Breaking news: creditors lose money in MF Global collapse!

by Russ Roberts on November 2, 2011

in Financial Markets, Gambling with Other's $

The collapse of MF Global, a highly leveraged gambler on Europe’s fate using other people’s money means that those who funded those gambles have lost virtually all of their money. Some of those who financed those gambles were pretty savvy firms. William Cohan, writing at Bloomberg, wonders what those with an ownership share were thinking as MF Global took on more and more risk:

Where, for example, was J. Christopher Flowers, the billionaire founder of J.C. Flowers & Co.? According to MF Global’s most recent proxy statement, Flowers’s firm owned 6.8 percent of MF. But then Flowers had reasons to have blind faith in Corzine: It was Flowers who recruited the former governor to MF in 2010, and also made Corzine a partner in his private- equity fund. When the two men were at Goldman Sachs in the 1990s, they had a symbiotic relationship: As Flowers was head of the financial-institutions group, Corzine relied on him to make introductions to other Wall Street bosses so they could ponder strategic deals.

Where were MF Global’s other institutional shareholders, such as Fidelity Investments (which held a 14.8 percent stake, according to the proxy), Guardian Life Insurance Co. (7.4 percent), TIAA-CREF Investment Management LLC (6.6 percent) and Piper Jaffray Cos. (PJC) (6.3 percent)? Were they too dazzled by Corzine’s resume to take a serious look at how he intended to transform MF Global from a backwater to a major player on Wall Street? Where was MF Global’s auditor, PriceWaterhouseCoopers LLP, which managed to pocket almost $25 million in fees from the company over the past two years?

Those are all good questions. But these were equity investors who stood to make lots of money if the bets of MF Global paid off. Perhaps they had ways of hedging against the risk that MF Global was taking. The real question is why the creditors of MF Global lent so much money with so little security or upside. Eric Lewis writes at CNN:

So what happened? Last week, MF Global disclosed that it had $6.3 billion exposure to the shakiest of European sovereign debt.

Its balance sheet was huge but terribly fragile. While it had lots of assets on its books, it also had a huge amount of borrowing. For every dollar of its own capital on its books, it had borrowed $40, a leverage even greater than that of Lehman Brothers at the time of its collapse.

Why is that a problem in a time when near-zero interest rates extend as far as the eye can see? Because leverage is always treacherous and 40-to-1 leverage is madness. Even when interest rates are low, lenders demand security. When the value of that security goes down, the demand for margin — additional collateral to secure the debt — goes up.

The plunge in the price of European sovereign debt meant that MF Global had to stump up more cash or easily marketable securities to its lenders so that they would have adequate security for their loans. A well capitalized, reasonably leveraged firm should be able to handle margin demands and survive. But with only 2.5% or so of its assets representing capital rather than borrowed money, MF Capital could not find enough of its own cash to satisfy its lenders.

Did those creditors who allowed MF Global to be so leveraged think that Corzine’s political connections would lead to the bailout of creditors as had occurred with Bear Stearns, AIG, and others? Or were they just naive or too trusting or too busy or too hungry for yield? Did they think that MF Global’s bets were likely to pay off despite the risk?

It’s the same debate over why the financial crisis occurred. Was it moral hazard or greed coupled with stupidity (or at least overconfidence)? In this case, it hardly matters because MF Global is headed to bankruptcy court and the investors and creditors will get whatever scraps are left of the company. There doesn’t seem to be a crisis despite a bankruptcy of $40 billion heading to court. And I have this strange view that losing most or all of their money will make some of those investors and lenders a little more careful down the road. It’s a feedback loop that is very powerful. Lend money and lose it all and you feel the pain. That’s how capitalism is supposed to work. Maybe, just maybe, the next MF Global will have have a hard time convincing lenders that it’s OK to be leveraged 40-1.

But both Lewis and Cohan believe that the natural forces of profit and loss are inadequate to discipline recklessness. They both want more regulation. Here is Cohan:

The collapse of MF Global points once again, in the strongest possible terms, to the importance of having a substantive, teeth-bearing regulatory regime charged with overseeing the kind of asynchronous risk-taking that gives people like Corzine the incentive to gamble with other people’s money in hopes of reaping financial windfalls. And yet, more than three years after the collapse of Lehman Brothers and the onset of the financial crisis, we don’t have in place anything close to necessary regulations to try to prevent companies like MF Global from exploding.

Why does the collapse imply a need for regulation? I don’t get it. Earlier in his piece, Cohan writes:

It didn’t have to be this way. The tragic element of Corzine’s MF Global is that Monday’s bankruptcy filing could have easily been avoided if Corzine’s ego and ambition had been held in check by someone — anyone — willing to stand up to the former New Jersey governor, senator and senior partner at Goldman Sachs Group Inc. (GS)

Is that a problem now? Isn’t it pretty clear that from here on out, we don’t have to worry about someone holding Corzine in check? He’s done it all by himself. He’s going to find it a lot harder to get people to fund his risk-taking the next time out. And what “didn’t have to be this way?” That’s a question for the investors and creditors to answer for themselves. Why is it a question for the rest of us? Why do we want the government to protect naive or greedy investors from their own shortcomings? Let’s them learn a lesson for a change. Why won’t that work?

Here is Eric Lewis:

Many will view the demise of MF Capital as just another bit of the “creative destruction” of capitalism. The Republican candidates complain that Dodd-Frank, last year’s financial reform bill passed in response to the credit crisis, is stifling healthy risk-taking. The reality is that Dodd-Frank does not do enough to prevent financial institutions from taking excessive risks with investors’ money. While it imposes leverage requirements on banks, those requirements are still quite limited, and institutions not regulated by federal banking agencies are not restricted in their risk-taking in any meaningful way.

If their huge bets on European debts had paid off, Corzine and his colleagues would have added to their immense wealth. All of their incentives were to borrow as much money as possible so that small price movements in their direction would make them rich and large price movements in their direction would make them unimaginably rich.

Their debts did not pay off; they are still rich, but there are many others who will be much poorer. Leverage is the steroid of modern finance that creates the hazardous incentives to bet big, keep the winnings and dump the losses onto others.

What MF Global shows is that the problem is not too much regulation but too little. Without meaningful leverage restrictions on borrowers and meaningful lending restrictions on those who are willing to underwrite this steroidal debt expansion, MF Global is likely to be the tip of yet another iceberg. And we have yet to recover from the last financial Titanic.

There are two ways to restrain imprudent leverage. The first just got imposed on Corzine. His creditors lost most or all of their money. They’ve learned a lesson. If they were overly optimistic about a bailout, they have adjusted their expectations somewhat for the next time. If they were just overly greedy or optimistic or naive they’ve had some prudence and sense knocked into them in a very expensive fashion. If we can avoid the temptation to bail out firms leverage will shrink as lenders learn its risks or at least lose their money. Both make it harder to keep leverage high in the future.

The alternative is capital regulation which Cohan and Lewis advocate. We’ve tried that already. Count along with me: One Basel, Two Basel, Three Basel. That approach has failed. They’ll respond and say we just need to do it right. Or that it’s too risky to let firms go bankrupt when there’s systemic risk.

Who writes the regulations? They do. Not us.

Who should lose money? Them, not us.

Let’s change the rules of the game. Let’s tell creditors that they can lose all their money. When that actually happens, I think it will actually change their behavior. You’re on your own. You can’t go to the regulator and make a case for why your kind of leverage is actually really safe. You’re on your own. You make good decisions, you make money. You make bad decisions, you lose money. It’s called capitalism. Let’s try it.

 

Be Sociable, Share!

Comments

comments

155 comments    Share Share    Print    Email

{ 155 comments }

Todd Ramsey November 2, 2011 at 3:52 pm

I’m still fearful the Federal Government will find a rationale for bailing out Governor/Senator Corzine.

aldous November 3, 2011 at 12:51 pm

no they won’t. they commingled funds. it would be government complicity in a felony if they bailed them out. this is the real reason they aren’t being bailed out. Look. Jeffries is next on the list.

Nikolai Luzhin, Eastern Promises November 3, 2011 at 1:16 pm

What a really stupid statement.

Corzine just did a triple twist off the high board into a dry pool

The fraud chart stops at $400,000 million and 30 points. Add 6 plus role in the offense and a few others and under the guide lines you are looking at a level 40 plus

http://www.crimdefend.com/files/federal-guidelines.pdf

that is 292 months min (20 years plus). My bet is that he will not get out of prison until in his upper 80s, if he should live so long.

Wish we had a Shakespeare around to gauge this madness at work. Corzine, I understand (boredom and ambition are a deadly cocktail) (what madness resulted in him being hired in the first place?), but his lieutenants?

Jon Murphy November 2, 2011 at 3:56 pm

Wow, Russ. That was a lot more…intense then you usually write. I’m not complaining, but rather I just want to say “good job!”

Krishnan November 2, 2011 at 4:07 pm

Corzine and others losing money and the Feds doing nothing about it? Of course not. Here comes the bail out – for those that took the risk and lost. I will bet that someone associated with MF Global and Corzine and all those that lent money will be at the Tax Trough getting (no, TAKING) money that they lost by being reckless. It is coming, I have no doubt. And then they will use that to say we need more regulation.

