Here is the conventional wisdom on MF Global, which I’ve sort of defended when provoked:

[I]n many ways, it’s a very satisfying morality tale. We’re in this time of Occupy Wall Street, a lot of people are already dissatisfied with Wall Street in general, and this is moral hazard — excessive risk-taking. Here, the firm fails, it happens in an orderly way, it doesn’t take down the financial system and everyone feels that this is the way things are supposed to work. We’re not supposed to stop financial firms from failing, but if they must fail — due to their own actions — shouldn’t it be this way? In a way that doesn’t hurt too many other people?

Isn’t it pretty to think so?

The problem is that it hurts the heck out of some people – people like the MF Global customers who are “scrambling for money” because apparently someone at MF Global thought they were running an online poker site rather than a futures broker. Those people will probably get their money, I guess, but I suspect that they’re not as jazzed as everyone else about creative destruction, the free workings of the market, and slaying the beast of moral hazard.

And it’s not hard to feel some sympathy for them. MF’s finances were not totally transparent. Life is complicated and you have to make decisions at the margin not only with your money but with your attention. Rational ignorance can be, well, rational; I for example let other people worry about the Kardashians and spend my time on regulatory flowcharts. I’m quite certain that Western civilization would collapse if someone wasn’t keeping constant track of the mark-to-market on Kardashian nuptials, but it doesn’t have to be me. Similarly, if you trade commodity futures, you spend a lot of time diligencing your positions and thinking about – I’m gonna stick with soil erosion. Spending time worrying about the security of your brokerage accounts can be an annoying distraction from that – and, almost all of the time, will be less relevant to your returns than the soil erosion.

Many problems in the world come from people not understanding what level of diligence they’re supposed to exercise with different things. Rich people know they can lose a lot of money in angel investing but don’t expect their 10%-a-year, steady and stable, hedge fund run by a former head of Nasdaq to turn out to be a Ponzi – and they certainly don’t expect their fund-of-funds with its emphasis on due diligence and diversification to be just a front for a Ponzi. Companies know they’re supposed to do a lengthy due diligence process before spending $50mm on an acquisition, but can pretty casually decide to park $100mm in the nearest money market fund. Local banks know they’re supposed to have a certain percentage of their assets in AAA rated bonds but don’t want to do the credit work to figure out which AAA bonds.

If you were trading commodity futures in the last few years, a lot of things could have gone wrong. Like, your commodities could have moved against you. One thing that you were probably less focused on was that your CME member, CFTC regulated, SIPC insured futures broker would not only file for bankruptcy but also maybe forget where it put your money. In the future, you’ll be focused on it.

So the main fallout from MF Global probably isn’t going to be ruin at JC Flowers (out on $150mm face of preferred and also exposed, as are MF Global, the Treasury, and Dealbreaker, to volatility in the market for loving and/or hating Goldman alums), Jefferies ($9mm of bonds), or Fortress (“literally zero”).

The main fallout will probably be that if you have the choice to work with a too-big-to-fail bank or a just-small-enough to fail bank, on a whole variety of things, you’re going to go too-big-to-fail. Sure, there are lots of small brokers who are well capitalized and take the time to get the little things right, like segregating customer accounts. But how can you know unless you do a lot of diligence? Easier to just trust that a megabank squarely in the regulators’ sights will get it right – or, if they get it wrong, won’t be allowed to blow up in a way that blows up customers.

You can hear this from Jamie Dimon: he may think that capital surcharges on “global systemically important financial institutions” are un-American, but he also knows that “In some ways a G-SIFI will be a plus. You’ll win business that other people will have hard a time competing for us.” Increasing capital by a few hundred basis points for an official stamp of “customers are never going to have their positions shut down and their money spirited away in the dead of night” is a pretty cheap price to pay.

And you can sort of see it with BofA. That’s a behemoth big enough that a bankruptcy of any of its bits would be systemically challenging and might get government support – though Moody’s isn’t so sure. But, still, just to be on the safe side, wouldn’t you rather have your BofA derivatives with the FDIC insured bit rather than the broker-dealer bit that is protected only by the document-mangling crowd at the SEC and FINRA?

The easy answer is to say “well, in a first-best world, there would be no too big to fail government-backstopped banks” – or, alternatively, that those banks would no longer be risky because of Volcker or whatever. That is appealing when you talk about stockholders, and almost as easy when you talk about bondholders. Few will shed tears for those who bought MF Global bonds at 6.25% in August.

But it can’t really be true for customers. You do actually want a financial system where some decisions can be made without extensive due diligence. Rational ignorance is frequently valuable; we don’t want people to have to devote a lot of time to examining the books of their FDIC insured banks just to open a savings account.

