November 7, 2011
The European debt crisis has claimed another victim. On the morning of October 31, 2011, markets were presented with the news that broker/dealer MF Global had filed for chapter 11 bankruptcy. After releasing a troubling earnings report the prior week, MF Global worked tirelessly to save itself, but ultimately excessive exposure to European sovereign debt, among other circumstances, proved to be their downfall. While this may alarm some, investors should use this event as a learning opportunity to be more prepared in the future.
MF Global has deep historical roots. It was spun off from Man Group, the London based alternative asset firm established in 1783 as a sugar and rum brokerage, and MF Global began trading publicly in 2007. The spinoff focused on matching buyers and sellers trading commodities, options, and futures contracts, and expanded its business lines to include equities, fixed income, and foreign exchange products. In March 2010, John Corzine was brought in as the Chief Executive Officer. Corzine has a respectable history of leading Goldman Sachs, becoming a U.S. Senator, and prior to his role at MF Global, was the Governor of the State of New Jersey. Many observers have referred to him as a strong leader, and not afraid of taking risks. However, this time the risks caught up to him.
As the core broker/dealer lines of business became less profitable, Corzine had the objective of boosting earnings. He was under the belief that European sovereign nations would not be allowed to fail, and as their debt began to trade at discounted levels, he directed MF Global to invest great sums of firm capital in debt of the so-called PIIGS nations (Portugal, Italy, Ireland, Greece, and Spain). In the firm’s second quarter report, it was revealed that the PIIGS exposure increased to $6.3 billion. As the debt fell further in market value, the firm became subject to margin calls, eventually to the extent that it drew down all of its lines of credit. When the firm’s liquidity ran out, and they could not find a suitor to acquire them, they were left to file for bankruptcy. The bankruptcy marked the seventh largest in the United States in terms of assets behind Lehman Brothers, WorldCom, General Motors, CIT Group, Enron, and Conseco.
Whether anyone will be subject to criminal investigation is up for debate. Many similar firms converted to a bank holding company during the economic downturn to save on financing costs, in exchange for being restricted from making the type of proprietary trades that brought down the likes of Lehman Brothers. However, MF Global remained a broker/dealer, which made the sovereign debt exposure inline with their regulatory requirements. However, $633 million, or 11.4%, in client funds remain unaccounted for. MF Global, after claiming initially that all client funds had been accounted for, now claims that the discrepancy is attributed to money being held as collateral for trades at other institutions. Regardless, the Chicago Mercantile Exchange claims they have evidence that MF Global comingled customer assets with their own, which is a regulatory violation.
The MF Global Bankruptcy filing is a good reminder to investors to remain disciplined, focused, and prudent. Investors should regularly review their goals, and understand what role their portfolio will play in achieving them. With risk comes reward, and the ends may or may not justify the means, it depends on each investor. Furthermore, it is critical for investors to understand the value of diversification. No one necessarily knows what the future holds, and excessive exposure to any individual asset could run the risk of placing the investor in an adverse position. For some, taking on greater risk provides fulfillment, for others it does not, it all depends on the individual investor.
This report is prepared for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument or service. Market prices and other data may be obtained from outside sources and is not warranted as to completeness or accuracy. Any comments, statements and/or recommendations made herein are subject to change without notice, and may not necessarily reflect those of Alamo Capital. Alamo Capital has no affiliation with any political party. Investing involves risk. Consult with a Financial Professional for additional information to determine the suitability of this or any other financial product or issue as it relates to your particular situation.