When will this stealing from tax payers stop? (yea, I do see this coming, the stealing by rich and well connected thugs and burglars)

Miles Stevenson November 2, 2011 at 4:14 pm

“Why does the collapse imply a need for regulation? I don’t get it.”

It’s because most of the population does not think beyond stage one, Russ. Hell, there are still tons of Americans that avoid vaccines because they can’t be bothered to think, and you want them to think about whether or not the evil, greedy “rich” guys should have Uncle Sam watching over them?

Perhaps you (and we) are asking too much.

Methinks1776 November 2, 2011 at 4:22 pm

But these were equity investors who stood to make lots of money if the bets of MF Global paid off. Perhaps they had ways of hedging against the risk that MF Global was taking.

Not necessarily, Russ. Even if they didn’t hedge their exposure, If MF Global was a small enough percentage of their portfolio, then they may have been fine with the risk. And they did have ways to hedge MF Global risk exposure

However, it’s important to remember that creditors also had ways to hedge against MF Global risk. Although, the more risk it piled on, the more expensive that insurance would have gotten. I don’t know if they did insure.

What’s interesting is that MF Global floated a bond with a covenant that stipulated that if Corzine left, the interest on the bond would go up. Maybe they should have had that covenant the other way around.

Also interesting is the moral hazard lesson Corzine learned. He is responsible for for the decision to pile on Italian debt. It was one giant bailout (Italian bailout, not MF Global bailout) bet. He was sure that Italy was TBTF even if Greece wasn’t.

Whatever his decisions were are between him and his shareholders and creditors. They took their chances and they suffered the consequences. As it should be. Note that while liquidity has suffered (MFG was a large broker dealer) – especially in Futures – the market is largely unscathed by its bankruptcy. Its customers’ accounts will be picked up by other clearing firms and life will go on. As long as the rumour that Corzine tapped his customers’ funds as the firm was drowning aren’t true. If they are, then Corzine will rot in jail with Bernie Madoff.

txslr November 2, 2011 at 5:24 pm

I wonder if the covenant had value because Corzine was such a spectacular investor (pause while breathing into a brown paper bag) or because creditors figured he was connected enough to arrange a bail-out if the portfolio hit the fan?

Methinks1776 November 2, 2011 at 5:59 pm

I don’t know. I doubt it had to do with a bailout. I know it’s popular to think that after 2008, but, believe it or not, nobody wants their firm to fail. They’d much rather make money.

I think it had to do with his reputation as a titan on Wall Street and destroyer of the state of New Jersey. I also suspect the fact that he was politically connected and had pull with the regulators factored in (but not because that would get him a bailout). I’ don’t think I’ve ever heard of a broker dealer – even a big – getting a bailout when it blew up.

PKSully November 2, 2011 at 6:09 pm

I can personally attest that life goes on for former clients of MFG. Our whole clearing operation moved to Dorman and we were allowed back on the floor today but the CFTC, the guardian for us with segregated funds, is not releasing our capital. They might be nice enough to let go of enough to cover the margin of our positions but only reluctantly. Methinks, what do you think of the opinion that the change in rules on what defines a credit event in re to Greek debt that effectively made CDS insurance on that debt worthless led to MFG blowing out? Some think that his position was hedged properly (until it wasn’t). (For others, the powers that be agreed that since the haircut taken on the debt would be voluntary it wouldn’t trigger a default and the insurers of the debt wouldn’t have to pay off. That’s the best insurance to sell– the kind you never have to pay claims on.)

Methinks1776 November 2, 2011 at 6:35 pm

PKSully,

My understanding is that he wasn’t adequately hedged. If he was, I have to eat my words. If that’s what did MF Global in, then there’s no way we can lay the blame at Corzine’s feet (although, the bill shouldn’t be handed over to taxpayers either, I’m sure you agree).

You will not be surprised that I think preventing the CDS payout is a disaster. It means that investors in sovereign debt who paid a lot of money for insurance have been robbed. It’s terrible for the whole market. Not only does it render CDS contracts on sovereign debt worthless (note the sell-off in PIIGS sovereign debt in response to ISDA’s decision), but it potentially puts CDS contracts on all debt into question.

Officially, it’s ISDA’s decision, but I can’t help but think it was under heavy political pressure. I don’t know if you agree.

I have a question for you. I was thinking about our conversation about CDS contracts (exchange traded vs. OTC). Do you know why they didn’t just create an exchange traded CDS in addition to OTC? I suspect it had something to do with regulatory hurdles, but I thought you might have some insights.

PKSully November 2, 2011 at 6:43 pm

Methinks,
I’m as cynical as they come so I definitely think that decision was political. I’m also skeptical that Corzine was covered with CDS. Whether he was or wasn’t, his position was toasted by that decision.
I know the Brooksley Born/ Greenspan turf war was primarily about swaps but could her (the CFTC) loss in that fight meant there wouldn’t be a fight over CDS. Or the exchanges didn’t want to fight it. They’ve got a lot of fights, maybe that one didn’t make sense.

Methinks1776 November 2, 2011 at 6:46 pm

Also, I’m sorry to hear you’re affected by this mess. A friend at the CBOT said traders clearing through MFG were trying to close out trades all week as the news worsened. Glad to see the CFTC is so generous as to sometimes maybe let you meet margin. Mighty big of them.

Methinks1776 November 2, 2011 at 6:55 pm

PKSully,

Whether he was or wasn’t, his position was toasted by that decision.

True. But, you know, on second thought, I’m not going to eat my words about Corzine. Even if you were perfectly hedged, would you ever do that kind of size? Would you ever put on that trade with 40x leverage? Doing that size implies a certain feeling of invincibility, Godliness even. It’s hubris at its most deserves-to-get-his-ass-kickedness.

WRT CDS, the disaster is that there had to be a fight about trading contracts on exchanges at all. In a real free market, the contracts would have just been created, traded and the more desirable version would have survived.

PKSully November 2, 2011 at 8:27 pm

Methinks,
I know I wouldn’t risk blowing out but I’m only sure of that because we are self financed. I can’t say for sure that I wouldn’t take what I consider stupid risk if someone else was left holding the bag if the position went south. I’d like to think that I would still be responsible but getting short volatility, which practically speaking was MFG’s position, is the default position for traders trading with other peoples money.

Methinks1776 November 2, 2011 at 9:03 pm

PKSully,

I have to think about that. I have outside investors as well as my own capital in the firm and I would never allow that kind of trade in that size (particularly since CDS doesn’t hedge all fixed income risk). But, in general, I think you may be right. Investors sort of push you to take more risk too. For them, you’re a small part of their portfolio. They want you to roll the dice. But, where’s the skill in that?

tms November 3, 2011 at 7:53 am

I know for a fact that I owned MF Global, but it was one of 10,000.

tkwelge November 2, 2011 at 4:27 pm

Wow, so a mistake made by a banker who used to work for the government based on what he believed would be the actions of foreign governments, which he made using money that was most likely artificially brought into existence by centralized credit expansion, is a clear sign that more government intervention is needed. BLBLBLBLBLBLBLBLBLBLBLBLBLBLBLBBLLBLBLBLLB!

kyle8 November 2, 2011 at 8:32 pm

Well you know, it’s a matter of principle!

Dan S November 2, 2011 at 4:29 pm

Great piece, Russ!

Methinks1776 November 2, 2011 at 4:31 pm

Incidentally, this isn’t the first BD to go down after mismanaging risk. Anyone remember Refco , the commodities and futures BD, as a recent example? Broker Dealers blow up all the time. Hedge funds blow up all the time. No bailouts and the world does not end.

I know it’s very easy to say that they should have seen it coming, but even in better managed firms, things can change on a dime. Literally, overnight. That’s just the world of trading. There’s no perfect hedge and you’re always taking a risk – sometimes (not in this case) one that is impossible to calculate. Risk management is maddeningly difficult (not that this was such an issue – this is something that was obviously stupid). It’s so easy to judge in hindsight. But, the existence of incalculable risk is not an excuse to rob innocents at gunpoint to make risk takers whole.

PKSully November 2, 2011 at 6:12 pm

I was born into the industry as a Soc Gen trader, cleared LFG (blown out in Russian Debt crisis) as a local, moved to Refco, then MFG and now a smaller Chicago firm, Dorman. Each one was about 5 years apart. My advice is to get short Dorman in 2016!

Greg Webb November 2, 2011 at 6:19 pm

:)

Greg Webb November 2, 2011 at 6:19 pm

Hmmm, it did not take my post. Well, LOL anyway!

Methinks1776 November 2, 2011 at 6:59 pm

OMG! :)

I can’t afford to hold a short position until 2016! :) Have you seen what’s happened to rebates?

Chucklehead November 2, 2011 at 11:54 pm

The Russian Debt crisis is what got LTCM too. It was the beginning of the end. Just wait until the currency wars really take off.

Nikolai Luzhin, Eastern Promises November 3, 2011 at 6:01 pm

until the currency wars really take off

seems to me that have too.

Eastern Europe has to go to $39.99 a night for great hotels.

