As Repeatedly Warned, Quarter End Window Dressing Key Factor In MF Global's Demise
Was it just two weeks ago when we penned "Another Quarter, Another Blatant Window Dressing By The Primary Dealer Banks To Make Their Balance Sheets Seem Strong", the same post in which we said, "We have made it clear time and again, that this chart [see below] demonstrates nothing short of the end of quarter window dressing, when PDs convert their asset holdings into cash to make their Tier 1 Capital much more robust than it truly is. After all, none other than JPM and Citi were praising just how prepared for Basel III they are with their "sterling" capitalization ratios... which were only sterling courtesy of precisely the highlighted window dressing which occurs each and every quarter. We expect nothing less from Bank of America and Morgan Stanley when they report their own numbers in the coming days. We also expect the regulators to do absolutely nothing to prevent this blatant abuse of fiduciary duty which has no other purpose than to hide the true sad state of America's banking system." Ironically, we have just found out that had regulators not only listened to us over the two years we have been pointing this out, but also done something on it, MF Global would likely not have filed for bankruptcy. Here is the WSJ, confirming all our worst fears: "For the past two years, MF Global Holdings Ltd. may have disguised its debt levels to investors by temporarily slashing the debt it was carrying before publicly reporting its finances each quarter, according to an analysis by The Wall Street Journal. The activity, referred to in the financial industry as "window dressing," suggests that the troubled financial firm was shouldering more risk and using more borrowed funds to facilitate its trading than investors could easily detect from the firm's regulatory filings. And scene: but wait, there's more. As we have shown over and over and over, this has continued for 8 quarters in a row since Lehman first exposed this criminal activity. Sure enough, another company just went bankrupt because of the SEC's gross and criminal negligence, incompetence, and overall corruption.
For the visual learners, here is what we charted and wrote two weeks ago, before virtually anyone had heard of MF Global.
Chart 1: cumulative Primary Dealers assets by week. The red line demonstrates the end of quarter asset holdings, and the arrow shows the Q3 end position. What is of note is that not only the PDs close Q3 with the smallest non-cash asset position in the entire quarter, but that their total asset holdings dropped from $291 billion on August 24 to $202 billion on September 28, a massive window dressing drop of nearly one third. What is also very notable is just how long the window dressing practice has been going on for. Naturally, the first week following the EOQ window dressing has seen the PDs promptly ramp up their asset holdings by a good $24 billion from the Q3 minimum of $202 billion to $226 billion. We expect this number to grow to nearly $300 billion in the coming weeks.
Chart 2: this chart removes any noise (and doubt) and shows just the minimum, maximum and end of quarter position of PD assets. There is absolutely no mistaking what is going on. Beginning in Q1 2008, with just one exception (Q3 2008, when Lehman blew up and killed the whole window dressing practice as PDs then had other more pressing concerns on their hands), every quarter PD asset holdings have closed their quarterly books with disclosed assets at or just near the quarterly minima, with min to max swings as large as $126 billion (Q4 2010). The past quarter saw the PD community liquidate assets into the quarter end to the tune of $93 billion from the intraquarter highs of $295 billion hit on July 27, 2011. If there was any Evidence A to be presented in a court of law, this would be it.
And here is where the Journal comes in:
In each of the past seven quarters, from late 2009 to mid-2011, MF Global's quarter-end borrowings were an average 16% lower than the quarterly average, according to the Journal's analysis. The quarter-end numbers were lower than the peak for each quarter by an average of 24%, according to the analysis.
For example, in 2010's third quarter, MF's short-term borrowings were listed as $18.7 billion when it reported to shareholders. During the quarter, however, those borrowings peaked at $28.4 billion—34% higher—and averaged $24.4 billion during the three-month period, according to the Journal analysis. Short-term borrowing typically pumps up risk-taking, allowing banks to make bigger trading bets.
Window dressing isn't illegal, but it can mask a financial institution's true levels of borrowing and risk-taking. That is an issue of particular concern with MF Global, where borrowings fueled large trades on European sovereign debt that helped lead to the firm's demise.
"Every quarter, seven quarters in a row, it's always lower," said Charles Mulford, an accounting professor at the Georgia Institute of Technology. "It sounds like they are actively managing their [borrowing] to see that the level is lower when they report to shareholders."
And so on.
Yet despite this persistent evidence presented by Zero Hedge, we are confident that the regulators will do nothing, and we are even more confident that another small to medium Primary Dealer will, as a result of this "enabling" behavior, file for bankruptcy within the next 3 to 6 months.
Thank you Mary Shapiro and thank uber-regulator, Ben Bernanke.