• 30 Jan 2012 at 6:25 PM
  • Credit

MF Global Was Doing Great Until It Wasn’t

“Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone,” but every banker also seems to forget the modern corollary, which is that, if you have to prove you are worthy of credit, however good may be your arguments, don’t do it over email. Here’s someone who forgot that and does it surprise you to find his name in the same sentence as “House Financial Services Subcommittee on Oversight and Investigations”?:

A week before MF Global Holdings Ltd. collapsed, its chief financial officer told Standard & Poor’s in an e-mail that the futures broker had “never been stronger.”

S&P provided the House Financial Services Subcommittee on Oversight and Investigations with an excerpt of the e-mail from MF Global CFO Henri Steenkamp. S&P also informed the panel that Jon Corzine, then MF Global’s chief executive officer, met with its analysts on Oct. 20 to reassure them that his $6.3 billion bet on European sovereign debt was no threat to the firm, according to a Jan. 17 letter obtained by Bloomberg News.

U.S. lawmakers will turn their attention to the role of the ratings companies in the failure of MF Global at a Feb. 2 hearing after summoning Corzine, the former governor of New Jersey and Goldman Sachs Group Inc. co-chairman, to two hearings in December. S&P ranked MF Global as investment grade until its failure, while Moody’s downgraded it to junk status four days earlier.

“MF Global is in its strongest position ever,” Steenkamp told S&P on Oct. 24, according to the letter to Representative Randy Neugebauer, a Texas Republican, from Craig Parmelee, a managing director at S&P in New York.

Who can understand the workings of an MF Global? Not me. Apparently they had a money vaporizing device, which in its final days was being manned by employees not wholly familiar with its proper operation, and which caused some unpleasantness when it was aimed at clients’ money. Still to a first approximation it seems reasonable to think that poor foolish-sounding Steenkamp was basically right. MF Global had some assets and some liabilities and its assets exceeded its liabilities. It had a short-term reasonably safe bet on some European government bonds that proved reasonably profitable, and that bet was funded with matched-maturity funding that was reasonably stable until it wasn’t. Then everything went south, that matched-maturity funding was pulled, MF Global needed to sell assets and post more collateral to remain in business, and in the confusion someone accidentally turned on the vaporizer.

But from a casual observer’s perspective it seems reasonable to conclude that Steenkamp was more or less right in the boring old senses of “our assets exceed our liabilities by the most ever” and “our liquidity exceeds our current need for liquidity by the most ever.”* It’s just that, a week later, liquidity needs were rather higher than anticipated and asset values were harder than anticipated to realize. There is nothing new under the sun; banks look solvent until the run, and then they look insolvent. Implicit in Steenkamp’s email, or any pronouncement by any banker ever of the form “we are in awesome shape,” is the caveat “unless there’s a run on us.” Nobody survives losing all of their credit.

Of course nothing inspires a run quite like a lack of confidence, so people in Steenkamp’s job are in a rough spot. If they say “yeah, maybe we’ll survive, maybe we won’t, who can say?,” then they probably don’t survive. If they say “we are doing GREAT, thanks for asking!,” then their chances of survival improve, but not to 100%, and, conditional on non-survival, they dramatically increase their chances of having their email make it into a snarky headline and become fodder for congressional and/or criminal investigations. Good. Times. This feels like a corollary of the you-fuck-one-sheep theory of email management: not only can one negative email sink you if you’ve gone around saying how good a deal is; one positive email can sink you if you’ve gone around … well, filing for bankruptcy and losing $1.2 billion of client money.

To be fair, the congressional hearing isn’t about Steenkamp’s overconfidence. It’s about S&P’s and Moody’s overconfidence:

S&P did not alter its opinion of MF Global’s creditworthiness until October 26, less than a week before the brokerage failed on October 31.

Moody’s waited until October 24 to downgrade the company’s credit, more than seven weeks after MF Global disclosed that regulators required it to hold more capital against its European bet.

Members of Congress plan to quiz Moody’s and S&P executives about why the rating services were allegedly “overreliant” on MF Global to provide them with information, rather than conducting their own due diligence, people familiar with the matter said.

So, yeah, sure, fair questions. But not in the form “why did Moody’s only downgrade MF a week before it failed?” Moody’s didn’t “downgrade MF a week before it failed”; MF failed a week after Moody’s downgraded it – the downgrade started the vicious spiral of lost confidence and collateral calls that led to its failure. When dealing with highly leveraged financial institutions that rely on short-term credit, Moody’s and S&P have a magnified version of Steenkamp’s problem. As long as they say things are going great, the bank will probably more or less survive – but maybe not. To keep any credibility at all, the agencies have to occasionally be willing to downgrade a financial institution to junk even if before it has filed for bankruptcy. (This actually happens all the time outside of FIG. Go figure.) Doing so dramatically raises the risk of a run on that financial institution – which in turn dramatically raises the risk of a bankruptcy. Which raises to a near certainty the risk of a congressional committee saying “damn, Moody’s, why did you wait until a week before bankruptcy to downgrade MF Global?”

MF Global Said ‘Never Been Stronger’ a Week Before Failure [Bloomberg]

Ratings agencies to be quizzed over MF Global [FT]

* Again, from a casual observer’s perspective. It would also be reasonable to conclude that, given a September revolver draw, MF’s liquidity could not fairly be described as the best ever.

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Comments (66)

  1. Posted by ReaganLaw | January 30, 2012 at 7:11 PM

    "Members of Congress plan to quiz Moody’s and S&P executives about why the rating services were allegedly “overreliant” on MF Global to provide them with information, rather than conducting their own due diligence, people familiar with the matter said."

    'Due Diligence' – Can you use it in a sentence, please? May I have the language of origin, please? May I have the definition, please?

    - Moody's Exec.

  2. Posted by Dos Equis Quant | January 30, 2012 at 7:12 PM

    I don't often read multiple long winded, overly verbose financial blog posts but when I do, their Matt Levine posts.

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