Greg Webb November 2, 2011 at 4:33 pm

Russ, excellent post! There is no firm that is Too Big To Fail. And, as a former regulator, I can assure you that there are not many field examiners who would take on the political class ensconced as the executive management of the regulatory agency. And, those that do are pushed aside with the official report showing nothing is wrong.

Laws and regulations are used to give the public the perception that the government is doing something. But, perception is not reality. And, regulation never works, especially in good economic times when these firms are making huge amounts of money from taking those high risks.

muirgeo November 2, 2011 at 4:40 pm

This is still the tip of the iceberg. It’s a problem of financial deregulation pure and simple. The guys and gals who predicted the first crash have been saying all along nothing is fixed and the worst is yet to come. We were warned years before the first crash of the dangers of these financial weapons of mass destruction. Here I was laughed at for my ignorance and still people defend the need for allowing Wall Street to be turned into a casino. What is happening in Europe can no longer be blamed on Barney Frank.

Greece will blow up the world when it’s people are given the choice to default and hopefully most of the pain will fall onto the jack asses who created and pushed these toxic financial products. Unfortunately, many unsuspecting people will suffer and many criminals who work the system will get out with billions. Human civilization will have effectively been held back 20 or 30 years of real progress because we let these jerks run the show.

Allowing them to fail IS important but prevention is always the best medicine. There were never and prospects of bailouts through all the boom and bust cycles prior to the Great Depression. The only thing that controlled them was good regulation.

The solutions are simple enough as much as the Wall Streeters would try to convince you otherwise. The Hayekian view that we should not try to control markets because they are too complex is bunk and is dangerous. Like going to a faith healer for your cancer. We are living the results of too much of that mindset. There are plenty of smart people who DO have good and simple ideas to make the system more stable. We had a stable system and tossed it out. Separate commercial and investment banks and simply impose tougher capital requirements are some of the obvious fixes.

Anyway… the Greeks are set to change the world…. hang on… it’s such an unnecessary growing pain but civilization will be better for it.

Dan H November 2, 2011 at 4:44 pm

“Greece will blow up the world ”

Yes, allowing their $309 Billion economy to fail will collapse the world. Right.

To put that in perspective, Walmart had revenues of $422 billion last year.

GAAPrulesIFRSdrools November 2, 2011 at 5:07 pm

Dan, perspective is not something Muirbot understands. You know how spell-check can’t account for context?

brotio November 4, 2011 at 12:36 am

Tells you something about our Dipshit Ducktor, when even Greece isn’t socialist enough for him.

Here’s a question for you, though: If Russia attacked Turkey from the rear, would Greece help?

muirgeo November 2, 2011 at 7:21 pm

How much was Lehman Bros economy?

muirgeo November 2, 2011 at 7:22 pm

Anyway.. you are both on record saying it’s not too significant…. watch and see!

CalgaryGuy November 3, 2011 at 2:04 am

So, how did financial deregulation lead to a possible Greece default? Please explain.

Government borrowing is not new, but it’s nice to see you on the record stating that a government that overspent is going to blow up the world.

T Rich November 3, 2011 at 10:07 am

I hope you expect only the sound of crickets as a response to your direct question to Muir?

Nikolai Luzhin, Eastern Promises November 3, 2011 at 9:29 am

Dan H

your comment is totally disingenuous. It is not about the size of the Greek economy, it is about the size of Greek debt, confidence, and deflation.

The EU needs to devalue the Euro to re-start the economies of Greece, Portugal, Spain, Italy, and France but can’t, so that are attempting to build an extraordinarily complex financial mechanism to do indirectly what ought to be done, directly.

Europe, like Japan, is hanging on a cross of trade. They are export driven economies and the only way for them to create demand for exports is to cut the value of their currency, but they can’t get such done because the USA and China are implicitly printing money faster (and in the case of Europe it is said to be “illegal” for the ECB to print Euros.

Dan H November 2, 2011 at 4:46 pm

The Soviet Union was just a little big bigger than Greece. Did the absolute collapse of the Soviet Union bring the world to its knees? Last time I checked, the ’90s were a pretty good decade.

SmoledMan November 2, 2011 at 5:15 pm

Don’t bother muirgeo with reality, he prefers constructing infinite straw men in his fantasy bubble.

txslr November 2, 2011 at 5:19 pm

If I’m not mistaken (and I’m not) Greece is structurally insolvent because the government there stimulated itself right into the ground. So the solution to this problem is…more government!!!

muirgeo November 2, 2011 at 7:29 pm

txslr,

“If I’m not mistaken…” Uh you indeed mistaken. Greece had a rightward push in their government and decided not to collect any taxes. They grew great debt and criminally backed it with Wall Street toxic assets to get entrance into the European Union. The assets blew up and here we are. The people of Greece have been screwed by their government and Global Finance Mafia. Now there will be a showdown between democracy and and the Global Finance Mafia. I know who I’m betting on.

Jon Murphy November 2, 2011 at 8:37 pm

“Rightward push in their government…” Huh? They became a socialist government. That’s not a rightward push. It also doesn;t help that 75% of workers in that country worked for the government.

Nikolai Luzhin, Eastern Promises November 2, 2011 at 8:43 pm

muirgeo thinks, “the people of Greece have been screwed by their government and Global Finance Mafia.”

muirgeo, you really make it hard when you write this silly stuff.

The people of Greece were not screwed by their government. I believe most wanted the Euro; the pros and cons are fairly well know. Most everyone said they could not make it with Germany being so much more productive.

They are now being given a vote. My view is that they should vote down the Euro and devalue, letting the Germans save their cash for Spain, Italy, etc.

The inescapable reality is that Greece must reduce its best hotel rooms to about $39.00 a night, so that millions of people travel there. It has no chance to make products or services competitive with the Germans. The same is likely true for Portugal. Spain, Italy, and France are more productive and have a chance to compete with the Germans, but that will take 5/7 years (and we should have lots of good French and Italian food and wine to enjoy).

Nick November 2, 2011 at 9:47 pm

Nikolai Luzhin, Eastern Promises v. murigeo.

Round 1 of Trolls trolling Trolls

Methinks1776 November 2, 2011 at 10:38 pm

Round 1 of Trolls trolling Trolls

Every swing is a miss…..

Greg Webb November 2, 2011 at 10:59 pm

George, does the psychiatric ward know that you have access to a computer?

Greg Webb November 2, 2011 at 11:05 pm

Round 1 of Trolls trolling Trolls

:)

muirgeo November 3, 2011 at 2:10 am
Nikolai Luzhin, Eastern Promises November 3, 2011 at 9:19 am

muirgeo

i saw your reply pointing out that after Greece issued debt that Goldman Sachs played both sides against the middle.

This has absolutely nothing to do with the current crisis which is about the debt and the differences in productivity between Germany and Greece

(Second) Not that it matters to you, but the deal about Goldman Sachs about which you complain was with sophisticated people who knew they were playing with fire, knew exactly what GS is and does. I really am not worried about the rich stealing from the really really rich.

What bothers men is when GS and others steal from us 99 percenters

muirgeo November 3, 2011 at 11:25 am

That’s the whole point Nikolai,

The government and the bank acted irresponsibly and now the people are suffering the results. The austerity measures are simply more TARP funds going to the banks and further impoverishing the citizens. The citizens long ago made it clear they’d just assume default… and now the prime minister with more pressure from other political hacks and the banks have decided NOT to let the people decide.

It’s funny to watch the neoliberals try to position themselves on this issue. They either have to side with the people who they hate or with the political rentier class who they are supposed to hate. It’s an easy guess for me to know who they will side with.

Nikolai Luzhin, Eastern Promises November 3, 2011 at 6:06 pm

muirgeo

you push to many things together

your arguments are about 97% right but you need to be more subtle in your distinctions at times.

Greg Webb November 3, 2011 at 6:19 pm

Round 2: Trolls kissing Trolls
Nikki and Muirgeo coming together on illogic and leftist propaganda…

Paul Andrews November 3, 2011 at 12:02 am

“It’s a problem of financial deregulation pure and simple.”

What gives you such confidence that moral hazard and loose central bank credit did not play their parts?

muirgeo November 3, 2011 at 2:06 am

You trying to tell me the Central Banks and the big banks are different people? The Fed has done everything Wall Street desires.

Greg Webb November 3, 2011 at 6:20 pm

Nope! The Federal Reserve System has done everything that corrupt politicians and their political cronies want them to do.

Paul Andrews November 4, 2011 at 6:59 am

“You trying to tell me the Central Banks and the big banks are different people?”

No I am not, I agree that they are. Financial deregulation is not the cause of this. It’s inherent in the central banking model.

“The Fed has done everything Wall Street desires.”

Indeed. And so has the government. Hence the moral hazard. Big banks and corporations in bed with big government. The reasons this situation arose are a lot more complex than “deregulation”.

Methinks1776 November 2, 2011 at 4:45 pm

Russ, this is such a meaty post. I want to hit on another point you made.

There are limits to regulation. Broker Dealers both have customer accounts (the customers may be other BDs – and in the case of MFG, I think they were entirely institutional) and it can trade for its own account. They can also be just securities dealers, but MFG was a full BD.

