SKARBECK: Bankruptcy shows how far financial system has to go

November 5, 2011

Ken Skarbeck InvestingThe failure of brokerage MF Global—the eighth-largest bankruptcy in U.S. history—is troubling: It demonstrates that behavior and incentives have not really changed in some corners of our financial system, and that regulators are still behind the curve.

Last year, MF Global hired consummate Wall Street and Washington insider Jon Corzine as its CEO. His vaunted career includes more than two decades at Goldman Sachs, including a stint as CEO, and nearly 10 years as a U.S. senator and governor of New Jersey.

Corzine’s employment contract with MF Global even provided that he would receive $12 million if he left the firm. This windfall clause apparently was added after rumors swirled that Corzine might be considered for Treasury secretary if Tim Geithner were to leave. Clearly, the company’s board thought shareholders and employees were lucky to have Corzine.

He set out to remake MF Global into a mini Goldman Sachs by taking greater risks. He ramped up leverage, borrowing $34 for each $1 in capital and placed an oversized bet of $6 billion on the debt of Spain, Italy, Belgium, Portugal and Ireland—but not Greece.

Things quickly unraveled. In June, regulators became concerned that MF Global had a huge position in European debt and requested that the firm boost its capital. In August, the company issued $325 million in bonds with a maturity of five years at 6.25 percent. Questions are now being asked whether the firm disclosed all material information in its offering documents.

Then, in late October, after a ratings downgrade on those bonds and an earnings loss of $186 million, MF Global’s bond prices sank to 35 cents on the dollar and its shares dropped below $1, down 78 percent on the year.

With the company’s brokerage customers fleeing, a final attempt to sell the firm to Interactive Brokers Group fell apart when client funds were discovered missing. MF Global filed for bankruptcy Oct. 31.

The FBI is investigating the apparent $600 million in missing client funds. Regulators are trying to determine if client money was misappropriated to support the firm’s proprietary trading.

Serious questions will be asked about the Federal Reserve’s role in overseeing MF Global. The firm was one of only 22 designated by the Fed as a primary dealer in U.S. Treasury securities. Considering the damage excessive leverage caused during the credit crisis, how did the Fed allow this meltdown to occur at one of its primary dealers?

In the end, MF Global was brought down by the same activity that has been the bane of our financial system in recent times: a reckless trader using excessive leverage. The failure of MF Global will cost shareholders and creditors billions and put 3,000 employees out of work.

While no taxpayer money will be needed to bail out MF Global, it appears we have a long way to go to insulate some of our financial institutions from a casino mentality in the executive suite. One solution to improve behavior would be to tie the CEO’s and the board’s net worth to their activities. That way if the firm fails, they also are left insolvent.•


Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or


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