MF Global filed for bankruptcy on Monday. There are several interesting points.
This isn’t the first time and it isn’t the last time that a bank failed. MF Global was medium-sized. It isn’t a huge monster like Goldman or Citigroup or Bank of America. However, it is big enough to cause some damage. This isn’t big enough to place the entire financial system at risk, but it’s really bad news for MF Global customers. Perversely, it was bad for MF Global customers and creditors that MF Global was big, but not “too big to fail”.
If you were a MF Global customer, you are SOL after the bankruptcy. It you have a brokerage account with MF Global, either directly or through a smaller broker, then you may be in trouble. Your account may be frozen for awhile, limiting your access to your capital and your ability to trade.
MF Global had two important businesses. First, they managed other people’s brokerage accounts as broker-dealer, including clearing. Second, MF Global’s executives were speculating with the firm’s money and their customers’ money. This leads to “WTF? Repealing Glass-Steagall was stupid!”
If you manage customers’ money as a broker-dealer or for clearing, then you shouldn’t be allowed to also speculate with the firms’ own money. This is also the “Volcker Rule”, which the banksters lobbied against and successfully crushed. If you act as clearing or broker for others *AND* gamble with your firms’ own money, then your broker-dealer customers are exposed to the risks of your speculative trades. In effect, your clearing and broker-dealer customers are bankrolling your gambling. The banksters like speculating with other people’s money, because that’s a key component of the bankster scam. You take risks with other people’s money, and you make a big bonus when you’re right, and you declare bankruptcy and default when you’re wrong.
This story illustrates how MF Global customers were screwed over by the bankruptcy. Suppose you were a brokerage customer that cleared through MF Global, either directly or through another broker. Suppose you owned cattle futures on the CME, purchased via my MF global account. When MF Global declares bankruptcy, your account is frozen. If you want to buy or sell cattle futures, you can’t do that because my account is frozen. If you’re long cattle futures but the price tanks, then you’re unable to sell. (However, they did later allow closing transactions. You won’t be able to create new positions until you transfer your account to another broker and free your frozen assets.) If you had capital on deposit with MF Global, that’s frozen until the bankruptcy is partially resolved. You may have to get in line with all the other creditors in bankruptcy court, to try and recover your investment. Even if you have a segregated account with MF Global, you may not recover 100% or your account may be frozen for awhile.
MF Global executives weren’t just speculating with their own money. They were speculating with their customers’ money. If you were a large MF Global customer, you may not recover your investment.
The Federal Reserve and SIPC all decided to crack down on MF Global. The Federal Reserve can prevent the bankruptcy of any bank, by lending them more and more money at 0% interest. If you can lend people money at 0% by printing new money, then the bankruptcy of any bank can be put off indefinitely. The Federal Reserve can buy worthless assets from the bank, and then push the loss on to the Federal Government’s balance sheet, indirectly via the Federal Reserve “negative liabilities” trick.
Here’s what happens when a bank goes bankrupt. Regulators get together from the Federal Reserve and SIPC and FDIC and SEC and DTCC and others. They all decide “We’re not lending MF Global any more money!” This naturally leads to immediate bankruptcy, when their line of credit is revoked. A group of regulators make the call “Bailout, or no bailout!” In the case of MF Global, the regulators voted “no bailout”. Frequently, when regulators vote “bailout”, they subsidize another bank’s purchase of the failing bank. For example, when JP Morgan Chase bought Bear Stearns, the Federal Reserve gave JP Morgan Chase a put option, limiting potential losses. Even if that option was not exercised, it still was very valuable for JP Morgan Chase.
If the Federal Reserve wanted to bail out MF Global, they could have printed new money and lent it to MF Global at 0%, no matter how bad MF Global’s balance sheet actually was. The Federal Reserve wouldn’t even have to publicly disclose that they lent MF Global money. The only limit is that, if they are too flagrant, then Ben Bernanke and others wouldn’t be able to speak on TV without laughing. Also, if the Federal Reserve lends 0% free money to every insolvent bank, then they’re encouraging more reckless behavior.
There’s another “perk” of not bailing out MF Global. MF Global is now forced to liquidate at fire sale prices. Other bigger banks can pick up MF Global’s assets at a discount.
Due to SIPC insurance, an MF Global customer has their position guaranteed up to $1M. HOWEVER, you may not be allowed access to your capital for awhile. In the meantime, the value of your positions might decrease. If you have a segregated account, you may or may not recover 100% in bankruptcy. Even in a segregated account, it may be frozen for awhile. Also, SIPC insurance isn’t free. It’s paid via a tax on brokerage accounts. I pay higher brokerage fees, because some MF Global customers and Madoff cusotmers got a bailout.
What happened to MF Global? MF Global executives made a big bet on European bonds. That bet turned out to be wrong. If they were right, then they would have made huge profits and paid themselves a huge bonus. When they were wrong, they declare bankruptcy and default. The executives aren’t forced to give up any of their personal possessions, to pay for the loss. The executives aren’t forced to pay back last years’ bonus check or salary.
