Corzine: Weasel, Idiot, or Both?
Coverage of MFer John Corzine’s House testimony yesterday has focused on his repeated denial of any intent to dip into customer seg funds. That’s walking a thin legal line, and it’s unclear that lack of intent would be sufficient to evade time in the pokey. That part of his testimony seemed weasely, at best.
But this piece suggests idiocy:
Why did you bet the survival of the firm on European sovereign debt?
“We looked at the ratings, but they were not the only consideration. We looked at what counterparties would charge for initial margin. We would look at how individual securities were looked at by regulatory authorities around the globe – what they were able to use as collateral. We look at prices in markets to determine whether people thought the default or restructuring risk was being priced into it.
“There were many considerations along with the ongoing dialog that, which after the fact clearly can be second guessed, that the European community was going to take a much more forceful steps to avoid bankruptcy or insolvency.”
Looked at initial margins? What about the risk of variation margin or the equivalent? What about the risk of ratings trigger-induced increases in haircuts?
Initial margin isn’t what killed the trade. It was increases in margin–additional collateral calls based on adverse movements in the price of the European debt, and perhaps collateral calls based on the downgrade–that sunk the company.
In other words, what killed the firm was its inability to fund the trade over its life in the face of adverse price moves. Note that nowhere in Corzine’s answer does he mention mark-to-market risk, funding risk, haircut risk, variation margin risk, or anything related. Given the firm’s leverage and the leverage in the trade, that oversight is beyond idiotic. The main risk of a trade like that to a firm like MF was that prices would move against it and it wouldn’t have the resources to fund the additional collateral calls.
That’s exactly what happened–and per Corzine’s answer, that risk played no role in his decision to make the trade. None. That is just beyond belief.
Could he really have overlooked that risk? Or was he just weaseling again, leaving out the crucial risk of the trade from his account, in the hope nobody would notice?
But of course, not being a bank, mtm accounting is a very different thing in MF global’s setting. They saw the ECB’s funding facility supporting these bonds to term, which means one can ride out interim price variations by hedging (avoiding haircuts and margin callse), which they did. Correlations in the market that were very unlikely destroyed that strategy, but that happens sometimes. He made a bad trade – that doesn’t make one an idiot, just as making a good trade doesn’t make one a genius. Also, you ignore the FINRA actions that worsened their capital position, an externality that is impossible to forecast or quantify. Even the best money manager’s are right only about 60% of the time. Since when is losing money a crime?
Comment by Glenn — December 10, 2011 @ 12:28 pm
They avoided margin calls? Really? That’s what did them in. Period. They didn’t hedge all the risk.
By MTM risk I was not referring to MTM accounting, but the fact that interim MTM changes in the bonds could lead to margin calls/haircut changes that had to be paid, and if they weren’t paid, the trade would blow up. Re FINRA–a firm in a dodgy capital position doesn’t take into account risks that regulators would do things that require more capital. In this environment? Again–really?
The point of the post is that the main risk to this trade was funding it in the face of adverse price movements prior to maturity. And Corzine’s testimony made no mention of that risk. So, I stand by my judgment: he was either weaseling by leaving out the main risk from his answer, or he was an idiot for overlooking it.
Your comment reminds me of the old joke: “Other than that, how was the play Mrs. Lincoln.”
Sometimes people’s ignorance of the very basics of finance is staggering. Look, if something is yielding 10% to maturity, and you can borrow for the same term at 5%, no one in their right mind is going to lend you that money at 5 without additional security. If they would and take on the entire default risk of the instrument you are financing, why wouldn’t they just but the 10% yield themselves. In the real world such trades that completely transfer risk disappear quickly (arbitrage, anyone?).
Following this logic there MUST have been an additional security incentive for someone to lend to MF, namely the haircuts and right to call for more collateral. The only reason this kind of nonsense can exist is the overall baroque rules of off balance sheet financing vehicle for such as conduits, etc. The old accounting principle of if you have the probability of a loss, you own it, has been violated time and time again – see ENRON. The last thing we need is the shadow banking world – time to get rid of this stuff.
Comment by Sotos — December 10, 2011 @ 1:27 pm