I am sure you have had more than your fill of Eurozone news following the European Leaders Summit held in Brussels on Thursday and Friday. It doesn’t seem to me that a whole lot was accomplished by the agreement that the leaders (excluding David Cameron on behalf of the United Kingdom) reached. I certainly think less was accomplished than was contemplated, expected, or even hoped for. See my December 6 commentary ‘Friday, Dec 9 – An Important Day?’ – reading time 2 minutes – where I mentioned that I wasn’t as convinced as others seemed to be that the Brussels Summit Meeting was going to result in anything very startling.
Essentially, all that I think was reached on Friday was an agreement to subsequently agree next March on a process that would cause Euro countries to be subject to sanctions if they exceeded pre-determined annual budget deficits. I wrote about this last week, and don’t have much to add to what I then said. It think that, far more to the point, near-term (if not immediate) agreement needs to be reached and solutions found with respect to the continuing question of how existing Eurozone country specific debt – particularly that of Greece, Italy, Portugal and Spain for starters – will be dealt with going forward.
The European Union leaders did agree to advance the International Monetary Fund 200 billion Euros to enable the IMF to help with the Eurozone deficit issues. That strikes me as simply another ‘rob Peter to pay Paul’ postponement step. The IMF will now go out to non-European countries to solicit them for further help. However, surely non-European countries will be hard pressed to advance funds, if they prove to be prepared to do that at all, without being given ‘certain security’ for whatever amounts they advance.
If you want to read yet one more article on the current Eurozone situation, I suggest you read ‘Euro zone agreement only partial solution – IMF’ – reading time 4 minutes. You can also read, what I take to be, the beginnings of ‘push-back’ on IMF intervention by possibly acting as a conduit to help monetarily with the Eurozone deficit issues – see an article published yesterday in the U.K. Telegraph titled ‘Bundesbank rejects Europe’s IMF funding ruse’ – reading time 3 minutes.
MF Global and Re-Hypothecation?
I suggest you read this commentary carefully. I think you may find it of significant value if you are unaware of the ‘money manager’ practice of re-hypothecation, or are not familiar with the detail of it and its possible implications in the current world economic and banking environment.
A December 9 article titled ‘MF Global judge approves (U.S.)$2.2-billion transfer to customers’ – reading time 4 minutes – reports on just what its title says. I suggest you read this article, which reports on the findings Friday of U.S. Bankruptcy Judge Martin Glenn who overruled MF Global creditor objections, and approved the distribution request made by the liquidating trustee. The article also reports:
- the MF Global bankruptcy to be the eighth largest in U.S. history, and the largest since Lehman Bros. in September 2008. My comments: For the reasons set out in this commentary, the old saying ‘you ain’t seen nothing yet’ may well be in order. This is because of what is said to be the use of re-hypothecation by MF Global, and I assume by others, in its (their) hedging activities. Simply put, in concept ‘re-hypothecation’ in this context means the ‘use at risk’ of ‘Other People’s Money’ by financial institutions for their own benefit;
- that this distribution will mean that MF Global’s customers will recover 72% of what they otherwise would have lost from the MF Global failure;
- MF Global’s parent company October 31 bankruptcy filing listed assets of $41 billion and debt of $39.7 billion, simplistically resulting in a ‘book shareholders equity’ of $1.3 billion. The article reports that it was a “wrong-way $6.3 billion trade on its own behalf on bonds of some of Europe’s most indebted nations” that resulted in the MF Global bankruptcy. If losses on that trade had been accounted for by October 31, which they may or may not have been, one can only wonder at the extent of the risk-taking that was going on in MF Global where its accounting debt:equity ratio appears to have been somewhere in the order of at least 30:1; and,
- on the testimony of Jon Corzine before Congress on Thursday, December 8, where he said under oath before the Congressional Agriculture Committee that he “was stunned when (he) was told on Sunday Oct. 30 that MF Global could not account for many hundreds of millions of client money”, that he “remain(s) deeply concerned about the impact this has on MF Global customers and others”, and I say ‘amazingly’, he “simply do(es) not know where the money is.” With respect to Corzine’s testimony you might also want to read a New York Times article titled ‘Corzine’s Testimony Came With Plenty of Caveats’ – reading time 4 minutes. I also suggest you watch a 5 minute video titled ‘Frendel: Corzine testimony “phenomenal”’. My comments:
