Guest Post: MF Global Shines A Light On Monetarism's Incapacity To Enhance The Real Economy

Tyler Durden's picture

Submitted by Jeff Snider, President & CIO of Atlantic Capital Management

MF Global Shines A Light On Monetarism's Incapacity To Enhance The Real Economy

The temptation to compare any financial institution’s failure to those that preceded the 2008 crisis and panic are reasonable.  It is easy to classify MF Global as 2011’s “Lehman” event, just as it was to use the same term to describe Dexia a few weeks ago.  The use of the term “this year’s Lehman” is somewhat misplaced simply because its users are looking for an event that kicks off another crisis or panic.  Instead of using “Lehman” to describe a potential inflection point that propels the crisis into panic, it might be better to see MF Global as AIG.

The comparison to AIG is not to say that MF Global was as interconnected, that its failure will be as devastating, or that it is the straw that breaks the European camel’s back.  The urge to see the past in the present is historically valid, but it will never be exactly alike (Mark Twain had this right).  Rather I think the comparison is useful in that AIG taught the wider world what was really rotten at the core of modern finance, namely hidden risks that were shockingly existential.  MF Global’s failure importantly shows that none of the lessons have been heeded in the days since, providing a somewhat unique window into the real dangers that still lurk hidden in the shadows.  More than that, though, MF Global demonstrates an obvious shortcoming of the financial system as it relates to the real economy.

ZeroHedge posted the bankruptcy affidavit of MF Global’s President and Chief Operating Officer Bradley I. Abelow, drawing attention to Section E, item 33 on page 13.  Mr. Abelow makes the following statement under oath:

“On September 1, 2011, MF Holdings announced that FINRA informed it that its regulated U.S. operating subsidiary, MFGI, was required to modify its capital treatment of certain repurchase transactions to maturity collateralized with European sovereign debt and thus increase its required net capital pursuant to SEC Rule 15c3-1.” [emphasis added]

The transaction in question was a “repo-to-maturity” financing deal, collateralized with the troubled sovereign European debt that everyone has been talking about in the past few days.  What is particularly striking about this is that a “repo-to-maturity” deal is accounted for as a sale, meaning that what is essentially an ongoing collateralized loan is, surprise, hidden off the balance sheet.  Maddeningly, MF Global likely booked a profit up front at the transaction’s consummation using obviously faulty mathematical expressions of those “reasonable” expectations of profit, thus avoiding the need to post any liability to the balance sheet.

This makes a lot of sense, then, in why FINRA “demanded” it change its capital treatment of the transaction.  Though it was “properly” accounted for according to convention, the risks of collateralizing a loan with questionable debt means that MF Global has ongoing liquidity risk attached to it.  As the value of the European debt collateral is questioned, or falls, the lender/cash owner counterparty will ask for additional collateral posting as it applies a stricter haircut to that original, troubled collateral.  So, even though this transaction has fully cleared MF Global’s books, the company is still on the hook should it be required to post additional collateral or cash (which ended up with the company in bankruptcy, just like AIG).

The stink here is that this is not an isolated case of cheating (aside from MF Global’s use of client funds).  It is a pervasive shadow element to the modern financial system, fully allowed by accounting conventions and regulators.  Just like AIG, MF Global was not brought down by bad debt per se, it was brought down by the hidden liquidity risk of the deterioration of off balance sheet arrangements that were allowed by accounting standards.  The fact that it was classified as a sale was completely inappropriate in terms of describing the overall liquidity risk of the company, as FINRA belatedly recognized.

MF Global was expressing a bet that it could earn a spread, essentially risk free, on the rate it paid on the repo transaction (the lowest borrowing rate around) and the interest it received on the Euro sovereigns (among the highest rates of the sovereign class), all the while counting on the European politicians and the ECB to provide enough “support” to maintain a relatively constant debt price in order to fool the marketplace into complacency about real risks.  So the risk hidden but embedded within the transaction appears long before there is a default, hitting the company once the repo counterparty devalues the collateral (the market was apparently not fooled enough by the ECB’s attempts at price stability).  This is the essential financial misrepresentation of the age.  Repo accounting is responsible for so much hidden risk, yet it has become central to the ongoing survival of the system as it is currently constituted.

The pliability of how the system is allowed to “book” and account for risk is certainly the driving force making repos so vital to modern banking.  For instance, a gold or silver lease arrangement is essentially the same as a repo-to-maturity transaction, yet it is accounted for in exactly the opposite way.  A gold lease is really a sale transaction since the physical metal is literally removed from the custody of the gold owner, yet it is accounted for as a collateralized loan where the gold remains on the owner’s books as if it is really there (since it technically involves a repurchase agreement on the back end, even though these deals are simply rolled over in perpetuity and the repurchase never takes place, nor is it intended to).  Both gold leasing and the repo-to-maturity transaction are forms of collateralized loans, yet they receive far different treatment so that they accomplish exactly what the banks want to accomplish, which is disguising the real nature of each transaction.  The gold lease presents risks in that metal may not be where everyone thinks it is, and the sale treatment of the repo-to-maturity removes haircut and liquidity risks from what are supposed to be transparent statements of condition.