It is illegal to co-mingle customer accounts with the firm’s proprietary trading accounts. There is growing suspicion by the regulator that MFG tapped its customers’ accounts to meet margin calls as it was sinking and the regulator had no idea and was helpless to stop it. that’s the optimistic version. The more cynical version is that the regulator allowed it to happen because it was their buddy, Jon, after all.

It is not practical or possible for regulators to monitor thousands of firms in real time. Furthermore, the MFG books are a mess. I don’t understand why. The regulator receives a FOCUS report every month and examines the firm at least every year – and (speaking from experience) these exams are very thorough. My only guess is that they were allowed to slide because MFG is politically connected.

But, if the regulator can’t even police simple, straightforward regulations regarding accounting and co-mingling prohibitions, how the hell so these clowns expect them to do better with the arduous task of risk managment?

txslr November 2, 2011 at 5:15 pm

I wonder what pardons are going for these days? “Get Eric Holder on the phone!”

PKSully November 2, 2011 at 6:15 pm

My question is and has been, how did the CME not catch this? Aren’t they supposed to check this stuff twice a day? Isn’t that partly what I’m paying for?

Methinks1776 November 2, 2011 at 7:13 pm

Ever have that conversation with your reg examiner during your annual where he gets really comfortable chatting with you and reveals how much politically connected firms get away with? You’re paying that fat reg fee every month to protect the world from small potato locals who aren’t big enough to cause a ripple, not BSDs like Jonny Corzine.

God, this business makes a person cynical!

Greg Webb November 2, 2011 at 4:46 pm

Muirgeo, you said, “Here I was laughed at for my ignorance” and “the only thing that controlled them was good regulation.”

As a former regulator, I can assure you that there are few, if any, field examiners who will say that the most politically-connected firms are taking too much risk in good economic times. To do so would be career suicide. That is why regulation can not work. We are still laughing at you for your ignorance.

muirgeo November 2, 2011 at 7:36 pm

Greg,

You are also on record saying Europe is n big thing.

Your laughing at me is meaningless to me. I’ve been on this blog and others well before the 2009 crash and I saw who correctly called the bubble and crash…. It wasn’t these two professors.

Russ actually went through an evolution and an awaking pushing his position more in the direction of mine with regards to the banking and finance sectors culpibility.

So what years were you a regulator… I’m guessing indeed you did a very poor job. You were a regulator and YOU didn’t see this coming. And like I said I have you on record as telling us not to worry about Europe. Laugh clown…laugh.

Greg Webb November 2, 2011 at 8:58 pm

George, please let me know where I said “Europe is no big thing.”. I predicted that Greece would get kicked out of the monetary union and that the Euro might fail, which are big things. I even said that it would be a good thing if the Euro fell apart.

I was a regulator with the Comptroller of the Currency and left many years before the current crash. I left because the regulatory authorities had the necessary tools, but would not use them. In government, the primary rule is don’t rock the boat.

I, and everyone else, are still laughing at you for pretending at knowledge that you obviously don’t have.

BTW, did you hear that Vernazza and Monterosso were flooded from a long rainstorm. Very sad. But, I’m sure they will rebuild.

Nikolai Luzhin, Eastern Promises November 2, 2011 at 9:52 pm

Greg Webb writes, “I left because the regulatory authorities had the necessary tools, but would not use them.”

This is also my experience with both the OCC and Fed Reserve, but the cause has been that every time the Republicans get in they purge anyone who has tried in the name of Hayekian deregulation.

Greg Webb November 2, 2011 at 11:06 pm

Nikki, you’re so stupid!

muirgeo November 3, 2011 at 2:18 am

“BTW, did you hear that Vernazza and Monterosso were flooded from a long rainstorm. Very sad. But, I’m sure they will rebuild.”

No I didn’t hear that. We’re planning to go back there in May. Bummer…anyway you’re wrong about all the other stuff.

You did tell me I was being hysterical about the implications of Europe. I’m not gonna waste time finding it.

I think this Greek vote/ default may be a historic event. The powder keg is growing all around the world. People are fed up with so much inequality, poor representation and corruption. Greed has no end and these people on top like entrenched dictators will only make things worse for themselves.

And you guys have no solutions because you don’t even recognize the problem.

Greg Webb November 3, 2011 at 3:23 am

George, you said, “. . . you guys have no solutions. . .”.

Good economists, like good physicians, follow the rule of “first do no harm.”

You also said, “. . . you don’t even recognize the problem.”

The problem is political cronies who break the rule noted because they have an axe to grind or are attempting to buy the vote of those who do have an axe to grind.

They following will be “big things” that may occur (some are more likely than others): (1) Greece is kicked out of the monetary union, (2) the responsible member states pony up 2 trillion Euros to bail out the irresponsible member states, and/or (3) the monetary union and the EU fold. All important, all costly, all good in the long run.

You said, “I think this Greek vote/ default may be a historic event. The powder keg is growing all around the world. People are fed up with so much inequality, poor representation and corruption. Greed has no end and these people on top like entrenched dictators will only make things worse for themselves.”

It sounds like you believe that there will be world-wide revolution with the “people-led democracy” occurring as you have been advocating. You should be happy. Utopia is on its way.

My experience is that world-wide revolution is often predicted but never happens. The world will muddle through this politician-created mess as it has always done.

Nikolai Luzhin, Eastern Promises November 3, 2011 at 9:36 am

Greg Webb

Now there is a name that will live in the halls of stupidity for ever.

He writes:

I left because the regulatory authorities had the necessary tools, but would not use them. In government, the primary rule is don’t rock the boat.

His solution: deregulate even more

this makes you a world class idiot.

the solutions are obvious–make government more transparent so that the public knows that regulations are not being enforced and democratic so that us 99 percenters can vote the cronies out

Greg Webb November 3, 2011 at 1:00 pm

Nikki, you claim that I am a “world-class idiot” because I said that government does not use the regulatory tools it has because of political interference to protect political cronies. Then, you claim, despite this clear and convincing evidence that regulation does not work, that the solution is even more regulation.

LOL! Albert Einstein once said “The definition of insanity is doing the same thing over and over again and expecting different results.” Thanks for proving your insanity. Please let the head nurse of the psychiatric ward know that you have unauthorized access to a computer.

Nikolai Luzhin, Eastern Promises November 4, 2011 at 7:13 am

Below Gregg Webb really proves that he is a world class idiot.

He said that we had adequate regulations but politics (K street lobbyist for the One Percent) keep them from being enforced.

I replied, “the solutions are obvious–make government more transparent so that the public knows that regulations are not being enforced and democratic so that us 99 percenters can vote the cronies out.”

This is not a call for more regulations. It is a call to reform government.

Gregg Webb cannot understand that a more transparent and democratic government might even require less regulation

Methinks1776 November 4, 2011 at 7:36 am

Do you know how I know that you’re either a shit lawyer or you’re not a lawyer at all, Luzha?

Because you don’t understand that regulations are so vague that the regulator can’t clarify how to comply with them, let alone how to enforce them. Also, it seems to have completely slipped your notice that they are, in part, written that way intentionally to give the state more flexibility in criminalizing activities at will and without warning.

If the regulators can’t fully understand the regulation and the regulated can’t fully understand the regulations in their own industry, then how do you expect the average house frau to wrap her mind around the billions of pages of regulations governing every industry and keep tabs on what’s enforced and what isn’t?

In financial regulation, we still have regs on the books dating back from the days when everything was done on paper instead of electronically. Technically, we’re supposed to store reams of hard copies (including order tickets) and be able to produce them for the regulator whenever asked. Guess what? They don’t enforce that regulation. Maybe we should alert Mrs. Smith of this regulatory failing! I’m sure she’s versed in the finer points of the OATS, Reg NMS compliance, how to calculate net capital to comply with reg 15c3-1 and the definition of “associated person” (and maybe she can teach my SRO what that is because they spent 3 days debating that one during my last reg exam). For. Every. Single. American. Firm.

See, now, if you were a lawyer instead of an idiot (I realize they are not mutually exclusive), you’d understand all that and you’d see the stupidity of your assertion.

Greg Webb November 4, 2011 at 10:51 am

Methinks1776 said, “See, now, if you were a lawyer instead of an idiot (I realize they are not mutually exclusive), you’d understand all that and you’d see the stupidity of your assertion.”

No, Nikki is too stupid to “see the stupidity of [his] assertion.”

Greg Webb November 4, 2011 at 10:55 am

Nikki, you said, “us 99 percenters.”

LOL! No, 99% of the US population is not stupid like you are. In addition, to pretending at knowledge, leftist idiots also pretend at popularity.

Dizzy Ringo November 2, 2011 at 4:46 pm

The perceived wisdom used to be that leverage ratio should be 70% equity, 30% debt max. Or is that too old fashioned?

Methinks1776 November 2, 2011 at 4:49 pm

No, it’s too cookie-cutter.

SmoledMan November 2, 2011 at 5:15 pm

Explain me when 40-1 leveraging is ever a good idea. I’m anxiously waiting for that one.

