MF Global And Repo-To-Maturity

MF Global went bankrupt. $600M of customer funds were missing.  Even though most accounts were transferred, any equity may be lost and tied up in bankruptcy court.  For example, if you owned 1 gold future and had $20k of equity, you may have been able to move the future, but not the $20k equity.

Will prosecutors go after Jon Corzine, MF Global’s CEO? Will they prosecute MF Global’s CFO? Given the large anti-bankster sentiment, I don’t see how they can avoid it. After declining to prosecute Lehman Brothers for accounting fraud, it would be embarrassing if they also declined to prosecute Corzine.

I thought that it would be a slam-dunk easy conviction, to convict Dick Fuld for the Repo 105 accounting fraud.  However, the correct bribes were paid, and there was no prosecution.

If I had 5 minutes to explain it to a jury, I could easily convince them to convict Jon Corzine.  Here’s all a prosecutor needs to tell a jury, to get them to vote “guilty”.

MF Global was both acting as broker for customers, and gambling in the markets. Customer money is supposed to be segregated. That law goes back to the Great Depression. Corzine stole $600M of customer money, and used it to make losing bets in European bonds.

MF Global committed accounting fraud in the months leading to bankruptcy. They used “window dressing” to make their balance sheet look good at the end of each quarter. They used the “repo-to-maturity” accounting trick to hide losing bets on European bonds. Therefore, you should find Corzine guilty of violating Sarbanes-Oxley.

Here is a source for the law that says “customer accounts must be segregated”.

Investigators are also still trying to track down $600 million in missing customer money that should have been placed in segregated accounts – another potential avenue for criminal charges if the money was misused. The Commodities Exchange Act, 7 U.S.C. § 13(a)(1), makes it a crime punishable by up to 10 years imprisonment for anyone associated with a commodities dealer

to embezzle, steal, purloin, or with criminal intent convert to such person’s use or to the use of another, any money, securities, or property having a value in excess of $100, which was received by such person or any employee or agent thereof to margin, guarantee, or secure the trades or contracts of any customer or accruing to such customer as a result of such trades or contracts or which otherwise was received from any customer, client, or pool participant in connection with the business of such person.

That article also pointed out that MF Global sold $325M in bonds in August 2011, shortly before declaring bankruptcy.  Did Jon Corzine lie about the state of MF Global’s books, when he sold those bonds?

“Window dressing” is when a corporation does accounting tricks, to present a favorable end-of-quarter balance sheet snapshot. One example is Lehman Brothers’ “Repo 105″ trick, used to hide losses.  Another example is repo-to-maturity, which is Corzine’s spin on the usual off-balance-sheet accounting tricks.

Here’s where Jon Corzine and Dick Fuld say “Every big bank uses accounting tricks.  We only got caught because we filed for bankruptcy.”  Just because every big bank is committing fraud, doesn’t excuse you for doing it.

This is a defect in the accounting rules. A corporation should be required to report daily cashflow, rather than merely an end-of-quarter snapshot. There is no chance that rule will be changed. CEOs and banksters love accounting rules that have exploitable loopholes.

Corporations only provide an end-of-quarter snapshot, and not a daily cashflow report.  That encourages CEOs and CFOs to play accounting tricks.  At the end of each quarter, you do some tricks to make your balance sheet snapshot look good.

MF Global made “repo-to-maturity” trades. These trades are almost identical to the “Repo 105″ trades that Lehman Brothers made.  Here is another explanation.

A “repo-to-maturity” trade has no economic value. The only “benefit” is that assets are moved off-balance-sheet, enabling the CEO and CFO to hide losses.

In a regular repo trade, a bank borrows money for a few days. Rather than sell assets and incur a transaction fee, the bank does a repo. The bank sells $1.03B of bonds for $1B, and agrees to buy the bonds back a few days later for $1B plus interest. Typically, Treasury debt is used as collateral, but any asset can be used. This trade is virtually risk-free for the lender, because the lender has collateral that can be sold in the event of a default.

In a repo-to-maturity trade, the repo lasts until the bond matures.

Here is an example.  MFG buys $1B of Italian bonds, yielding 5%.  MFG does a repo-to-maturity trade with Y, at a rate of 1%.  MFG gives Y the $1B bonds, and Y gives MFG $1B cash.  MFG pays Y 1%, and Y pays MFG the coupon on the Italian bonds.  When the bond matures, MFG gives Y the $1B back, and Y gives MFG back the bonds.

Isn’t that silly?  What’s the benefit?  Why should MF pay the fee of 1% to Y?

The “benefit” of repo-to-maturity is that the Italian bonds are now on Y’s balance sheet instead of MF Global’s balance sheet.  It’s a pure accounting gimmick.  The repo-to-maturity trade has no economic value.  It only lets MF Global lie about its balance sheet.