That is why this system has to change at some point.  It is exactly designed to be misleading, and the reason is so very simple.  In any fractional system there will be a desire to amplify that fraction to the maximum degree.  But in doing so, participants recognize that the process of maximization entails creating negative human emotions and perceptions since history is not really that kind to this manner of fractionalization.  So the system has institutionalized, abetted by the very regulators that are supposed to cap fractions and leverage, these methodologies of hiding just how much financial entities have engaged in maximizing themselves under the cover of mathematical precision.  Trillions in derivatives are no problem because there are powerful and elegant equations to net and hedge them.

Without any sort of exogenous anchor to credit production and banking, risks are theoretically nearly infinite (since the slightest disruption to expected haircuts renders firms utterly bankrupt!), while at the same time there are multiple avenues for misdirection and disguising those realities.  The Panic of 2008 was supposed to correct these excesses and remedy the fact that risks have not been accurately priced for decades.  Yet the system has resisted every effort, simply settling for redefining the appearance of safety yet again.  Somewhere in that mathematical pursuit of maximum fractions, the very goal of finance changed, as if traditional banking was no longer sufficient to support the pursuit’s ever-growing ambitions.  So the financial economy has broken away from the real economy, using the ironic cover story of enhancing price discovery to the process of intermediation – complexity is good!

Intermediation is supposed to be about matching the wider (real) pool of savings to worthwhile economic projects that have a real, productive impact on the real economy.  MF Global’s repo-to-maturity transaction cannot be fairly classified as real intermediation since the firm knowingly advanced credit to an economically unfeasible obligor with the expectation that the price would never reflect that reality (how’s that for enhancing price discovery).  This crystallizes, I believe, just how far the financial system has moved away from real intermediation and reflects the biggest part of the real problems in the real economy – money is no longer productive in economic terms and has not been for decades. 

The Occupy Wall Street crowd sees this as a problem with capitalism.  I believe that they are correct in their target, but wrong in their diagnosis.  This is not a problem of capitalism since Wall Street is a practitioner of monetarism.  A real capitalist system works through real intermediation creating positive opportunities for productive enterprises (scarce money is actually vital here).  Our current system of repo-to-maturity and gold leasing is nothing but empty monetarism’s habit of regularly forcing the circulation of empty paper.  And when the system begins to doubt itself, as it did in 2008, the answer is always about finding a way to restart the fractional maximization process yet again, which means disguising the real risks inherent to that process.  There is no real mystery as to why prices and values have seen such a divergence, and why that is a big problem to a system that depends on appearances.

The fact that money is disconnected from the real economy never enters the consciousness of monetarists since money is always the answer.  But make no mistake, the primary reasons for this global malaise are that money has lost its productive capacity and its proper place as a tool within the system, not as the ultimate object of that system.  MF Global’s failure is an apt demonstration of just how far modern finance has strayed, just as AIG was three years ago.

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mynhair's picture

But it's for the Children!

iDealMeat's picture

Get to know em!    See any Familiar names?

Michael G. Stockman Chief Risk Officer Michael Stockman is chief risk officer of MF Global Holdings Ltd. He joined the firm in January 2011. In his role, he oversees management of the firm’s global risk profile including market, credit and operational risk. He is a member of the firm’s management committee and reports to the firm’s chief operating officer. Mr. Stockman has more than 25 years of domestic and global experience in risk management, trading and capital markets. From 1995 to 2008, he held several senior positions at UBS Investment Bank including as chief risk officer for the Americas and as a managing director in the fixed income, currencies and commodities divisions. Prior to joining UBS, he held senior mortgage and asset-backed trading positions at Morgan Stanley and Goldman Sachs. He began his career in mortgage trading at Salomon Brothers. Prior to joining MF Global, Mr. Stockman helped build a risk management and capital markets advisory practice including a quantitative real estate solutions business—initially in a joint venture with State Street Global Markets—at financial services boutique CQ Solutions, LLC.

SwingForce's picture

As I suspected, it is/was the traders who have all the brains. LBO the trading Arms guys! Don't let cronie Jamie or Lloyd become your new boss, they are A1 Assholes. Good luck.

WestVillageIdiot's picture

So Mister Stockman has gone from the Gambino family, to the Genovese family, to the Lucchese family and settled at the less well known Bonanno family.  That is really what I get from what you copied and pasted.  These are not financial firms.  These are mafia style organizations with a capo de regime at the head with names such as Lloyd, Jamie or in the case of MF Global, Jon. 