Methinks1776 November 2, 2011 at 5:34 pm

S-man,

There’s an ocean of difference between levering up 40x (particularly if you’re just rolling the dice on a giant directional bet) and forcing every strategy to comply with 0.5x leverage.

for instance, any brokerage will allow you to lever 6x if you deposit as little as $150K in your account. It’s called “portfolio margin”.

Typically, equity options market makers are extended at least 15x leverage very safely and that can safely go up to 30x leverage, depending on hedging, etc. Same with ETF market makers.

A long/short equity strategy will have a hard time getting more than 6x leverage (or thereabouts).

A retail account smaller than $150K will not be illegible for more than Reg T margin, which is 2x leverage.

See my point?

Hell, you only have to put 20% down to buy a house! And that’s “back in the day”.

What I want to know is whose bright idea was it to allow financially unsophisticated Average Joe, who it now turns out can’t read a mortgage contract, to use 100% leverage to take one giant bet on a single illiquid asset – his house!

Greg Webb November 2, 2011 at 5:49 pm

Methinks1776, you said, “What I want to know is whose bright idea was it to allow financially unsophisticated Average Joe, who it now turns out can’t read a mortgage contract, to use 100% leverage to take one giant bet on a single illiquid asset – his house!”

LOL! You know that your federal government did. It’s called low-to-moderate income lending. A Federal Reserve Bank of Boston study “proved” that low income people would do anything to avoid losing their home, thus traditional lending standards, such as down payments, were not necessary. Bankers, confused at having to offer home loans to low-to-moderate income people without a down payment, felt that they could not require down payments of their most-able-to-repay customers. And, that is where the trouble first began. :)

Methinks1776 November 2, 2011 at 6:05 pm

Grrrrrreat! So, you’re telling me the Boston Fed couldn’t figure out how rent-to-own changed incentives? Well, it looks like the low-income people outsmarted everyone.

Why, 40x leverage just pales in comparison.

I hope these aren’t the same economists who will be in charge of planning future Keynesian stimuluseseses!

muirgeo November 2, 2011 at 7:50 pm

“What I want to know is whose bright idea was it to allow financially unsophisticated Average Joe, who it now turns out can’t read a mortgage contract, to use 100% leverage to take one giant bet on a single illiquid asset – his house!”

methinks

How incredibly arrogant. Yeah, because we should leave these matters only to the sophisticated Wall Street people. You know the ones who did such a good a job buying , repackaging, securitizing, rating and shorting these loans using their own financial creations.

You are like the Jack Ass surgeon I worked with last night who criticized a mother for having the temerity to question his judgement.

You know what if you never reply to me again I’ll never reply to you again. The above post by you is 100% absolute proof what a disgusting person you are. You left no glimmer of doubt.

kyle8 November 2, 2011 at 8:37 pm

What the political and to some extent the business classes are relearning, at great cost, is that there are no substitutes for sound money, and sound lending practices.

No regulatory scheme, no fancy new economic theory, no new exotic security, no market, nothing can substitute for those two things.

Greg Webb November 2, 2011 at 9:00 pm

Kyle8, that is exactly right.

Greg Webb November 2, 2011 at 9:05 pm

George, you said, “How incredibly arrogant!”

It’s incredibly arrogant for foolish and corrupt politicians to create perverse incentives then blame free people and free markets when the results of those incentives is economic chaos.

Nikolai Luzhin, Eastern Promises November 2, 2011 at 10:05 pm

Methinks has forgotten that it was Alan Greenspan, a Hayekian and Ayn Rand follower, who “whose bright idea was it to allow financially unsophisticated Average Joe, who it now turns out can’t read a mortgage contract, to use 100% leverage to take one giant bet on a single illiquid asset – his house!”

Just to cut off your bullshit. The regs, for example or national banks are at 12 CFR Part 34 (the LTV regs).

The SEC could have also regulated the loan pools, but we had Hayekians there also.

Nikolai Luzhin, Eastern Promises November 2, 2011 at 10:08 pm

Methinks1776 writes, “I hope these aren’t the same economists who will be in charge of planning future Keynesian stimuluseseses!”

I agree. Let’s hope we have a Keynesian in charge of planning future Keynesian stimulus,” and perhaps we can trade for one from China (whose stimulus worked)

Greg Webb November 2, 2011 at 11:08 pm

Nikki, you are really,really stupid!

PKSully November 2, 2011 at 8:41 pm

I’ve been busy between this and home stuff so haven’t read every detail. When is the 40:1 leverage number being measured? I mean, at the moment just before you become illiquid the leverage is millions to one i.e., an $80 mortgage on a $100 dollar house is 4:1 but when the value of the house drops to $80.05 it becomes 1,600:1.

Methinks1776 November 2, 2011 at 9:24 pm

Good question. Forbes says it was 80x.

http://www.forbes.com/sites/robertlenzner/2011/10/31/corzine-had-mf-global-leveraged-80-to-1/?feed=rss_home

How do you do that 15c3-1 net capital requirement calculation again? :)

I’ll bet they were compliant. Oh well. So much for the regulators saving us from doom.

Nikolai Luzhin, Eastern Promises November 4, 2011 at 7:14 am

when the “1″ is not your money, idiot

OPM, remember the movie, idiot

Greg Webb November 4, 2011 at 10:58 am

Nikki, you said, “remember the movie.”

Try living in the real world. Movies are fiction.

Shidoshi November 2, 2011 at 4:54 pm

With leverage that high, there is not much difference between debt and equity in terms of risk. Although the equity holders are the ones who will benefit upon the projected returns, and the bond holder’s are stuck with their fixed return. It really seems like just a total lack of oversight on behalf of the investors – not doing their due diligence.

Greg Webb November 2, 2011 at 5:00 pm

Insured commercial banks are supposed to take little risk which, according to the government, justifies the low capital ratios of 8% to 10%. But, investment banks were never supposed to be insured or bailed out so capital ratios could be much less than that based on the theory that creditors would put limits on risk taking by investment banks. Creditors don’t worry about risk taking if they feel comfortable that they will be bailed out by the federal government if the investment bank fails.

Methinks1776 November 2, 2011 at 5:10 pm

Greg, MF Global was a broker dealer, not a commercial or investment bank.

Greg Webb November 2, 2011 at 5:29 pm

Thanks, Methinks1776. But, I thought that Jon Corzine’s strategy was to change it into an investment bank.

My comments regarding commercial banks and investment banks were to give everyone a better understanding of what the government feels is adequate capital for government-insured commercial banks vs. not-supposed-to-be-government-insured investment banks and why.

Methinks1776 November 2, 2011 at 5:48 pm

I thought that Jon Corzine’s strategy was to change it into an investment bank.

Well….he didn’t make it!!! Bwahahahaha!

I’m sorry, Corzine is just such a pig. I feel really bad for all of the firm’s customers who had nothing to do with any of this, who make a living trading and whose livelihoods were threatened by this disaster.

I see what you’re saying. I also think that the bank creditors were thinking “they’ll never let bank xyz fail”! But, in general, I’m not so sure that creditors always feel uncomfortable with risk taking if they don’t sense a bailout coming (which is not what you were talking about). I mean, there are junk bonds, after all.

Greg Webb November 2, 2011 at 5:52 pm

Jon Corzine is a known political crony. I do not feel sorry for him or his investors. I would have gotten out once I knew that he would be involved.

Methinks1776 November 2, 2011 at 6:11 pm

I didn’t feel sorry for myself when I lost all the money I invested in my friend’s start-up when it went belly-up and I don’t feel sorry for MF Global investors and creditors. You you make your bet and you suffer the consequences – good or bad.

It’s the customers (who are neither creditors nor shareholders) I feel bad for. I feel especially bad for them if it turns out Corzine stole their money to meet margin calls on his bad trades (and these Italian bond trades were Jonny’s idea – he wouldn’t listen to his subordinates who were becoming increasingly alarmed by his swagger). It is illegal to co-mingle funds. We’ll see if he did. I don’t think that’s clear yet.

Greg Webb November 2, 2011 at 6:18 pm

Good points. A thorough investigation into Jon Corzine’s activities needs to be conducted to determine if the allegations are true. It would not surprise me if they are. If so, Jon should go to prison and be required to reimburse those who lost money as a result of his commingling funds.

Nikolai Luzhin, Eastern Promises November 3, 2011 at 9:44 am

Gregg Webb

you are really stupid, so stupid that Methinks is brighter than you, pointing out that MF Global was not a commercial bank

you also don’t understand risk.

You really should read Peter Drucker on risk. People in business are not risk takers; the ones who are successful are the ones who are the best at avoiding risk. I am not going to put up the entire essay, but your entire discussion of risk is that of an idiot.

We require bank reserves because we know that lenders cannot stop lending at the top, even when market conditions would warrant doing such, because of winnner’s curse. As Prince said, as long as the music plays you have to dance. You just hope there is a chair for you when the music stops.

Greg Webb November 3, 2011 at 9:58 pm

Nikki, so says the guy who claims that more regulation is the answer when regulation failed to prevent Jon Corzine, another idiot leftist, from blowing up MF Global.

