was an obvious place for momentum monkeys to chase and it seems that was the undoing of MF Global. The Dec 2012 Italian bonds (in which MF held 91% of its ITA exposure), as highlighted in today's Bloomberg Chart-of-the-day, appears to be the capital-sucking instrument of doom for the now-stricken MF. As if we need to remind readers, there is a reason why yields are high - there is no free lunch - and while some have already leaped to the defense of the bet-on-black Corzine risk management process with comments such as 'He was simply early and will be proved correct' should remember that only the central banks have bottomless non-mark-to-market pockets to withstand the vol. It also sets up a rather useful lesson for those pushing for EFSF leverage to buy risky sovereign debt - but given today's issue demand, perhaps that is moot.

And the winners are.... Moody's Ba2-; S&P: BBB-; Fitch: BB+;  Congratulations to Egan-Jones for once again being the only rating agency worth their money and calling this collapse in advance.

Full bankruptcy filing attached below, where we find that in addition to owing JPM and Deutsche Bank $1.2 billion and $1 billion respectively, as bond trustees, the 7th biggest unsecured creditor with $845,397, is... CNBC? Perhaps that explains the objective reporting the Comcast station has provided on the topic of MF over the past several weeks, considering the caliber and quality of guests invited to opine. It also should be a reminder to all advertising collections offices to never be more than 30 days late on collecting receivables. Of course, this is pure speculation on our behalf. We are confident CNBC will provide a far more rational explanation why it is owed nearly $1 million by MF Global, and just what is the nature of services rendered...

Three years after upgrading Lehman days ahead of its bankruptcy, here is Dick Bove on CNBC last week assuring anyone idiotic enough to listen to him that, you guessed is, MF Gloal is fine and a buyer will promptly materialize. How much longer will the Comcast financial comedy channel tolerate this individual?

Game Over. And in the meantime, we get the following report from a media source: "CME’s acting like the MF Global thing just happened.  They’re haphazardly locking traders out who clear with MF, blocking access to the floor of not just MF Global employees but people who clear through them.  As a result, nobody wants to leave the floor and nobody who still has access wants to trade just to get locked out."

Statement Regarding MF Global Inc.

The Federal Reserve Bank of New York has informed MF Global Inc. that it has been suspended from conducting new business with the New York Fed.  This suspension will continue until MF Global establishes, to the satisfaction of the New York Fed, that MF Global is fully capable of discharging the responsibilities set out in the New York Fed’s policy, “Administration of Relationships with Primary Dealers,” or until the New York Fed decides to terminate MF Global’s status as a primary dealer.

Is this the way MG Global ends, not with a bang, but a T.1 trading halt (although not in Europe, where shares are down 60%)? Stay tuned as we find out if, as we expect, we are about to see a prepack MF bankruptcy, with Interactive Brokers as a lowball stalking horse bidder, ala what Barclays was to Lehman when that bank filed. We will also find out if indeed all the contagion risk from a MF filing is non-existant, very much like Paulson thought when, yes, Lehman filed. In other news, can Jon Corzine become CEO of Bank of America next please? Or at least America's next president? It's not like Goldman does not need a few more competitors taken out...

The deadline to submit a bankruptcy filing to the Southern District of New York is around midnight, which probably explains why even as MF Global is proceeding at a feverish pace to sell parts or all of it to what appear increasingly skittish investors (who, like China will likely wait until the stalking horse auction to show their bids), it has, as the WSJ has just reported, hired bankruptcy and restructuring lawyers in the face of Weil Gotshal, best known for collecting hundreds of millions in hourly legal fees for its work on the Lehman bankruptcy case, as well as Skadden Arps. It appears that the sale process has not gone quite as well as hoped for, and now the company is bracing for the worst with just under 6 hours left to iron out a going concern solution.

We have often discussed the use of the Treasury 2s10s30s butterfly as a carry tool and it makes sense that primary dealers would proxy this in their inventories to earn a much more risk-managed carry than a simple curve trade from a net interest margin perspective. With MF Global drawing down its credit lines and facing immediate stress, it also makes sense that they would look to sell down any and every holding they had in order to show liquidity. In the 24 hours from mid-day Wednesday to mid-day Thursday the 2s10s30s butterfly experienced one of its largest ever shifts higher (unwinding the carry trade) at over 4 standard deviations and only matched by moves in Q4 2008 (LEH?). Equity markets tracked this massive and unending rise in 2s10s30s almost tick-for-tick which we think explains how such a no-news summit in EU can create such a massive move in US equities. Moreover, the attractiveness of the 2s10s30s butterfly is reappearing up here and it is compressing suggesting stocks have room to fall here.

A short, sweet and spot on summary of what is most likely going to happen to MF Global courtesy of the only rating agency worth listening to, Egan-Jones. "A race - the Company is in a race to re-establish its business while clients, employees, and its business position slides. The major issues are the real losses from poor investments in the EU, whether MF can attract interest in salable assets, and if interested buyers are willing to step up currently or wait until a transaction is potentially blessed by a trustee in a reorganization (in the case of the Lehman Brothers reorg, Barclays was confronted with a fraudulent conveyance issue). The most likely outcome is that the majors will pick off MF key employees and clients will flee. No news is bad news."

Update: and the hits just keep on coming, first Fitch and now... MF GLOBAL CUT TO JUNK BY MOODY'S... "At the end of the second quarter, MF Global's $6.3 billion sovereign risk exposure represented 5 times the company's tangible common equity. Moody's said the downgrade reflects our view that MF Global's weak core profitability contributed to it taking on substantial risk in the form of its exposure to European sovereign debt in peripheral countries." But other major US banks have no exposure whatsover right? Oh wait...They're hedged... Through "CDS".

Bloomberg has just broken that MF Global has likely just entered a terminal deathwatch after not only tapping its credit facility, but aslo exhausting it. From Bloomberg: "MF Global Holdings Ltd., the futures broker run by Jon Corzine, drew down its revolving credit lines this week as the firm reported its biggest quarterly loss and had its credit ratings cut, said three people with knowledge of the matter. The New York-based company exhausted its revolving lines, the people said, speaking on condition of anonymity because the move wasn’t disclosed. MF said in an Oct. 25 investor presentation that it had $1.3 billion in unused revolving credit facilities, without giving a date for the tally." This development means that instead of an M&A assignment as many were attributing the retention of Evercore bankers to (despite the dreary presence of David Ying in their midst), Jon Corzine's firm was far more likely focused on salvaging anything of value. However, now that traditional M&A is out of the picture (nobody in their right mind will pay anything close to market value for a company without cash), it is quite likely that the firm's bondholders, who most likely also have collateral exposure with MF global, whose plight started following the disclosure of extensive European exposure and which was downgraded to junk today by Fitch, will pull all liquidity and instead opt for a debt for equity conversion either in court or as a prepack. What is probably the biggest  take home here is just how much of a capital drain European exposure (and we are confident MF was "hedged".... just like Morgan Stanley) can become, and how quickly a firm can become completely insolvent. As a reminder, the firm reported $710 million in cash as of June 30. Obviously all of that cash must have been burned through if the firm also not only tapped but exhausted its $1.3 billion in revolvers in the past quarter (which have rating associated rate step ups, which don't take too kindly to a junk rating). Net result: $2 billion in cash (or about 9 times its makret cap) burned in 4 months primarily due to "hedged" European exposure.