This week in The Institutional Risk Analyst we published a comment on the ongoing financial genocide at MF Global, “MF Global: Where's the Cash?” http://us1.irabankratings.com/pub/IRAstory.asp?tag=515
The comment correctly identifies the location of the “missing” $1.6 billion as JP Morgan Chase and other bank custodians of MF Global. The trouble is that even though we now know where the missing customer money has gone, namely JPMorgan, there is little chance that the defrauded customers of Jon Corzine will ever recover a dime.
Here’s the link to a video by William Rochelle of Bloomberg News explaining how the safe harbor in Section 546(e) of the Bankruptcy Code likely will prevent MF Global customers from ever getting their $1.6 billion back -- even when it’s located, as it has been evidently.
When Bill recorded the video, the bankruptcy trustee hadn’t yet raised the loss estimate from $1.2 billion. In case you’re wondering why Bill is so knowledgeable about bankruptcy law, he was head of bankruptcy litigation at Fulbright & Jaworski in New York before he decided to take up journalism.
What people need to understand is that like the case of WorldCom, the MF Global bankruptcy illustrates the way in which the large Wall Street banks have used their Washington lobbyists to encroach upon the rights of investors. Even if it were proved that John Corzine and his colleagues committed criminal violations of the Uniform Securities Act and state law, there is little chance that the investors in MF Global will ever receive equity and justice. Again, read the WorldCom case.
The problem here is that the existing laws against pillaging customer accounts and other acts of fraud are in conflict with the bankruptcy statute designed to make the world safe for large banks and over-the-counter derivatives. Specifically, the post 2005 bankruptcy laws prohibit trustees from clawing back the $1.6 billion in stolen customer funds. Indeed, the Bankruptcy Court and trustee are precluded from pursuing the banks just as the trustee in the Madoff fraud has likewise been stymied.
In addition to the clients of MF Global who were apparently defrauded, the big losers in this mess are the smaller independent broker dealers who have acted as custodian of client funds. Once institutional customers understand that they have no rights in the event that management of a small broker-dealer absconds with client funds to pay bank margin calls and a broker-dealer fails, the ability of independent dealers to hold customer funds is going to evaporate.
Purely as a matter of due diligence, no fiduciary will ever again be able to use a US-based broker dealer as a custodian. To do so would be reckless and would expose the fiduciary to claims of negligence in the event a loss similar to MF Global occurred.
Until the Congress rectifies the current bankruptcy laws and allows trustees to claw back payments made to secured lenders and other counterparties, there is no reason for any rational personal to allow a broker dealer to hold securities in custody. All of this business will go to the big banks, who will be just as happy to see the smaller dealers thrown into the meat grinder.
Now why, you may be wondering, did the lobbyists from the big banks push Congress to expand the safe harbor for secured parties in the bankruptcy code? As one former Bush II Treasury official told me last night: “The canard the banks used to get 546 amended was that overriding the trustee's normal avoidance powers was said to be necessary to limit systemic risk and ensure access to credit. God forbid the banks be required to do some due diligence. As the bailouts showed, the systemic risk was in fact enhanced by the changes to the bankruptcy code and the illusion of superior claims to collateral, thus increasing leverage.”
The MF Global bankruptcy provides yet more evidence that the 2005 bankruptcy reform legislation passed by Congress is an abomination, but the cancer goes even deeper than the years of Bush II. The big banks who earn the lion's share of their profits in the quantum world of derivatives are literally looting the real economy and real investors, all with the full approval and complicity of the Fed.
Fred Feldkamp, learned securities counsel and expert on RMBS, put the problem in perspective:
"Greenspan proved his total ignorance of the current state of the law when he stupidly eliminated regulatory restraints on fraud saying there was no need for regulation because "fraud is self-regulating." The "Supremes" don't "get it" as of now and Congress precluded just about every other means for controlling fraud between the last 2 years of Clinton and the 8 years of Bush II. It took a decade (1929-1938) before the Supreme Court woke up to the Great Depression's root cause (fraud of the 1910s to 1929). Blaming Obama for this is understandable in one sense, but overly simplistic."
It may be overly simplistic to blame President Obama for the financial mess, but don't think that this president won't throw Jon Corzine to the wolves to make political points. "Jon Corzine is not well-liked in Washington," one veteran republican operative told me over dinner tonight. "Don't be surprised if we see a high profile prosecution of Corzine by the US Attorney to prove Obama is distancing himself from the big banks."