Nikolai Luzhin, Eastern Promises November 4, 2011 at 7:28 am

Gregg Webb

You are such an idiot. It takes no equity to engage in investment banking as practiced today. Today, underwriters do not “buy” a stock offerings and then re-sell such over time, as was the former practice. IPOs are now pre-sold to investors. Banks, today, engage in similar behaviors, like bridge loans on management lead buyouts, but such is not was is traditionally thought of as investment banking.

The best way to control the behavior of a Goldman Sachs would be to prevent it from having any equity. Then, no one would sign a contract with it as a counter party for they would know that the promise was meaningless, for you cannot get blood out of a turnip. The return to a world of best efforts and comfort letters would be a good thing.

You are too stupid to understand it, but Goldman Sachs is the only firm left from the tombstone in the early 1950s for Ford. We used to have hundreds of investment bankers. The closing of all these firms has really really hurt entrepreneurial effort in this country.

Not so long ago, Home Depot went public with only 4 stores. That would never happen, now. We need to return to that era

Methinks1776 November 4, 2011 at 7:41 am

for you cannot get blood out of a turnip

And you can’t find intelligence in a luzha.

Shidoshi November 2, 2011 at 4:51 pm

The bondholders are fools to not put covenants in their credit agreements to disallow the firm from over-leveraging itself. 40-1?

Nikolai Luzhin, Eastern Promises November 3, 2011 at 9:51 am

Shidoshi

You fail to understand that there is no law of economics that says that the amount of money available to be lent is equal to the number of good loans.

If you have money, the choice is not among good loans, it is “What is the least bad loan that gives me the rate of return I need to make?” Since everyone in finance believes (wrongly) that they are from Lake Wobegon (“the little town that time forgot and the decades cannot improve … where all the women are strong, all the men are good-looking, and all the children are above average.”) and are entitled to ALPHA, you get, with hindsight, really dumb loans

Jon Murphy November 2, 2011 at 4:57 pm

Reality is the best regulator out there. What’s the SEC going to do if a company over-leverages itself? Force them to deleverage? Make them pay a fine? Worst case scenario you go to jail for a few years?

Reality is a harsh mistress. She will take your money, your reputation, your family, your friends, your stuff without even a second glance.

Jon Murphy November 2, 2011 at 4:57 pm

I had a more colorful way of making my point, but this is a family show.

txslr November 2, 2011 at 5:04 pm

“The reality is that Dodd-Frank does not do enough to prevent financial institutions from taking excessive risks with investors’ money.”

What does this mean? The government should decide how much risk investors should take on? You might think it refers to risk-taking with insured deposits, but that wasn’t the case for MF, and the next sentences are:

“While it imposes leverage requirements on banks, those requirements are still quite limited, and institutions not regulated by federal banking agencies are not restricted in their risk-taking in any meaningful way.”

So Eric Lewis is concerned that the government doesn’t limit the amount of risk that individuals are allowed to take with their own money? Is this incandescently stupid?

Nikolai Luzhin, Eastern Promises November 3, 2011 at 6:07 pm

Dodd-Frank does not do enough

whose fault is that?

AU03 November 2, 2011 at 5:08 pm

::stands::
::applauds::
::receives weird stares from co-workers::
::sits back down::

Chris O'Leary November 2, 2011 at 5:14 pm

“Let’s change the rules of the game. Let’s tell creditors that they can lose all their money. When that actually happens, I think it will actually change their behavior. You’re on your own. You can’t go to the regulator and make a case for why your kind of leverage is actually really safe. You’re on your own. You make good decisions, you make money. You make bad decisions, you lose money. It’s called capitalism. Let’s try it.”

Literal — and slightly awkward since I’m reading this in a public place and now look crazy — LOL.

Chris O'Leary November 2, 2011 at 5:15 pm

Hah. I didn’t see the post immediately above mine. Does this site support animated GIFs? I know which one I’d post.

Mogden November 2, 2011 at 5:14 pm

The title of the post assumes that creditors will actually lose their money. Is that certain?

Chris O'Leary November 2, 2011 at 5:16 pm

Excellent — and telling — question.

Economiser November 2, 2011 at 5:22 pm

They are in Chapter 11. Yes.

gandalf November 2, 2011 at 7:05 pm

Not necessarily, depends on the eventual POR or 363 sale (or alternatively, the liquidation). I haven’t dug into any details on the case, but the creditors almost certainly won’t come out whole.

Shidoshi November 2, 2011 at 11:21 pm

Yes – they will lose money. The market value of the assets which collateralize their credit interest is gone, if it was based on derivatives betting on a European crisis resolution.

Gregory Wallin November 2, 2011 at 5:19 pm

It seems to me that we are determined to prevent people from learning life’s lessons. Falling down is part of learning to walk.

All the regulations give people a false sense of security or make them lazy. Why should an investor worry about risk? The government has already taken care of it for them. We can’t regulate away risk.

Nikolai Luzhin, Eastern Promises November 3, 2011 at 10:01 am

You make a very interesting claim that, “All the regulations give people a false sense of security or make them lazy.”

My two cents is that it is the regulators who falsely promote that they are doing a good job that leads to this effect.

There are other variations. What I believe is worse is when you let a regulated business engage in unregulated activity. This really misleads.

The worst offender in this way, recently, was Larry Summers, who would under no circumstances admit how wrong he was about decisions made about derivatives, especially synthetics (which are just gambling)

Economiser November 2, 2011 at 5:26 pm

To the point about regulators managing this sort of scenario, Interactive Brokers was diligencing MF Global as a potential acquisition through the weekend. They only walked away on Sunday night as a result of the bookkeeping discrepancies. MF Global filed for bankruptcy Monday morning.

If it took until Sunday night for a potential buyer to determine that something was rotten, how in the world can anyone expect government regulators to figure that out in advance and take corrective action (whatever that may be)? It’s simply not possible.

Dallas Weaver November 2, 2011 at 5:55 pm

Who were the people who lent them 97.5% of an assets value at a lower interest rate than the asset was paying? I assume the lenders were also shorter time scales than the assets to justify a lower interest rate, but a very small change in bond interest rates dramatically changes the bond value. From a risk viewpoint, I don’t see how it makes any sense unless you assume insider information or crony capitalism to make the risk small than it appears.

Darren November 2, 2011 at 6:03 pm

It seems like it’s always “more regulation”, with absolutely no acknowledgment there’s any such thing as “bad” regulation. At least most people who want less regulation tend to acknowledge there is “good” regulation.

Martin Brock November 2, 2011 at 7:32 pm

What does a regulator do exactly? Threaten penalties for misbehavior? So Corzine and company misbehaved, and they’re being punished. Right?

Invisible Backhand November 2, 2011 at 6:45 pm

Bah. What’s really breaking news is that I’m now published in the NYT:

http://i.imgur.com/FimjM.png

Invisible Backhand November 2, 2011 at 11:17 pm

Bah. What’s really breaking news is that I’ve now shown my face:

http://i.imgur.com/y80zy.png

Shidoshi November 2, 2011 at 11:24 pm

Haha nice. but that image hurt my eyes.

House of Cards & Economic Freedom November 3, 2011 at 5:51 pm

It’s a Guy Fawkes mask from the movie “V for Vendetta.” It’s a mask worn by members of a real troll/hacker group calling itself “Anonymous,” one of Invisible Backhand’s handlers.

Invisible Backhand November 3, 2011 at 9:55 am

That’s a great pic! Did you do that yourself or use a meme generator?

You should come by my site http://www.reddit.com/r/CafeHayek/ and harass me some more. Sign up takes 10 seconds and you don’t have to provide an email addy.

BTW, what email addy are you using to impersonate me? Only Russ and Don can see it so I know you don’t know what it is…or do you?

Nikolai Luzhin, Eastern Promises November 3, 2011 at 10:03 am

cool

Invisible Backhand November 3, 2011 at 3:24 pm

Phony IB: I don’t have your mad photoshop skilz but I did this one just now:

http://i.imgur.com/40iMx.gif

Invisible Backhand November 3, 2011 at 5:46 pm

I don’t have your mad photoshop skilz

And I don’t have sane economics skills, either.

Invisible Backhand November 3, 2011 at 5:57 pm

If you had street smarts you wouldn’t believe a load of propaganda that some billionaires pay Russ and Don to pour on your head.

Invisible Backhand November 3, 2011 at 7:28 pm

If you had street smarts . . .

I’m right, as usual: knowledge of economics isn’t necessary. All one needs is street smarts.*

Hooray for the anti-intellectual revolution of the left!

* Street smarts . . . and some handlers from Anonymous.

Methinks1776 November 3, 2011 at 9:31 pm

Okay….but, where are the street smarts? I don’t see anything from Irritable Bowel that suggests smarts of any variety.

vidyohs November 2, 2011 at 7:59 pm

“If their huge bets on European debts had paid off, Corzine and his colleagues would have added to their immense wealth.”

If.

If frogs had wings they wouldn’t bump their little butts when they hopped.