Freddie's picture

The Mafia families (who are scum) are far more honorable than Goldman, Morgan Stanley, MF Global, State Street et al.

AldousHuxley's picture

Where are the mafia folks who lost money with the banksters?


We could use some mob justice about now.


You know shit is really bad when mafia looks better than banksters and police.

Canaduh's picture

Because con men are usually good at spotting other cons.

iDealMeat's picture


Tried to "qote" but was blocked by a reply..  nextime. 

sgt_doom's picture

Thanks for the due diligence on this one, iDealMeat.

Surprisingly, a hedge fund or corp. blows up and Martin Feldstein ISN'T on their BoD (he was at HCA when they paid the $1.7 billion out-of-court settlement for medicare/medicaid fraud, at Eli Lilly when they paid the then largest criminal penalty in US history for illegal marketing certain drugs, and at AIG Financial Products group when they were involved in the largest insurance swindle in US history -- selling $460 billion worth of swaps with little or no capital on hand to cover them).

Again, thank you.

iDealMeat's picture

thanks for the leads...  casually working on a BoD project..

mynhair's picture

Gave all the late to the party Aholes a TD.

Go reply to number 2 comment, bitchez!

I waz first.  Sukkers.

Bitchez don't even do me the courtesy of a TD.

They just like being on top.

I am a Man I am Forty's picture

I can't imagine why there was a problem.

paarsons's picture

Good Citizens of Metropolis!

According to my calculations, we've got another 10 to 15 years of this shit.

It's a good thing I'm an idiot.

gangland's picture


paarsons your posts and blog crack me up, i enjoyed the one about your son the bluce  your style cracks me up, reminds me of a good friend of mine.  look forward to continued reading. regards.


fuck you dirty marxist motherfuckers, ill pray for your souls oh and fuck lloyd blankfein.


btw i live next to mr lee's market, great beef, 6 buck 6 pack of soju in tiny cans. deadly.

PAPA ROACH's picture

Voodoo economics coming home to roost.

JLee2027's picture

Even a caveman can understand it.

Mactheknife's picture

So...they made a 6.3bil trade that only allowed for a 3% move against them that blew up the firm. My GUESS is that they had already lost a boatload of client money and bet the farm trying to get it back. Several names for that come to mind, caveman isn't one of them.

AldousHuxley's picture

cavemen saw the world of today and went back into the cave. At least he is not in debt slavery (mortgage, education, auto, credit card)

Mr. Lucky's picture

I think I got it.  This is a ponzi with in a ponzi with in a ponzi etc...   Eventually the music stops and there are no chairs at all.

Don Birnam's picture

Yes, like one of those Russian nesting dolls: one is opened and -- voila ! Another !

peekcrackers's picture

Don Birnam +1

Ashkenazi  russian dolls

JPM Hater001's picture

Almost.  This was like collateralizing an insurance contract with a ponzi scheme designed to hide the depth of the ponzi scheme they were on the hook for covering...namely in the interest of the companies future.

peekcrackers's picture

compairing  the biggest thief  allways a good read.  ..real life crime stoires

proLiberty's picture

Don't confuse creating (paper) money with creating (real) wealth. 

SwingForce's picture

Don't confuse being a Clearing Broker & Fed Dealer with being a lowlife online broker- MF was BIG TIME in the biz it knew best, don't let these guys go down without glory- MF Traders know the biz like no others, this is another example of MSM and Sheeple having no brain cells.

Listen to CME- who gets these "seats" when MF poofs, JPM? HSBC? GS? Corzine is a PATSY no doubt.

AldousHuxley's picture

Banksters ate up main street so there's nothing left. Banksters ate up savings of old Americans so there's nothing left. Banksters ate up futures of young Americans so there's nothing left.


Banksters eating each other now. GS, BAC, JPM are TBTF.....MF is not. Corzine's rival was Hank Paulson.


Capitalism will self-destruct from within just like any powerful group. Even look at  the Koch brothers with billions...half of the brothers are non-speaking terms with each other. All that money just ends up spliting up the family. All that money will just end up spliting up America.

New American Revolution's picture

Bravo dude!!!  Excellent rendition of MF's current event in the economic fabric of money and time.   Kudos.

kaiserhoff's picture

Excellent summary of the sorry state of modern accounting.  Ben's sorry ass should be a lot more worried.

Powerful and elegant equations to net and hedge them.

Tell it to the judge.

A Lunatic's picture

But, but..........I thought Congress did "something" back in 08 so this type of thing could "never ever" happen again.........

wombats's picture

Look for something like a Dodd-Frank II

jcaz's picture

Sad part is, both Dodd and Frank understand how this works, yet they intentionally wrote law that failed to address it;

That makes both of them the biggest criminals of all in this equation.