Limited liability incorporation encourages MF Global executives to take unreasonably big risks. If their bet was right, then they would have paid themselves a huge bonus. When they are wrong, they default via bankruptcy and then go get another job. Given those odds, why not take as big a risk as you can? You get to keep the money when you gamble and are right. You cheat your creditors via bankruptcy and limited liability when you’re wrong.
Imagine if you could gamble in a casino, knowing that the taxpayers will cover any loss but you get to keep any profits. If you can do that, why not make the riskiest bets you can?
The losses for MF Global are borne by creditors, bondholders, and brokerage customers. The SIPC may make a payout, with money stolen from other brokerages via taxes.
As a customer, you can’t know ahead of time which banks are about to go bankrupt. You don’t know which banksters are taking big bets and losing. At any time, the management of a big bank can decide to start taking big bets, and bet wrongly. The incentive is for management to risk their customers’ money.
These “too big to fail” banks could not exist in a really free market. The Federal Reserve keeps interest rates negative, funneling money to big banks and the Primary Dealers. If interest rates are 0% while true inflation is 20%-30%+, then that’s a huge bankster subsidy. When you have a principle of “too big to fail”, then you’re forced to only do business with banks that are “too big to fail”. If you use a bank that isn’t “too big to fail” like MF Global, then you risk being cheated in bankruptcy. It’s much less risky to be a Citigroup or Goldman Sachs customer, because you know that they will always get bailed out. However, the principle of “too big to fail” can be temporarily suspended at any time, as occurred with Lehman Brothers.
There is no “limited liability incorporation” in a really free market. The US Supreme Court made a big mistake in the late 19th century, when they decided to allow limited liability incorporation and give corporate executives the same (i.e. more) rights than individuals. It was a huge amendment to the Constitution, allowing limited liability incorporation.
Most of the bank disasters in the late 19th and early 20th century were due to limited liability incorporation, combined with fractional reserve banking fraud. Those banksters were using the MF Global profit model. They gambled with customers’/depositors’ money, making huge profits when they were right and defaulting via bankruptcy when they were wrong.
Imagine if MF Global’s shareholders and executives were *ALL* personally and jointly liable for the loss. Then, they would have been much more careful. Limited liability incorporation rewards risky behavior. You get to keep the profits when you gamble and win, and you default via bankruptcy when you gamble and lose. With limited liability incorporation, the incentive is to lie about the state of your finances and lie about your balance sheet and lie about what risks you’re taking. If your a good liar, then you can convince people to lend you more and more money, giving you a chance to get lucky and become solvent again. If MF Global’s management were honest, customers would have started moving their accounts months ago, avoiding their current disaster. By lying, MF Global’s management got to keep gambling and hoping to get lucky.
With limited liability incorporation, it makes no difference if you go bankrupt with a net worth of -$1 or -$10B. Therefore, the incentive is to cover up problems and then cheat your creditors. When you do file for bankruptcy, your creditors and customers are stuck with a huge loss. Without limited liability incorporation, management of a nearly-bankrupt corporation would start deleveraging and returning money to customers. Knowing that you would be personally liable in bankruptcy, you would act more responsibly.
The MF Global disaster was 100% created by the State. The spin is “It’s just one bad apple. MF Global was shut down. Therefore, everyone else is behaving nicely.” That is false. It’s a symptom of widespread systematic corruption. The two biggest factors are limited liability incorporation and negative real interest rates. Limited liability incorporation gives executives a free option to default and cheat creditors. Negative real interest rates provide an incentive to load up on as much leverage as possible.
If you were an individual that speculated on a home during the housing bubble, you lost your home and your savings. When MF Global’s executives speculated and lost, they get to keep all their personal assets and savings. They will use their bankster political connections to find another cushy job.
Jon Corzine had a hand in the disaster. He’s a former governor and former Goldman Sachs CEO. When you’re stealing money via the State banking scam, it helps to have strong political connections.
Limited liability incorporation gives management a free put option to declare bankruptcy, default, and cheat customers/creditors. Limited liability incorporation is an abomination and should be eliminated. The Federal Reserve is also an abomination. Inflation is theft. The Federal Reserve is one big price-fixing cartel, fixing interest rates, the price of money. The Federal Reserve keeps interest rates negative. This gives the banksters an incentive to load up on leverage and make big bets. They know that they get to keep the profits when they’re right, and cheat creditors via bankruptcy when they’re wrong. MF Global’s losses will fall to customers and bondholders and the State/taxpayers. MF Global’s executives weren’t gambling with their own personal money; they were gambling with customers’ money. Customers suffer from frozen accounts, and they may not recover 100% in bankruptcy. The doctrine of “too big to fail” means that you should never do business with a bank that isn’t “too big to fail”. The other banksters are going to make a nice profit off of MF Global’s bankruptcy, when MF Global is forced to liquidate at fire sale prices.
The MF Global disaster was 100% created by the State. It could not happen in a really free market.