MF Global Would Have Done Better To Misuse Government Money / Not Go Bankrupt

Publish date:

This doesn't seem to be much of a story and hey deservedly not:

The Federal Reserve Board on Monday issued a consent cease and desist order and assessed a $6 million civil money penalty against the Bank of New York Mellon (BNYM), New York, New York, a state-chartered bank that is a member of the Federal Reserve System. The order addresses allegations that BNYM breached certain representations and warranties made to Federal Reserve Bank of Boston in connection with BNYM's participation in the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF).

Boy is that boring. They breached certain reps and warranties! The actual story from the consent cease and desist order is maybe ever so slightly more scandalous but still pretty boring. BoNY participated in the AMLF,* which basically allowed banks to go buy asset-backed commercial paper from struggling money market funds and hand it to the Fed in exchange for cheap non-recourse loans against it. Cheap non-recourse funding is attractive especially if it is September 2008 and you are a bank, so BoNY did as much of that as it could, and also some that it couldn't. The total of (1) what it could do plus (2) what it couldn't do but did anyway was a little over $9bn - just for the first day of the AMLF (22-Sep-2008). The balance between (1) and (2) is not clear; the consent decree just says:

Due to a failure in its internal processes at that time, a portion of the ABCP collateral that BNYM had pledged to the Boston Reserve Bank was ineligible under the terms of the AMLF. As a result, BNYM received more in AMLF loan proceeds than it otherwise would have been advanced based upon the eligible ABCP collateral it pledged.

So honest mistake, except also:

[O]n September 22, 2008 and thereafter, BNYM identified but did not communicate to the Boston Reserve Bank the ineligibility of a portion of the ABCP collateral that was pledged to it under the terms of the AMLF as a result of a failure in BNYM's internal communication and escalation practices.

Anyway, someone apparently figured it out eventually, and they settled this thing for $6mm** and no admission of wrongdoing and everything is fine and you sort of can't imagine anyone writing more than this about it because, just, so, boring.

So let me tell you another story: once upon a time there was a futures commission merchant, and it had customer accounts that were topped up with its own money as most FCMs do, and it got margin calls from its clearing bank, and it took excess money out of those customer accounts, only at some point it got confused and screwed up and dipped below the minimum and took customer money out, and it met the margin calls, and a few days later it realized its error and returned the money to the customer accounts, and the customers all got their money back, and it didn't tell anyone for a while because, hey, embarrassing, but eventually it did, and it got a single-digit-millions settlement and no admission of wrongdoing. Right? I dunno. That didn't happen. Something else happened.

Or here's another one: a bank with a quarter-trillion dollars in assets, one of the main pieces of plumbing in the triparty repo system and global finance generally, at the height of the financial crisis borrowed nine billion dollars from the Fed under false pretenses - putting up collateral for those loans that was not eligible collateral for those loans. And then, because it was September 2008 and the world seemed like it might end - it did, and the collateral defaulted, and the bank went under and the government got taken for nine billion dollars of loans that it was not legally authorized to make.

One basic rule for financial decision-making in an uncertain world is that you try to do the thing that has the best distribution of outcomes and then try not to regret it if you fall on the bad part of the distribution. Of course it seems unlikely that anyone at BoNY made any decision at all here; they thought they were transferring legally eligible ABCP, and realized later on that they'd screwed something up. But if you could have had perfect clarity on this move - on September 22, 2008, mind you, when I suspect there was a certain amount of general freaking out going on at BoNY and when no one had all that much clarity on anything - the expected value of it was probably something like 90% mild embarrassment and $6mm fine three and a half years later / 10% HORRIBLE HORRIBLE JAIL FOR EVERYONE.

So they got the 90%. The probabilities for whoever did the naughty transferring at MF Global were probably a bit different - they sure look like that in hindsight right? - and, to be fair, even though they seem objectively to be in the horrible jail portion of the distribution, that hasn't happened yet. Heck, so far the regulatory consequences have been worse for BoNY, which has at least paid a fine and agreed not to do it again. But MF has gotten more press and congressional inquiries, and you get a sense that there's more to come.

Short-biased hedge fund manager John Hempton wrote a fantastic post this weekend where he complained that the SEC is making his job harder by removing repeated scammers from the pool of stock promoters / public company executives: when the authorities never banned or imprisoned fraudsters, he could make a nice living by shorting the stocks of companies run by repeat scammers, but now it's harder to find those and he has to go dig up scammers who haven't yet blown up public companies. It is harder! Harder for the authorities too it seems, since they're focused on the blow-ups. But as someone who lives in a world of expected values it's weird to see BoNY's scammy/careless misuse of billions of dollars of other people's money get a slap on the wrist because rather against expectations it worked out okay, while MF Global's scammy/careless misuse of billions of dollars of other people's money has gotten rather more attention because ... well, because they happened to lose all that money.

* This was weak acronyming btw; abbreviating acronyms in acronym-squareds seems like cheating to me. "ABCPMMMFLF" is lovely and onomatopoeic.

** Can you tell anything from that about how much BoNY got in ineligible loans? The breach supposedly lasted for about four months, late September '08 to January '09; BoNY was getting funded at 2.25%. 3m LIBOR was 3.2% on September 22, 2008 and spiked well north of 4% by early October; let's pretend four-month BoNY market funding would have been 4% so they saved 180bps running / 60bps over four months. If the fine is equal to their savings then they got $1bn of naughty loans out of $9bn in total loans. Obvs if it was more they got less.