How times have changed for Jon Corzine.
Probably the most sage coverage of this saga comes from Roger Lowenstein writing for Bloomberg:
Thirteen years ago, when the hedge fund Long-Term Capital Management was desperately negotiating with Wall Street banks for a bailout, Jon Corzine, the chief executive officer of Goldman Sachs Group Inc. (GS), called John Meriwether, LTCM’s founder, and read him the riot act. Wall Street would invest, Corzine said, but “JM” would have to accept more controls, including strict supervision over his firm’s trading limits.
Corzine, I wrote soon after, “understood the flaws” at LTCM better than anyone. The firm had no controls over risk limits, no accountability to anyone who wasn’t a trader.
Essentially, Corzine forgot the lessons of LTCM‘s failed arbitrageurs, and went the hyper-leveraged Martingale path. The trouble is that unless you predict accurately, this kind of activity is a quick and easy road to bankruptcy. Leveraged 50:1, a 2% drop in asset prices can be a wipeout, and end in insolvency.
There are two key points, and one key question to take away from this:
- The American banking system is susceptible to a Euro-collapse — MF Global went down betting on a Euro-stabilisation. The web of derivatives extends across the global financial system, creating ever-growing fragility.
- None of the lessons of AIG and Lehman have been learned — the bailouts and stimuli saved a broken system, and allowed it to continue to be broken.
And the question:
- What effects will MF Global’s removal from the web of debt have on the financial system as a whole?
The first point is obvious (although Morgan Stanley will keep denying it, and focus instead on how Groupon is worth at least $100 a share). The second point has been obvious for a long time.
The question is much murkier. Is MF Global too big to fail without sending financial systems into freefall (a la Lehman)?
The answer seems to be “probably not”.
So far, the problems at MF Global appear to not be spreading to other banks. While MF Global has $40 billion in assets, it only owed about $2 billion outright to other banks. What’s more, more than half of that debt is owed to J.P. Morgan, which is one of the strongest banks around. There are other banks that are owed $6.3 billion from loans MF Global took out to make its Euro debt bets. But those debts are backed by the bonds that MF bought, and if they end up being good as Corzine claimed, then those banks should get their money back, as well as the profits Corzine hoped to pocket for his firm. MF Global does not appear to have the same type of derivatives exposure to other banks that led to the demise of Bear Stearns and Lehman Brothers.
Nonetheless, we will see what we will see when we see it.