Something to keep in mind when that if comes up.

jorod November 2, 2011 at 10:00 pm

Hazlitt noted that artificially low interest rates encourages speculation.

vikingvista November 2, 2011 at 11:43 pm

The cheaper the funds, the less the risk to the investor, c.p.

Herman November 3, 2011 at 4:06 am

The extra regulations are required to deal with the problems that arise from the earlier regulations.

A bank failed and regular people lost money. So we created the FDIC and regulated the banks. But that creates the incentive for abuse – stashing risky but high performing assets in government-protected banks. So we create more regulations to address that.

It’s like providing free health care, but then using that as a rationale to regulate everyone’s diet. I mean, who is going to pay for your coronary if we let you eat all those Ho-Ho’s?

I do see a place for regulation, however, as a means to support specialization of the broad public. Take medicine for example. I am glad that they are regulated and inspected, because I do not have the time to become expert enough in pharmacy so that I know I’m not getting poisoned or ripped off. I spent that time learning engineering instead.

The same is true for financial products marketed to the broad public. I accept the benefit of regulation in order to avoid the cost of the public’s need for expertise. Not that this is one of those cases.

Nikolai Luzhin, Eastern Promises November 3, 2011 at 10:10 am

a great work of fiction

we created deposit insurance because of need for people and businesses to know that their demand deposits were secure so that hey could do business.

ever since, the abuse has come from depositors who have wanted to have their cake and eat it took (like interest paying savings accounts that pay a great rate of return). The worst promoters of this abuse are the Republicans whose standard matra these days is that savers are being punished by our low interest rates on insured deposits.

Methinks would explain that you cannot have you cake and eat it too. If you want to make 20% on your money you have to work long and hard. You could, for example, go buy and rent foreclosures, but that would be hard risky work and people with money are just as lazy are people here think poor people are without money

Herman November 3, 2011 at 12:33 pm

I took some dramatic license with history, but I don’t find any sense in your position. Depositors are the risk to the banking system? Hardly.

It works like this. You and a thousand of your friends deposit $250k with me the bank. You don’t care what I do with it, because you are insured. I use it to invest in ultra risky MBS. Heads I get rich, tails I lose your money. Problem? For who? Thus, new regulations are born out of the old.

Nikolai Luzhin, Eastern Promises November 3, 2011 at 6:11 pm

Herman

it is depositors who have convinced the Congress to increase the amount of deposit insurance. The rest is just K street feeding on the carcus.

There is no deposit insurance for investment banks, etc., olnly commercial banks, credit unions, and S & Ls.

There is investor protection against theft through SPIC

House of Cards & Economic Freedom November 3, 2011 at 5:57 pm

we created deposit insurance because of need for people and businesses to know that their demand deposits were secure so that [t]hey could do business.

And those demand deposits are secure . . . right up until the moment people’s banks become insolvent and there’s a run on them.

Economiser November 3, 2011 at 10:44 am

There’s a difference between certification and licensure. Products and services can be certified without artificial constraints on their supply. I’m very glad that certification exists, but it doesn’t have to come from the government alone.

For example, I don’t pick my pharmacy based on government regulation. I pick my pharmacy based on non-governmental certifications; i.e., I go to a national brand pharmacy because I trust their reputation. I also go to a local pharmacy because I know the people and I trust them. I’ve never stopped to consider if these pharmacies are government regulated and inspected, and quite frankly that would mean less to me than the other criteria. If I ever had a problem, I’d expect to get a better result by talking to the people in charge of the pharmacy than by talking to a city health inspector.

Rufino November 3, 2011 at 5:08 pm

No bail out, and more regulation. The two are not one in the same; the first should absolutely apply to the MFs of the world (or, the of the US at least, since these massive bankruptcies only seem to happen here nowadays), and the second should absolutely be implemented on the banking sector writ large. I believe the talking point going around is “privatizing profits while socializing risk”.

Methinks1776 November 3, 2011 at 9:47 pm

since these massive bankruptcies only seem to happen here nowadays

Did you miss Dexia? Or any of the other European banks levered 50:1 and loaded with PIIGS debt which they are undoubtedly fallaciously marking at par? I’ll translate: they’re all bankrupt and more bankrupt than any bankrupt U.S. bank ever was.

and the second should absolutely be implemented on the banking sector writ large

A.) Did you miss the fact that banking is and has for decades been either the most or one of the most regulated sector of the U.S. economy? And yet….2008.

B.) Did you miss the fact that MF Global was a broker dealer and not a bank of any stripe? Why would you insist that the banking sector needs more regulation because a non-bank went bankrupt?
That’s like saying you need to go to jail because my next door neighbour killed his wife.

C.) Did you miss the fact that there is no bailout for MFG and there won’t be one? There are no socialized losses.

I can’t tell you how refreshing it is to see someone so obviously oblivious to the facts in the case screech for more regulations. Apparently any regulations imposed on anyone will do.

Rufino November 4, 2011 at 2:39 pm

Hey Methinks1776. The simmering rage and condescension in your response is really conducive to positive debate and thought. Our country needs more people like you, especially at this moment in history.

“Did you miss Dexia? Or any of the other European banks levered 50:1 and loaded with PIIGS debt which they are undoubtedly fallaciously marking at par? I’ll translate: they’re all bankrupt and more bankrupt than any bankrupt U.S. bank ever was.”

Blah blah. Just making a point that American finance seems to be really good at creating spectacular company implosions lately. I did miss Dexia. So did everyone else. Because you’re making an allegation, rather than stating a fact.

“A.) Did you miss the fact that banking is and has for decades been either the most or one of the most regulated sector of the U.S. economy? And yet….2008.”

This seems to be unquantifiable and suspect. What are you basing this statement on? The number of relevant regulations? The impact of existing regulations? Requires further development and supporting evidence.

“B.) Did you miss the fact that MF Global was a broker dealer and not a bank of any stripe? Why would you insist that the banking sector needs more regulation because a non-bank went bankrupt?
That’s like saying you need to go to jail because my next door neighbour killed his wife.”

“C.) Did you miss the fact that there is no bailout for MFG and there won’t be one? There are no socialized losses.”

The author of the article here seems to establish a link between regulations and bailouts. I am stating that both are completely unrelated.

Have a nice day.

Fine. Replace “banks” with A,erican finance then. As for your murder metaphor – nice.

Perhaps more regulation is the wrong way to put it. Instead, rolling back the sustained deregulation of the 80s and 90s would be a better way to start, like bringing back Glass-Steagall.

Then we could get to work on regulating your posts.

Greg Webb November 4, 2011 at 5:20 pm

Perhaps more regulation is the wrong way to put it. Instead, rolling back the sustained deregulation of the 80s and 90s would be a better way to start, like bringing back Glass-Steagall.

Nice politically correct nonsense. Perhaps you would be better to read Titles 12, 17, and 31 of the Code of Federal Regulations. Once you finish your reading assignment, we can more intelligently discuss why you are wrong with your desire to increase regulation. I will talk to you again sometime early next year because you have a hell of a lot of reading to do. Oh, you should also read the Comptroller’s Handbook for National Bank Examiners, the FDIC’s Risk Manager’s Manual on Bank Examinations, the Federal Reserve’s Commercial Bank Examination Manual, and various SEC publications. Have fun!

Then we could get to work on regulating your posts

No. But, once you get an education in the financial industry and economics, you will understand Methinks’s posts. Until then, you should not post anything on subjects that you don’t know anything about.

Rufino November 4, 2011 at 7:35 pm

Greg, thanks for the reply and for the pass on my mangled post to Methinks (pasting error). My sarcastic praise of Methinks’s murder metaphor meant to follow statement B, and was supposed to conclude with a sincere wish to have a nice day.

Anyway, its amusing reading the emotional and vitriolic responses to criticisms of financiers/masters of the universe. I appreciate that it must be tough being the boogie men of our time.

As to your comments, I’ll pass on reading up on the current regulatory framework applied to finance. As you rightly point out, I’m not in finance (thankfully).

Suffice to say that the past few years have been without question the worst and most embarrassing period of American (and European) finance since the American gilded age.

Industry self regulation clearly produced an environment of casino capitalism and a financial culture of obscene and poorly thought-out risk taking.

And the finical sector’s atrocious performance over the past few years will not be corrected by more autonomy and less transparency.

Methinks1776 November 4, 2011 at 8:54 pm

Suffice to say that the past few years have been without question the worst and most embarrassing period of American (and European) finance since the American gilded age.

Really? So You’re less embarrassed by, say, FDR’s incarceration of the Japanese during WWII or Jim Crowe laws? Those items are less embarrassing for you?

Typical.

You’re clueless. Unfortunately for the rest of us, you don’t let your vast ignorance stop you from demanding all sorts of things you heard people talk about on the TV but can’t comprehend and have no desire to.

What we need is regulation of idiots. You’re definitely under-regulated.

Greg Webb November 4, 2011 at 10:42 pm

Ruffino, you said, “Anyway, its amusing reading the emotional and vitriolic responses to criticisms of financiers/masters of the universe.”