How are those slush funds doing these days, boys?

baby_BLYTHE's picture

Gerald Celente Predicts Ron Paul Can Win The Election.

 Gerald Celente Predicts, on Freedom Watch with Judge Napolitano, Congressman Ron Paul Can Win The Election . Ron Paul is America's leading voice for limited, constitutional government, low taxes, free markets, sound money, and a pro-America foreign policy.Gerald Celente says in many interviews that he thinks obama will win, but he does dream and hope that RON PAUL wins the republican nomination. Listen to what hes says at 3minutes cause its true. You start with 1% income tax and end? up with 30%. You start with Ralph Nader as a "wise regulator" and end up with the same corporatism. Let consumers vote with their dollars and pennies. Without big governments, business will fight themselves as dogs for a chance to serve a consumer. In that environment they cannot afford a mistake or a fraud for long.

zwscott33's picture

Ron Paul doesn't need to win the nomination. If he doesnt get it he should run as a third party candidate, even better, run with no party affiliation. End the two party system

mynhair's picture

Re-Elect Obama!

Vote Rue Paul!

Freddie's picture

I wish Ron Paul's son was running.  The son is really good.  I like the dad but he almost comes off as too nice.

baby_BLYTHE's picture

Rand isn't even 50 yet. He has at least half a dozen election cycles following the up and coming to throw his hat into the ring. If you wanted my honest opinion, I say Rand has a much better chance of becoming president than his father. The republicans will shoot themselves in the foot once again which they have done consistently the past 30+ years (HW Bush, Dole, W Bush, McCain) by electiing another puppet like Romney. Never has a true conservative Constitutionalist been nominated in almost all our lifetimes, unless you were alive for the likes of Goldwater (I was born in 1990). Unfortunately Obama will most likely be re-elected. However, after four more years of absolute misery the country will be in total dystopia with the impending dollar collapse and third World War that a Rand Paul (pending he continues to stick to his fathers consistent, time tested, Constitutional principles) will be uncontested in any future election. The MSM media will have no credibility once Obama leaves office after 8 years with U-6 unemployment at 40% and real inflation running at least that amount.

FeralSerf's picture

I was alive and supported him until his 1964 nomination acceptance speech. Then LBJ seemed the least undesirable of the two. What an awful choice.

Flakmeister's picture

I have heard the son talk enough about Medicare reimbursement of Doctors to know he is classic political hack.... Definately not a chip off the ol' block

theprofromdover's picture

No, he has to stay inside the system.

If RP stands as an independent, the mass media can ignore him, like they have been trying to do all of this year.

Archimedes's picture

Great! Another month of this bullshit!

mynhair's picture

You no like 3 digit daily moves?

Can see you never experienced 3 point daily moves.

defn8Dog's picture

You just know there's more to come like MF'ing Global as the "risk free" sovreigns get dumped. Think of it as the first shoe, like Bear Stearns was to Lehman.   Don't suppose there's a list of holders on Bloomberg, but you have to wonder how many U.S. retirement funds have Italian 10y.  Wait til the real world marks start hitting. 

NumNutt's picture

Amazing! MF Global snowballing into a huge ass problem, Greece getting ready to shit in the Euro bed...both things that will have a direct impact on peoples lives, and what does the MSM focus all their attention on? A twenty year old sexual harassment case that was settled out of court by a (maybe) next years presidential candidate. Total bullshit. It isn't like he posted his wiener on the internet, or was getting a BJ in the oval office, smoke and mirriors, keep the sheeple distracted...........

bobert's picture

You can't have multiple sexual harassment complaints managed by your industry's professional organization in your history and plan to run a successful campaign for US president.

Especially if you are a conservative black man.

Cain is finished!


NotApplicable's picture

Let's see if he plays the race card before calling him finished. (not that he was 'viable' to begin with)

Freddie's picture

I don't dislike Cain but he is ex-Federal Reserve which is a no for me.  I would take Ron Paul followed by Santorum.

DollarMenu's picture; background-attachment: initial; background-origin: initial; background-clip: initial; background-color: initial; color: #000000; display: block; font-family: Georgia, Times, serif; font-size: 2em; height: 240px; padding-top: 120px; text-align: left; text-decoration: none; width: 500px; background-position: 50% 0%; background-repeat: no-repeat no-repeat;" href="">santorum (san-TOR-um) n.
   1. The frothy mixture of lube and fecal matter
      that is sometimes the by-product of anal sex.

ThisIsBob's picture

The lesson here for all young black men is that if they aspire to high government office like the Presidency or the Supreme Court, it would be easier if they didn't try to get laid.