I don’t think there’s an easy answer to this. Obviously the CFTC-SEC-FINRA-CME crowd could do a better job of checking that the dealers they regulate are actually segregating money rather than, y’know, not. And obviously SIPC and similar protections mean that most customers are going to be inconvenienced rather than exploded by MF’s meltdown. But still. This week we have a blowup of a non-bank, non-too-big-to-fail, $40-billion balance sheet broker-dealer, futures merchant and Fed primary dealer. Customer trading was disrupted, customer accounts were confused, commentators are saying “this is the way things are supposed to work,” and regulators and politicians are keeping relatively quiet to avoid seeming to be too close to the politically connected CEO of the company. That is sort of just the ticket to encourage everyone to move all their financial dealings to the top half-dozen banks whose political support is at this point explicit and, y’know, actually being paid for in capital requirements.

44 comments (hidden to protect delicate sensibilities)
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Comments (44)

  1. Posted by Alexsey Veyner | November 1, 2011 at 2:34 PM

    No Chart, Matt? Were you to busy in the gym today? Can you bench 400?

  2. Posted by Attention to detail | November 1, 2011 at 2:39 PM

    Matt with a decent tag FTW!

  3. Posted by Guest | November 1, 2011 at 2:52 PM

    Good article.

  4. Posted by PermaGuestII | November 1, 2011 at 2:55 PM

    If these guys actually did misappropriate customer funds, JSC, the Chief Risk Officer and the entire board of directors should be tarred, feathered and locked in a pillory at the corner of Wall & Broad, while the City of New York sells buckets of shit to throw at them.

    -Guy who thinks some 18th century punishments should be brought back

  5. Posted by Skimmer... | November 1, 2011 at 2:56 PM

    Holy crap! Kim Kardashian and Jon Corzine are engaged?!
    Signed – ADHD Guy

  6. Posted by Anonymous | November 1, 2011 at 2:56 PM

    Matt, could you start doing an executive summary section on your articles?

    For each paragraph you write, condense it to a sentence there.

    If we still care about it, we will read the rest of it.

    -Guy who doesn't care about MF Global

  7. Posted by Hmmm | November 1, 2011 at 3:04 PM

    Goatse with a beard?

  8. Posted by Chunk | November 1, 2011 at 3:05 PM

    Couldn't you just, you know…NOT read the MF Global article?

  9. Posted by MDN | November 1, 2011 at 3:10 PM

    And the market thought NOONE could could manage MF more poorly than Kevin Davis!

  10. Posted by Guest | November 1, 2011 at 3:13 PM

    You didn't see the pic of JC? He's clearly explaining the chart Matt sent him for this article.

  11. Posted by Cliff Notz | November 1, 2011 at 3:15 PM

    Jesus Christ Matt. Just do a pod cast………or CD box set from now on.

    Or are you writing that much knowing nobody will read the whole thing, and figure out you are really Greg Michaels after a year of honing your skills studying Investopedia.

  12. Posted by Jon | November 1, 2011 at 3:15 PM

    If that's an invitation to webcast my distended rectum, I'll only do it if Lloyd and Jamie watch too.

  13. Posted by The Legitimate Years | November 1, 2011 at 3:19 PM

    he looks so regal in that beard. grandfatherly, even. it's a age old technique to mask the forthcoming assfucking

  14. Posted by davidrusso | November 1, 2011 at 3:21 PM
  15. Posted by PMCO/1+(1-Tc)x(D/E) | November 1, 2011 at 3:24 PM

    No, but i can!

    -The Anal_yst

  16. Posted by Kegels123 | November 1, 2011 at 3:27 PM

    speaking of Kardashian, JSC's hands look like they are tracing the shape of her badonkadonk

  17. Posted by henry 8 | November 1, 2011 at 3:30 PM

    NOONE? The guy from Hermans Hermits?

  18. Posted by Anonymous | November 1, 2011 at 3:31 PM

    Matt is under the impression that Bess is paying him by the word…

  19. Posted by Guest | November 1, 2011 at 3:32 PM

    Actually Matt thought he was tracing a Venn diagram, which is why he used it.

  20. Posted by Anonymous | November 1, 2011 at 3:32 PM

    a wee bit small for that, he'd need to move his hands farther apart

  21. Posted by Kris | November 1, 2011 at 3:37 PM

    And closer to his face.

  22. Posted by Matt convert | November 1, 2011 at 4:24 PM

    Hey! If Matt wanted to be treated like a piece of crap, he would have stayed at GS. Take your attitude and hit the road, bud!

  23. Posted by Pres. JSC Fan Club | November 1, 2011 at 4:31 PM

    Being a** banged by JSC as a NJ resident then again as a MF shareholder is the NKI!!!

    -JSC Repeat Receiver

  24. Posted by debauched | November 1, 2011 at 4:32 PM

    Summmary: Corzine has done for MF what he did for NJ……I can't wait until the public realizes how much MF paid this worthless POS. He's taken the liberal mentality to the board room…with predictable results.