- why was Corzine examined by the Congressional Agriculture Committee, a Committee that oversees legislation involving farms and farming, forestry, nutrition, rural development, rural electrification and watersheds, and school nutrition programs? I would have thought a special Committee of ‘financially knowledgeable senior Congressmen’ ought to have been struck to examine him – and ought to have examined him relentlessly,
- Jon Corzine was MF Global’s Chief Executive at the time MF Global declared bankruptcy. He is a former Governor of New Jersey, U.S. Democratic Senator, and former Goldman Sachs CEO. As such, he must intellectually understand the meaning of fiduciary responsibility,
- it is inconceivable to me that Corzine was not actively involved in the process that approved the $6.3 billion Eurozone Sovereign Debt transaction that is credited with being the transaction that resulted in MF Global’s bankruptcy,
- I think it likely is an overstatement to blame said bankruptcy on only one transaction. That transaction may have been the tipping point that resulted in the bankruptcy, but it strikes me there likely were other transactions that contributed to the balance sheet and cash flow position MF Global found itself in on October 31 when it declared bankruptcy,
- it is inconceivable to me that if Corzine was properly exercising his fiduciary responsibilities to MF Global’s clients he either knew, or ought to have known, in advance of October 30 that many hundreds of millions of dollars – clearly a material amount to MF Global – of client money was unaccounted for. Unaccounted for seems to me to be a peculiar term to use. I would better understand ‘lost’ as in ‘money lost pursuant to one or more transactions’. Simply saying ‘unaccounted for’ to me suggests ‘lost’ as in ‘I lost my wallet’ – I think this is a truly scary thought in the context of hundreds of millions of dollars,
- even if for some reason Corzine indeed ‘was stunned’ on October 30 by the news that MF Global could not account of many hundreds of millions of client money, there are thirty-eight full calendar days between that date and December 8. Thirty-eight calendar days is a huge amount of time for an intelligent, high energy person (which Corzine must be) to find out facts in a crisis situation, even if he was locked out of the MF Global offices. Surely as a minimum he would have been high on the list of people the Trustee would want to talk with. I would have thought that to fail to cooperate in any investigation would be contrary to his fiduciary obligations – but then perhaps U.S. law provides protection to him from self-incrimination or some other form of protection,
- if you watch the video, Corzine does not answer at least one important question directly, and the people questioning him did not ask the obvious hard follow-up question. On balance, I thought the Committee members treaded very lightly with him,
- it is highly unlikely that Corzine was not working as the CEO of MF Global for no remuneration, and I suspect knows a lot more than he said during the hearing. That said, the question that begs asking is: Will he as an individual face either criminal or civil charges arising out of the MF Global bankruptcy going forward? I suspect that in the current economic environment that may get back to a form of the ‘too big to fail’ scenario. Based on my commentary that follows, broad existing money manager re-hypothecation may be such a large overhang in the financial markets that I think it is possible that the MF Global bankruptcy may simply be ‘put in a box’ by the U.S. Government and Regulators with the ‘hope that it goes away and is forgotten about’,
- apparently the MF Global Board resigned en masse at the time MF Global declared bankruptcy. Query: where was the MF Global Board of Directors in all of this? Surely the materiality of the transaction that that is said to have brought MF Global to bankruptcy would have been, or ought to have been, known to the MF Global Board, perhaps at the time the transaction was executed – particularly when Eurozone Sovereign Debt has been the news almost every day for months,
- second query: Boards of Directors clearly have fiduciary responsibilities to company stakeholders. Is the MF Global Board going to be held accountable in any way or manner for the MF Global debacle?, and
- third query: is MF Global an October 2011 proxy for Bear Stearns as events around that firm transpired in March 2008. If so, one has to wonder when the next shoe is going to fall, how big a shoe that will be, and what the aftermath of that second shoe will be if indeed a second shoe does fall.