Another “benefit” is that repo-to-maturity lets MF Global load up on leverage and profit.  It can use the $1B proceeds from the repo trade to finance other bets.  If all goes well, MF scalps a profit of 4% times a huge leverage ratio.

Also, MF Global was a Primary Dealer.  This gave MF Global an incentive to load up on leverage and buy European bonds.  MF Global borrows at the Fed Funds Rate, and buys higher-yielding European bonds, making a practically guaranteed profit.

Even after the repo-to-maturity trade, MF Global is still on the hook for losses, if the bond defaults.  Also, MF Global is on the hook for margin calls, if the market value fo the bonds declines.  That’s what sunk MF Global, the margin calls on the repo-to-maturity trades, as European bond prices crashed.

That’s how this repo-to-maturity trade ended in diaster.  MF Global was hit with margin calls, as the market value of the European bonds declined.

Also, once MF Global’s credit rating was decreased, its cost of borrowing increased.  It was so bad that nobody wanted to lend MF Global money anymore, and the whole scam unraveled.

For a regular repo, it only lasts a few days.  There’s usually no need for margin calls.

For repo-to-maturity, the trade can last years.  The counterparty to the repo (Y in the above example), gets to demand extra margin calls, if the value of the collateral declined.

The European bonds did not technically default (yet), but their market value declined.  MF Global had to make margin calls on the repo-to-maturity trades.  At some point, MF Global ran out of cash and stole $600M of customer money.  This eventually led to bankruptcy.

If MF Global could have avoided bankruptcy *AND* the bonds didn’t default, then MF Global would have made a huge profit and Corzine would have paid himself a huge bonus for his brilliant leadership.  They would have made a lot of money from high leverage, borrowing cheaply from the Federal Reserve and buying higher-yielding European bonds.

The “repo-to-maturity” trick enabled Jon Corzine to lie to investors and regulators.  It enabled him to present a better-looking balance sheet than it actually was.

The scam unraveled when MF Global couldn’t make margin calls, as the value of the European bonds declined.  If the bonds were directly on MF Global’s balance sheet, they would have been forced to mark-to-market as the bonds declined.  With repo-to-maturity, there was no mark-to-market loss *BUT* there were margin calls on the repo-to-maturity trade.

MF Global was a Primary Dealer.  This gave them an incentive to load up on leverage and buy higher-yielding bonds.  The Federal Reserve is responsible for the MF Global disaster.  By keeping interest rates negative, they give the banksters an incentive to load up on as much leverage as they can.

If prosecutors want to nail Jon Corzine, they should be able to win easily.  Jon Corzine was a high-ranking bankster, which might give him some immunity.  On the other hand, a lot of people are angry, which may force a prosecution.

The MF Global disaster is *NEARLY THE EXACT SAME THING AS LEHMAN BROTHERS*.  It’s a couple of years later, trillions of dollars in bailouts, and the banksters are pulling the same scam.  Why not keep stealing, if you keep getting bailed out and keep getting away with it?

There are two specific bad things that MF Global did.  First, they stole $600M in customer money, to pay for gambling on European bonds.  Second, they used repo-to-maturity and other accounting tricks to hide losses.  MF Global sold $325M in bonds while they were lying about their balance sheet.

4 Responses to MF Global And Repo-To-Maturity

  1. Thanks for the clear explanation and examples.

    Regarding “Jon Corzine was a high-ranking bankster, which might give him some immunity”. Prosecutors need to be reminded of the 100′s that went to jail over the S&L crises. Also of interest may be former exchange president Richard Whitney who went to jail for, like Corzine, the crime named embezzlement. Responsible citizens need to ask why these crimes are being selectively (if at all) prosecuted and demand action.

    If John Doe steals a hundred dollars from a bank, he goes straight to jail.
    If John Corzine embezzles up to $1.2 billion, he resigns and says “my bad.”

    • There was $600M of missing customer money. That figure was updated to $1.2B. That’s funny. They don’t even know exactly how much money was missing, even a month later!

      With $1.2B missing customer money and the repo-to-maturity accounting trick, it should be a slam-dunk easy conviction, if the prosecutor tries.

  2. According to Wikipedia, civil charges were laid just last month against Corzine for failure to maintain segregation at MF Global.

    It’s long enough after the fact that you could argue it won’t be a show trial. My fingers are crossed.

    • Insiders like Jon Corzine have their assets well-protected in trusts. Even if he loses the civil lawsuit, there won’t be any assets to seize. Also, even if he’s “barred from the financial industry”, there are plenty of other lucrative jobs available for insiders like him.

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