MF Global And LTCM

Here’s another interesting MF Global observation.  MF Global went bankrupt for almost the exact same reason as Long-Term Capital Management (LTCM)!

LTCM was heavily using leverage.  They exploited negative interest rates to profit.  They borrowed cheaply and did arbitrage trades.

However, LTCM’s model assumed “No government will default on its bonds.”  That assumption was false.  Russia defaulted.  LTCM imploded.  With huge leverage, LTCM was going to default on its bonds.  There was a bailout arrangement, where big banks stepped in to prevent a default by LTCM.  LTCM’s creditors were big banks.  Via excessive leverage and derivatives, LTCM controlled assets with much greater value than LTCM’s equity.

Jon Corzine did the exact same thing!  He did it explicitly and directly, rather than via complex derivatives like LTCM.  Jon Corzine bet that there would not be a default on European government bonds!

There was not a technical default on those bonds.  However, the market value declined due to default risk.  MF Global was hit with margin calls on its repo-to-maturity accounting trick.  That was essentially a mark-to-market charge.

Jon Corzine raided customer money to make the margin call.  If European bonds had recovered, MF Global would have mad a huge profit.  Jon Corzine would have paid himself a *HUGE* bonus for his brilliant trade.  Nobody would have ever known that customer money was stolen.

Instead, the value of the European bonds tanked more than Corzine thought possible.  Even after stealing customer money, MF Global went bankrupt.

Those European bonds still haven’t defaulted yet.  They were sold at a huge discount to JP Morgan Chase and other insiders, further robbing MF Global customers.  If Corzine could have kept the scam going, and those bonds didn’t default, then Corzine would have made a nice profit and bonus.

That is an amusing analogy.  MF Global went bankrupt for the exact same reason as LTCM.  LTCM’s fancy model assumed that governments would never default on their bonds.  Jon Corzine bet his customers’ money, that there would not be a default on European government bonds.  It’s exactly the same thing.  The only difference is that LTCM was gambling other banksters’ money, so there was a bailout arrangement.  Corzine gambled his customers’ money; too bad for them.

The State explicitly encourages fraudulent and risky behavior.  Negative real interest rates give an incentive to load up on as much leverage as you can.  Limited liability incorporation gives executives a free put option to declare bankruptcy and cheat creditors/customers.  Once MF Global was in financial trouble, the incentive is to take bigger riskier bets, and rob customers.  If necessary, you can default via bankruptcy.

Negative real interest rates mean that you’ll profit eventually, *PROVIDED* you can keep the scam going.  In the recent financial crisis, most big banks were technically insolvent.  There were allowed to keep operating, and inflation eventually bailed them out.

These are periodic, regular financial disasters.  The Statist lie is “These are isolated bad apples.”   That is false.  It’s a systemic flaw, put there by design.  There’s LTCM, Lehman Brothers, MF Global, Enron, and others.  These disasters will keep happening, as long as there’s only fake reform and not real reform.

Two key State evils encourage crimes like this.  First, limited liability incorporation encourages fraud.  Executives have a free put option to declare bankruptcy and cheat creditors.  Second, negative real interest rates encourage insiders to load up on leverage.  This evil involves paper money, a central bank credit monopoly, and negative real interest rates.  If you load up on leverage and wait for inflation, you will profit eventually.  This provides an incentive to cover up problems and insolvency, because you will eventually be bailed out via inflation.

That is an amusing analogy.  MF Global failed for almost exactly the same reason as LTCM.

One Response to MF Global And LTCM

  1. Anonymous Coward January 7, 2012 at 2:02 pm

    I went for an interview at a hedge fund several years ago. The hedge fund didn’t have the courtesy to even get back to the recruitment firm that had placed me there for the interview. I did think this was a bit rude as you effectively waste the better part of a day traveling to an interview.

    My strengths are primarily in programming. I have worked indirectly for banks but in the field of credit card processing. I know practically nothing about financial derivatives. The hedge fund should have realized this from my resume/CV. However they solely asked me questions about financial derivatives and interest rates rather than software. I found this a bit of a waste of my time as it does not show my strengths.

    * Anyway my point is that I remember the interviewer gleefully saying that government debt/bonds are good as the government never defaults as they can always print more money. This is a bit of a cheat though as it causes inflation. Well it depends where the money ends up and how fast it gets spent. Money locked away in a suitcase won’t cause inflation. Money being spent will cause inflation over time.

    Ha! I can pay my debts to you as long as you wait for my printer to print it afresh and from nothing.

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