LOL! You really don’t have a clue as to what you are talking about. Certain investment banks, like Goldman Sachs, and broker/dealers, like MF Global, are operated by some of the worst political cronies on the planet. And, they get criticized all the time on this blog. Jon Corzine, the head of MF Global, is a very liberal member of the Democrat Party and is the former Senator and Governor of the State of New Jersey. So after destroying the finances of the State of New Jersey and adding to the financial woes of the United States, is it any wonder that he blew up MF Global?

The emotional and vitrolic responses that you see on this blog are statists like yourself whining pitiously when someone criticizes the incentives that create these messes. True commercial and investment bankers are not to blame. The political cronies, like Goldman Sachs, big contributors to the Democrat Party, are.

You also said, “I appreciate that it must be tough being the boogie men of our time.”

And, the boogie man of our time are corrupt politicians, their political cronies, and witting and unwitting “useful idiots” like yourself.

You said, “As to your comments, I’ll pass on reading up on the current regulatory framework applied to finance. As you rightly point out, I’m not in finance (thankfully).”

It does not surprise me. “Useful idiots never care about the facts and evidence.

You said, “Suffice to say that the past few years have been without question the worst and most embarrassing period of American (and European) finance since the American gilded age.”

Nope. If you took the time to educate yourself, you would realize that this is another embarrassing period in American and European political history, with corrupt politicians creating silly incentives that resulted in so much mal-investment, and then bailing out their political cronies with taxpayer money.

You said, “Industry self regulation clearly produced an environment of casino capitalism and a financial culture of obscene and poorly thought-out risk taking.”

Nope. Corrupt politicians along with their political cronies create incentives that lead to huge mal-investment in real estate. Also, you make another conclusory statement that is clearly wrong. Again, read the Titles 12, 17, and 31 of the Code of Federal Regulations and you will know better than to repeat leftist propaganda.

You said, “And the finical sector’s atrocious performance over the past few years will not be corrected by more autonomy and less transparency.”

Again, another incorrect conclusory statement by someone who does not let facts and evidence stand in the way of repeating stupid leftist propaganda.

Nikolai Luzhin, Eastern Promises November 4, 2011 at 8:13 am

the news this morning is that Corzine Resigns as Securities Firm Chief

this is really really dumb. He could not have copied the documents he needs for his defense, yet.

What was amazing was that there were directors and other officers left to accept his resignation. I guess that are still copying or already have an immunity deal

This is a dead elephant. All these people should just get up from their desks, walk out the door, stop at home for their passports and leave the country, especially the innocent.

Rufino November 4, 2011 at 10:09 pm

Ok, let me try to draw some of the venom that’s usually assocaited with anonymous online postings…

All I am saying is that most people agree that something went very wrong in 2008, and in the lead-up to 2008, in American finance.

The usual human response to error is to implement corrective actions. In this case, it seems corrective actions must entail rules that do not allow the financial sector to take undue risk with money that is deposited by institutional investors like pension and mutual funds. In 2008, it was a great many who suffered because of the, frankly, poor business decisions of a small few in the finance sector (not to mention the questionable AAA ratings of securities by the three ratings agencies).

So I guess I’d like to hear thoughts on alternatives to more transparency and regulation that would prevent another great recession perpetrated on a great many at the hands of a small few.

Allowing failure is of course a part of that, and I completely agree.

Is that it? Should the current system remain in place, unchanged?

And what about the larger question: who is to be accountable for 2008? Are the hands of the finical sector completely clean?

Most Americans would disagree with that statement.

Greg Webb November 4, 2011 at 11:06 pm

Ruffino, you said, “All I am saying is that most people agree that something went very wrong in 2008, and in the lead-up to 2008, in American finance.”

Yep. And, it started with easy monetary policies pursued by the Federal Reserve System, which lead to the dot.com boom and bust and then the real estate boom and bust. Government fiscal, tax, and regulatory policies gave people incentives to invest first in the dot.com companies and when that burst in real estate.

You said, “The usual human response to error is to implement corrective actions.”

But, make sure you address the cause of the error and not the symptoms. The government’s policies have lengthened the normal business cycle into a boom and bust cycle that won’t go away until government is properly regulated.

You said, “In this case, it seems corrective actions must entail rules that do not allow the financial sector to take undue risk with money that is deposited by institutional investors like pension and mutual funds. In 2008, it was a great many who suffered because of the, frankly, poor business decisions of a small few in the finance sector (not to mention the questionable AAA ratings of securities by the three ratings agencies).”

You are talking about symptoms and not the cause. You need to educate yourself with the details and not talking points from politicians and their friends in the major media outlets.

You said, “So I guess I’d like to hear thoughts on alternatives to more transparency and regulation that would prevent another great recession perpetrated on a great many at the hands of a small few.”

Let companies fail if they make bad business decisions. Re-regulate the federal government to require a sound and stable monetary policy, to limit fiscal policy so that corrupt politicians cannot bail out political cronies like Goldman Sachs, to eliminate incentives in the tax code that cause people to invest in certain industries for the tax benefits (i.e., subsidize the real estate industry as well as other industries) rather than make investments solely for their economic sense, and to streamline regulatory policies to facilitate competition rather than limit it to the benefit of political cronies who prefer fewer, and bigger, companies unhampered by competition.

You said, “Who is to be accountable for 2008? Are the hands of the finical sector completely clean?”

Corrupt politicians who created the monetary, fiscal, tax, and regulatory policies are responsible for every boom and bust cycle since 1916. Political cronies, like James Johnson at Fannie Mae, Jon Corzine, and Goldman Sachs are responsible as well.

You said, “Most Americans would disagree with that statement.”

Nope. Most Americans who educate themselves about what has happened will agree with my statements. In fact, I bet most Americans, regardless of whether they have educated themselves or not, suspect that politicians and their cronies are responsible.

Methinks1776 November 5, 2011 at 9:58 am

All I am saying is that most people agree that something went very wrong in 2008, and in the lead-up to 2008, in American finance.

Yeah and at one time most people believed the world was flat and that witches needed burning. Glad to see “most people” haven’t moved past that.

The usual human response to error is to implement corrective actions.

I don’t know about the usual human response, but your response is more correctly identified as an ignoramus demanding what he supposes is “corrective action” for things he doesn’t even faintly understand.

the financial sector to take undue risk with money that is deposited by institutional investors like pension and mutual funds.

That’s not what happened. So glad to see you’re seeking “solutions” before any attempt to understand which way is up. Glad you’re not a pilot.

Rufino November 6, 2011 at 10:56 am

What is this special font of knowledge that Methinks and Gregg seem to have access to but most other Americans have have yet to “get educated” on? Is it because they are both regular posters on Cafe Hayek that they posess special insights that others do not?

If thats the case I’m glad they choose to enlighten us mortals (or sheep, from the way they talk) with the their special knowledge. I mean, Methinks in a matter of three posts has managed to link murder, witches, and Japanese-American internment camps to the recent failings of American finance.

Brilliant!

Gregg wants to “deregulate the federal government”, whatever that means, and seems to imply that the Fed should raise interest rates to deter bad business decisions on Wall Street. Of course, that would be obvious if the rest of us just “got educated”.

It is this presumptuousness, brashness and arrogance reflected in their posts that symbolizes the broader ethos of American finance today, whereas financial executives used to be praised for intelligence and prudence.

Its no wonder with guys like these why American finance has been such a wreck over the past few years, and the laughing stock of the world.

Greg Webb November 6, 2011 at 11:56 am

Ruffino, you engaged in silly personal attacks when you said, “What is this special font of knowledge that Methinks and Gregg seem to have access to but most other Americans have have yet to “get educated” on? Is it because they are both regular posters on Cafe Hayek that they posess special insights that others do not?”

No. Silly personal attacks, Ruffino, are not a substitute for studying economics and finance as millions of other people have. You said you knew nothing about economics or finance, yet you demand that your unsubstantiated conclusory statements be imposed on others. I laughed at your stupid, controlling nature and told you to get educated. You ought to take my advice because being a stupid loud mouth is no way to live.

You said, “If thats the case I’m glad they choose to enlighten us mortals (or sheep, from the way they talk) with the their special knowledge. I mean, Methinks in a matter of three posts has managed to link murder, witches, and Japanese-American internment camps to the recent failings of American finance.”

Please stop babbling incoherently.

You said, “Gregg wants to “deregulate the federal government”, whatever that means, and seems to imply that the Fed should raise interest rates to deter bad business decisions on Wall Street. Of course, that would be obvious if the rest of us just “got educated”.”

Straw man alert! I said that the Federal Reserve should not use easy money monetary policies that create the boom and bust cycle. Most are educated. You admitted that you are not.

You said, “It is this presumptuousness, brashness and arrogance reflected in their posts that symbolizes the broader ethos of American finance today, whereas financial executives used to be praised for intelligence and prudence.”

Silly conclusory statement alert! It is presumptuous, brash, and arrogant to say you don’t know anything about a subject then proceed to bore us with your “brilliance” as to how you think they should be changed.

You said, “Its no wonder with guys like these why American finance has been such a wreck over the past few years, and the laughing stock of the world.”

It is no wonder that American politics has been a wreck and the laughingstock of he world when corrupt politicians and their political cronies are defended by “useful idiots” such as Ruffino.

Previous post:

Next post: