It started for me early on Monday morning (October 31). I was watching a “Futures Trading” contest on the internet when, suddenly, the professional traders who were competing were told that they could not initiate any trades; the system was “down”. Some of those logged on suggested that evil forces were at work — goblins and witches. But I am not a big believer in Halloween, so I started imagining real life causes: a power outage; a software glitch; a system overwhelmed by high frequency trading. The cause of the trading suspension became an even bigger mystery when viewers reported that they could not trade either.
After a long delay, news came from the trading contest sponsor that the cause for the system interruption was the bankruptcy of MF Global Holdings Ltd. – a huge financial firm (broker dealer) that reported over $1 billion in revenue for the year ended March 31, 2011. The downfall of MF Global was an outsized investment in European sovereign debt, which evidently was not adequately hedged. Perhaps the suggestion that “evil forces” had been at work was not so far off the mark.
The good news is that this failure is nowhere near the magnitude of the Lehman Brothers collapse over 3 years ago. The bad news is that the management of MF Global ignored the investment world’s “Risk Management 101”. As new investors/traders become trained – two of the most important initial lessons of “RM 101” include: 1) “Diversify, diversify, diversify”; and 2) and “you must be unwaveringly disciplined in your money management” (trade size, risk control, etc.). Translated, this means that you should never over invest in any one asset or asset class, and unless you invest in an instrument that has a guaranteed return, you should never invest money you cannot afford to lose.
So what lessons can we learn from the bankruptcy of MF Global Holdings? I suggest that helpful lessons include (at least) the following:
1) Even experienced, knowledgeable folks can make really bad decisions about investments. Therefore, don’t ever think that you have it “all figured out”. Hubris can be “the beginning of the end”.
2) You can never completely trust what the head of a U.S. corporation says. As recently as October 25, MF Global CEO, John Corzine, assured investors that all was well, the firm had ample opportunities to make good money, and their European government debt was “fully financed”. All of that was misleading enough. However, another statement that he made was, in my opinion, outright fraudulent: “We remain confident that we have the resources and expertise to continue to successfully manage these exposures to what we believe will be a positive conclusion in December 2012.” http://247wallst.com/2011/11/02/mf-global-and-corzines-folly/
a) However, perhaps it should not be a surprise that “truth” is an elusive concept for Mr. Corzine. After all, he is a former governor (New Jersey) and a former senator. So one could say that he comes by his deception honestly.
3) Just as frightening (or perhaps more so) is the recent corporate report regarding MF Global’s own, internal “risk management review”. Quoting from the report: “The results of the review, together with certain aspects of our risk management framework, support our conclusion that the Company’s compensation programs do not encourage unnecessary risk-taking. Moreover, we believe that there are in effect adequate safeguards that would prevent, discourage or detect excessive risk-taking.” http://www.smartmoney.com/invest/stocks/mf-global-exemplifies-whats-wrong-with-the-economy-1320259176188/
a. As has been written: “the proof is in the pudding”.
b. The fact that the corporate board did not and could not recognize “excessive risk” should send anxious shivers down the spines of every investor.
4) MF Global can serve as a “poster child” for the type of Wall Street greed and excess which is currently being protested by the “Occupy” movement.
a. Last year, Corzine was paid just under $3 million, which included a “bonus”. One wonders on what basis the “bonus” was paid.
b. However, there you have another instance of “excess” about which most could protest. The persons who voted on Corzine’s bonus were each receiving between $137,500 and $207,000 to attend a few meetings each year! It seems to me that they were “dis-incentivized” to rock the boat and demand more genuine accountability.
5) If it turns out that MF Global’s customers do not receive all of their money back, it will be interesting to watch how the government and legal authorities respond (at the time I wrote this, the trustee reported an estimated $600 million of customer funds missing.)
So the bottom line is that MF Global’s bankruptcy is a “wake up” call for the investment world and for us. Let’s hope that the news reports related to MF Global don’t get any more disturbing. Even more importantly, let’s hope that the massive sovereign debt crisis in Europe does not bring down much larger European and American financial institutions. If that happens, we will all feel the repercussions… and MF Global will become merely a small footnote in history.