  25. Posted by login | November 1, 2011 at 4:36 PM

    I'm not knit picking this article but it is one of the more common mistakes to suggest SIPC is in any way involved with an FCM; your term " SIPC insured futures broker"

    The NFA, National Futures Association, is the auditor and self regulatory body in futures. There is no insurance. They scrutinize the customer accounts and firm capital which must be a minimum percentage of the "seg.". This is in addition to the exchanges, for exchange member firms. That being said there has never a default on a single customer segregated account by any NFA member FCM since the advent of the CFTC in the 70's. I very much hope and expect that this will not be allowed in this case either. ( the other member firms have an enormous interest in maintaining the integrity associated with the clearing process etc. )

    I realize futures have historically been a backwater, but the tail has begun to wag the dog in the last 4 or five years since the advent of electronic trade in virtually all the futures contracts. ( This effectively eliminated the Iras and Vitos of the world which plauged the open outcry based industry previous to that. )

    Sadly, your braoder point about hastening the demise of the smaller FCMs will almost certainly be true. Without question the ability to solicit large, "institutional " clients will be seriously hampered.

  26. Posted by guest | November 1, 2011 at 4:37 PM

    so you are claiming you can read now ?

  27. Posted by "Hello Chicago" | November 1, 2011 at 4:38 PM

    Good guy actually. He was burned by the Refco purchase in retrospect.

  28. Posted by Not Impressed | November 1, 2011 at 4:46 PM

    I pray to God it turns out MF Global just "borrowed" customer funds the last few days, and that's why the regulators didn't catch on… and accordingly, someone at MF Global will be serving time.

    If this turns out to be another Madoff-type scandal where the regulators simply didn't look at the FCM audits closely enough… that's seriously scary. That eliminates any confidence I have in the system.

  29. Posted by Ddddsd | November 1, 2011 at 4:53 PM

    You're fucked & Wollensky

  30. Posted by login | November 1, 2011 at 5:06 PM

    remember money/$ are fungible. An audit can be legit, " accounts " are really just journal entries, one day, and the funds can be "moved" the next.

    it is simply a snapshot in time.

    no question that with 7.2 bil sitting in the FCM, marked to settlement every day, ( CME,ICE, MGX, EURONEXT etc.) there must have been tremendous temptation to use some for collateral with the intent of moving it back as the positions they were collateralizing rolled of or improved.

    You'll notice that very little of that money was withdrawn last week even while this was breaking so there was no risk that it need be in both places, so to speak, to meet customer withdrawls/transfers.

    "Regulators" is on of those CNBC words, has no real meaning, SPECIFICS are needed for serious analysis.

  31. Posted by Malcolm the 10th | November 1, 2011 at 5:08 PM

    On a personal level, I found him to be pretty pompous and curt.

  32. Posted by Kris | November 1, 2011 at 5:11 PM

    It's pretty common for people currently out of work.

  33. Posted by PermaGuestII | November 1, 2011 at 5:12 PM

    Absolutely agree.

  34. Posted by davidrusso | November 1, 2011 at 5:28 PM

    SIPC is not a government guarrantee, but most definitely is there to provide up to 500K backstop to involvent B/Ds (that's why it's being correctly brought up in the context of MF Global).

  35. Posted by Nit-picker | November 1, 2011 at 5:47 PM

    NIT-picking. Not KNIT-picking. Sorry, just nit-picking.

  36. Posted by guest | November 1, 2011 at 5:48 PM

    Kevin ? Definitely not curt, jesus, he was effusive if anything. Especially once he had a few.

  37. Posted by login | November 1, 2011 at 5:58 PM

    It is being misused in this article and more broadly elsewhere. The broker dealer customer accounts were almost nonexistent, the BD itself was simply, in retrospect, a kind of superstructure corsine used to speculate in.

    The vast majority of customer accounts were futures accounts. ( 7.2 BIL US$ a/o 8/31 )


    SIPC has NOTHING to do with Commodity futures accounts or Futures Commission Merchants.

    Surely this is understandable ??

  38. Posted by Sally Joo | November 1, 2011 at 7:16 PM

    Matt, Duh! SIPC doesn't apply to FCMs. If an FCM blows up FCMs are supposed to step in and make customers whole.

  39. Posted by login | November 1, 2011 at 7:34 PM


    Much better said than my attempt, and that is what has always happened. It is in their interest to do so, and has historically been de minimus sums.

  40. Posted by joe | November 1, 2011 at 8:20 PM

    corzine is a Democrat, they won't oversee him. Democrats don't break the laws, they make the laws.

  41. Posted by Adam Smith | November 1, 2011 at 9:01 PM

    Letting the market wash the losers of the street is the NKI

  42. Posted by Guest | November 1, 2011 at 10:17 PM

    Interesting link… but seriously, MSNBC? I'd take a link to the Onion more seriously

  43. Posted by guest | November 2, 2011 at 2:17 PM

    Full Tilt SUCKS! having properly executed DJX puts is the NKI!
    Former Full TIlt player headed to Vegas this week, the fish are in the house.

  44. Posted by P. Ivey | November 2, 2011 at 3:29 PM

    Yo MF, I'm ready when you guys want to shoot an ad.