MF Global Report Shows Limits Of The “Just Write All Your Positions On Post-Its” Method Of Risk ManagementBy Matt Levine
There’s a new report out today describing how MF Global blew up, which is not to be confused with the other two reports describing how MF Global blew up, and really enough is enough. If you’re interested in how MF Global blew up, basically Jon Corzine decided to put all its money into ultimately-not-all-that-horrible peripheral European sovereign bonds with repo-to-maturity funding, and the markets moved against him and he faced huge margin calls, and MF Global couldn’t meet those margin calls and went kaput, and at some point between the margin calls and the kaput MF Global seems to have used some client money to meet the margin calls, and that was a no-no, etc. Read more here or here or here or in the report.1
Still the report does have fun new details about just what a mess MF Global was. This one may have boggled me the most:
The Company’s efforts to sell its Euro RTM portfolio suffered a setback when Abelow brought a representative of the investment bank Jefferies & Company (“Jefferies”) to meet with Corzine to discuss selling the portfolio. Corzine refused to meet with the representative because he was in the process of auctioning some commercial paper, and needed to complete the sales before the close of the London market. Consequently, no sale of the Euro RTMs was discussed with Jefferies at this time.
This was on October 26, a day before the downgrade that ultimately sparked MF Global’s October 31 bankruptcy. I am trying and failing to imagine another financial company CEO missing his last chance to sell off a position in the bond trading book because he was too busy pricing a CP deal. Most financial companies have, y’know, treasury departments to sell their CP, and bond traders to trade their bonds.
Also on October 26, this happened:
When she received a copy of the internal Daily Segregation Statement (“Segregation Statement”), [MF Global North American CFO Christine] Serwinski emailed [MF Global Assistant Treasurer Edith] O’Brien, asking for an explanation for a large negative Firm Invested in Excess balance and expressed concern about a $200 million inter-company transfer (described as a “loan”) from the FCM2 that had been made on October 27. O’Brien responded that the transfer was not a loan, saying, “‘Lent is a strong word’ I would state — Fail to return intraday funding compounded by Funding B/D Customer Wires.” O’Brien explained that the erosion of the Firm Invested in Excess from October 25 to October 26 was due to $80 million in outgoing securities customer wires and $290 million in two inter-company transfers that the Operations Department personnel in New York failed to repay, which decreased the balance by a total of $328 million.
Soooooo let’s never send emails like that okay? If Thing A gives Thing B a pile of intraday money, and Thing B forgets to give it back at the end of the day, is that a loan? I submit to you that loan is the nicest word for it; the alternative – failure to return intraday funding because of sheer carelessness or insolvency or whatever – is not, like, “oh fine glad we cleared that up.”3
But you can see why she sent the email, since the explanation for pretty much every MF Global cash flow was carelessness. The report is filled with details suggesting that no one at MF Global knew anything about what was going on ever:
The problems were apparent on August 21, 2011, when [MF Global Global4 Treasurer Vinay] Mahajan sought a basic report of monthly cash flows. Mahajan first turned to [CFO Henri] Steenkamp, to ask for a cash flow projection report. Steenkamp replied that although this was something the Company had always wanted, the Treasury Department did not have the ability to monitor cash flows and create such a report. He suggested that a Finance department employee, Aviva Nussbaum (“Nussbaum”), might be able to get Mahajan the information he sought. Mahajan emailed Nussbaum the next day, again seeking a basic report of monthly cash flows. The Finance Department could not produce even a high level overview of cash flows for a period of a month or two. Nussbaum responded that the complexity of the business did not allow the Finance Department to create such a report and that the Finance Department did not have the systems to generate it. Mahajan continued to push for the information, but ultimately never received it before Holdings Ltd. and FinCo filed for bankruptcy.
Umm? Everything is like this; one executive describes MF Global’s treasury function as a “hodgepodge of systems and processes without a design.” Nobody could predict leverage, funding, capital, cash flows, anything, and everything had to be done manually because the systems didn’t work together. One example:
Unlike other financial institutions, the Company did not have a collateral management database to guide Treasury and Operations Department staff on which securities could be pledged to satisfy the conditions of the repo financing agreements. It also did not have a system that automatically identified which customer securities could be pledged. Instead, the Company would select collateral manually, enter the CUSIP numbers for the securities directly into the clearing bank’s technology platform, and then learn post-allocation whether the collateral selected was acceptable under the terms of the relevant agreements.
MF Global got its funding by just sending out all its securities and seeing if any money came back. One day, it didn’t.
