Streetwise Professor

November 22, 2011

Clearing Up Some MF Misconceptions–And Raising a Question

There are many misconceptions about the CME’s responsibilities in the MF Global situation, and the implications of this situation for the CME’s longstanding claims that no customer has lost money as a result of a clearing member default.  These misconceptions are epitomized by this Sun Times article:

CME owns the Chicago Mercantile Exchange, Chicago Board of Trade and the New York Mercantile Exchange, where much MF Global business took place. It legally clears, or guarantees, the trading on its markets and often boasts that no customer has ever lost money because a trading firm failed.

That more than 100-year record may be in jeopardy with MF Global, one of the largest brokerages on the Chicago and New York commodity markets. Former New Jersey governor and Goldman Sachs Group Inc. chairman Jon Corzine led the firm but made a disastrous investment in European debt.

The claim is true, and regardless of what happens with MF it will remain true.  The clearing guarantee is not in play here.

If clearing firm A defaults, customers of clearing firms B, C, etc., will get paid as long as the clearinghouse is solvent.  That has always been the case in the past, and it is true now.

It is possible that customers can lose money under the omnibus account system employed in the US, if there is a default on A’s customer account, and A cannot cover it, then A’s customers bear some of the losses.  As an example of this, the London customers of Griffin trading lost money when that firm went bust in 1999: no US customer customer lost.  (Customers of a COMEX member, Volume Investors, did lose when that firm went under).

There was no default in either MF Global’s house or customer accounts, so the clearinghouse guarantee never came into play.  So the Sun Times account–like many others–is fundamentally misleading.

Moreover, 60 percent of customer margin associated with open positions was transferred to other clearing members.  Most of the missing money in question, from what has been reported, was customer money on deposit at MF Global but not margin associated with open positions.  (That is the case with two MF customers I know personally.)  The CME clearinghouse guarantee has nothing to do with that money.

CME has raised the amount that it is willing to commit to cover any shortfalls from the bankruptcy trustee’s distribution of cash to customers.  This is not the CME’s legal obligation, but is, as I said in an FT article a couple of weeks ago, an indication of the importance of this situation to CME’s reputation.

CME will be subject to scrutiny primarily for its role as the MFer’s Designated Self-Regulatory Organization (and hence responsible for auditing it) prior to the firm’s rapid implosion.  Moreover, as Jeff Carter (a one-time CME floor trader and board member) writes, CME has not done itself any favors with its handling of the “public perception of the crisis.” (Though I have also heard that CFTC is attempting to control what the exchanges–CME and ICE–are saying.  As well it might, as it will also come under considerable scrutiny.)

A big question in my mind is why Corzine isn’t getting the Madoff treatment from the Feds and the media.  He has been called to testify in front of a House committee.  I wonder if he’ll invoke the amendment that comes right after the one about unreasonable searches and seizures.  But it is amazing to me how little critical coverage he has received.  Especially given the bad press that rich bankers are getting these days.

Oh, I forgot.  He’s a progressive Dem in good standing.  What was I thinking?  My bad.

So there are two major things wrong with coverage of the MFer’s tale.  The first is that the role of the CME’s guarantee to its customers is being misrepresented with some regularity–including by the home field rag.  The second is that the most likely culprit–and certainly the person ultimately responsible for the firm’s collapse, and anything that occurred as the firm crashed and burned–is all but invisible.

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  1. Yes, it would appear the clearing guarantee never foresaw a scenario where a firm would simply steal customer accounts before publicly disclosing its insolvency. Beyond that, I find the attempts to trash Celente by accusing him of wanting to start a bank run very lam-o.

    Comment by Mr. X — November 23, 2011 @ 1:41 am

  2. […] CME’s responsibilities when it comes to MF […]

    Pingback by FT Alphaville » Further reading — November 23, 2011 @ 2:29 am

  3. In the past, companies trading on the CME, Nymex or other commodity exchanges would not be brought down by dealings in sovereign bonds, because they had nothing to do with them. They were separate areas of business covered by separate specialist firms. We should get back to something like that: leave bonds for bond dealers, soft commodities for soft commodity traders, metals for metals firms and so on. This would be a return to the Glass-Steagall principle, in an area where Glass-Steagall was never needed because it is how it was anyway.

    Comment by Tom Lines — November 23, 2011 @ 3:27 am

  4. This will urge on the big traders to become a clearing member of the via State Street or another trust company: I have seen some of their operational plans and they actually maintain seggregat3ed accounts at Harris in the customer’s (member’s) name for both initial and VAR margin. No one can authorize movement but the customer and custodian, and most of these shops have good internal controls and limits on transfers.

    When one leaves money at a member firm, the key element is character – below is a partial re-posting of a blog concerning MF over at Spengler’s shop (to early in the morning to be original for this geezer):

    “..6. The final issue re Corzine and finance itself was summarized in testimony by JP Morgan Sr. in front of Congress: he was accused of only lending money to people who had it or collateral, not helping entrepreneurs, and all around vampire-ish villainy, etc. His response was that all the collateral in the world was useless unless first there was a judgement about character. No one took him seriously, but what the nasty old man was trying to say in his late Victorian manner was that if someone has no character, don’t deal with him. Will someone do what they say they will? Can they be trusted? This doesn’t necessarily mean that the man in question is a nice guy, or that they will not make mistakes. Instead will they bust a gut to keep there word and trust?

    On this front Corzine was and is a disaster, and while is extremely difficult to judge financial health of a firm, the man was an open book.”

    What this new process does to systemic risks, may be another story.

    Comment by Sotos — November 23, 2011 @ 7:34 am

  5. Listen to your Uncle Gerald…get out and get out now.

    Comment by Mr. X — November 23, 2011 @ 2:10 pm

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