Before turning to a general discussion of re-hypothecation, it seems to me that anyone participating as an investor or trader in the financial markets must in their own best interest seriously reflect on what the MF Global bankruptcy, and how MF Global got there currently may broadly reflect on the financial positions and conditions of investment banks and hedge funds, and depending on their own individual investment circumstances how these things may impact their own investments. I strongly recommend you discuss this with smart financial people you know, and with your investment/trading advisor(s).
Turning specifically to the concept of, and issues around, re-hypothecation, I suggest you read pages 10 – 18 of a 19 page PDF titled ‘Trading With Other People’s Money, The Collapse Of The World Financial System – Why MF Global Is Worse Than Europe’ – reading time for the 9 referenced pages 15 minutes.
While I read the first nine pages of the PDF I suggest you scan them or simply go directly to page 10. I found most of the content of the first nine pages to be an ‘author’s rant’ about the U.S. political and legal system. While pages 10 – 18 beginning with the heading ‘Trading With Other People’s Money – The International Loopholes That Are Threatening The Entire Financial System’ include some of that, those pages discuss the concept of re-hypothecation at some length. Re-hypothecation as the author describes it occurs “when a bank or broker utilizes collateral posted by clients, including those of hedge funds, to back the broker’s own trades and borrowings” (see top of page 15 of the PDF). The author says that this practice today involves trillions of dollars and is “faultlessly legal” under current U.S. (and I think after reading the PDF in some applications, U.K.) law. On page16 of the PDF the author reproduces what he claims to be Clause 7 of MF Global’s client agreement, or at least one of MF Global’s client agreements if indeed it had more than one. That Clause 7 is quoted as:
“7. Consent To Loan Or Pledge You hereby grant us the right, in accordance with Applicable Law, to borrow, pledge, re-pledge, transfer, hypothecate, re-hypothecate, loan, or invest any of the Collateral, including, without limitation, utilizing the Collateral to purchase or sell securities pursuant to repurchase agreements (repos) or reverse repurchase agreements with any party, in each case without notice to you, and we shall have no obligation to retain a like amount of similar Collateral in our possession and control.”
As I read the referenced PDF, it is this clause that enabled MF Global to re-hypothecate funds under its management, and make the bet on the aforementioned U.S.6.3 billion in Euro Sovereign Debt that it apparently did – and which transaction ‘went south’ and triggered its October 31 bankruptcy filing.
The disconcerting thing about what is said in the referenced PDF is, of course, if what it says about re-hypothecation of customer funds in the case of MF Global is accurate, how many other ‘MF Globals’ currently are out there waiting for the next ‘shoe to drop?
It seems to me if there is anything to what is said in the referenced PDF, that if you invest or trade in the financial markets through intermediaries that you check with your investment advisor(s) to determine if any (or all) of your investment funds are subject to re-hypothecation as that term is used in the PDF. Having followed the MF Global situation for several weeks now, and having read the referenced PDF, my view is ‘checking this re-hypothecation issue out’ in the current investment environment is nothing more or less than ‘chicken soup’. It can’t hurt and it might help. Let me know what you find out by writing to me at email@example.com.
I have already forwarded this PDF to my own investment advisor (who was unaware of re-hypothecation), have discussed the content of the PDF with him, and have requested that he speak with the senior person in his firm to determine if what the PDF says makes sense or not. Again, I suggest you do likewise with your own advisor(s).
About Ian R. Campbell
Ian R. Campbell, FCA, FCBV, is a recognized Canadian business valuation authority who shares his perspective about the economy, mining and the oil & gas industry on each trading day. Ian is also the founder of Stock Research Portal, which provides stock market data, analysis and research on over 1,600 Mining, Oil and Gas Companies listed on the Toronto and Venture Exchanges. Ian can be contacted at firstname.lastname@example.org