A parlor game in picking through the MF Global pieces is psychoanalyzing Jon Corzine, who clearly liked his risk and was not much for delegation. This new report provides plenty of ammunition for Corzine-as-rogue-trader theories; he pretty much ran over his risk manager and then there’s that thing with the commercial paper auction. You run a multinational corporation where one guy makes all the decisions, you’ll get some bad decisions.
But as a blogger and thus a narcissist, I prefer to psychoanalyze Corzine starting with myself. Why am I so into financial systems, like synthetic prime brokerage and DTCC, that abstract away from the grubby business of actually holding and keeping track of particular securities?
- running your risk management on a hand-inputted Excel spreadsheet was a no-no, but
- it’s not too surprising, even at a well-run bank like JPMorgan, since everyone’s risk systems are sort of kludged together on Excel.
But everyone I’ve talked to who once worked at Goldman Sachs and then went somewhere else5 had a slightly different reaction, roughly:
- sure, everyone’s risk systems are sort of kludged together on Excel,
- except at Goldman, oh do I miss it.
I have no particularly systematic evidence of this but it does seem to be the case that Goldman has long been ahead of most banks in terms of having a unified system tracking every position and feeding into risk, funding, collateral, etc. systems, in a single glorious whole that allows traders to see the big picture all the time without having to worry that the details are getting screwed up somehow.6
You can imagine some psychological consequences of this.7 A financial career spent with well-integrated data systems and strong back-office processes might, for instance, make you … somewhat unsuited to Jon Corzine’s job at MF Global, which per this report was basically to bring its systems into the modern age.8 Corzine’s era at Goldman was pretty long ago, and perhaps things were different, but I’d guess that, compared to everyone else at MF Global, he was more used to things just working – that his career as a trader and manager of traders involved, y’know, trading and managing trading risk rather than constantly trying to figure out who had the handwritten list of CUSIPs that the clearing bank would fund.
And then he found himself at a place basically run on an HP-12C and a Post-It pad. “I think European sovereign risk is mispriced,” he said to himself, correctly. “I’ll just go put on some of that exposure: as long as my thesis is right, everything else should take care of itself.” Some places, that might have worked. MF Global was not one of them.
Report of Investigation of Louis J. Freeh, Chapter 11 Trustee of MF Global Holdings Ltd. [via WSJ]
MF Global Trustee’s Report Blasts Former CEO Corzine [WSJ]
Report Hints at Possible MF Global Suit [DealBook]
1. I found this chart particularly impressive:
Lotta Euro bonds.
2. I.e. from the regulated, customer-funds-filled future commission merchant to the cowboyish Euro-repo-to-maturity-filled broker-dealer.
3. “I see you’re driving Edith’s car. Did Edith lend it to you?” “No … no … I just … have it.”
4. I believe the double-”Global” is correct, though I don’t know if he called himself that. I certainly would have.
The Goldman Sachs risk system is called SecDB (securities database), and everything at Goldman that matters is run out of it. … Database replication was near-instant, and pushing to production was two keystrokes. … Regtests ran nightly, and no one could trade a model without thorough testing (that might sound like standard practice, but you have no idea how primitive the development culture is on the Street).
I have seen tears well up in grown men’s eyes at the mention of TSDB and Slang.
Incidentally Matthew Taylor – the guy who amassed a rogue $8.3bn e-mini futures bet – kind of supports this theory? Taylor seems to have fabricated trades starting in late November 2007, and exceeded his risk limits on December 13; the morning of December 14, he was harassed by his bosses and by employees from Controllers, Operations, and Market Risk Management & Analysis, and he confessed by that afternoon. Kweku Adoboli lasted for years.
7. For one thing, it might encourage thinking in abstract exposures rather than individual positions – if you can see instantly how much delta [the model says that] your book has to any variable that interests you, you might get an inflated idea of your ability to fine-tune your exposures by adding more complex positions. (You can get this inflated idea even with less advanced systems, of course, and many people do; for instance, it was a big part of the Whale’s problem – taking model Greeks too literally, and “reducing his risk” by adding offsetting positions that turned out to be illiquid rather than by just cutting notional.) That might be my problem.
8. The report notes that the board had concluded that being “a voice-brokered FCM in a low interest market was a failing business model,” so they hired Corzine to transition into a full-service investment bank. Then they hired the Boston Consulting Group “as a consultant to evaluate Corzine’s vision,” and BCG knew what was up:
One of several key initiatives BCG identified was the build-out of a “robust risk management infrastructure, including platforms, tools, policies, and procedures for both market making and principalling.” BCG recommended shoring up operations and information technology and providing greater management information systems and transparency through tools and processes in the Finance Department. BCG identified infrastructure-related enhancements such as risk compliance and organizational restructuring as a priority for the strategic plan.
And then they left and guess what happened?