Futures traders — if you read just one blog I write all year, let this be the one. If you do not take action, futures trading as we have known it for decades will cease to exist.
Perhaps you are like me — you have tried to explain the MF Global situation to your elected officials, but they just cannot get their minds wrapped around it. They understand insider trading quite well — in fact, they have perfected the craft — but their minds just cannot (or will not) comprehend the complex subtleties of MF Global’s European debt trades and how your money was misused in the process. They see the insignificant $1.2 billion in losses by commodity futures clients and can’t make the connection between these losses and the integrity of clearing house function.For this reason I have attempted to reduce the complexity of MF Global’s act of thievery to a narrative that hopefully even a DC inside trader (i.e. Congress) might understand.
By the way, I think it is a mistake to even explain MF Global’s trade-gone-bad to our elected officials. MF Gloobal’s European bet is not relevent to the misuse of segregated client funds. In fact, Corzine’s trade itself was rather brilliant — but he got greedy, leveraged it to the max and didn’t have deep enough pockets to meet the margin calls needed to ride the trade to its eventual profits.
So, here goes, here is how you can explain the MF Global story to your elected dummies:
1. Suppose you conduct a financial transaction with a company that requires you to place funds into an escrow account at JP Morgan. The funds are supposed to remain in this escrow account as long as you remain in the financial transaction.
2. The company with which you conduct the financial transaction is allowed to collect interest on your escrow bank account, but is otherwise not allowed to transfer the funds to its own account.
3. However, the company moves your money into its own speculative endeavors and places a highly leveraged and complex bet on the bond debt of potentially bankrupt countries in southern Europe and elsewhere.
4. The bet made by the company goes bad. The company cannot meet the margin calls on its own trade and goes bankrupt. You are left to serve as the actual counterparty to the bet made by the company on its own behalf and to which you had no knowledge. As far as you knew, your money was still safe with JP Morgan.
5. An agency of the U.S. government was charged with protecting your money. One of its primary legislative mandate (perhaps its most important mandate) was to prevent the company in which your were dealing (and other companies like it) from access escrow accounts such as yours. The government agency was aware that your money was being drained even as it was happening and did nothing to stop its theft of your money. In effect, the U.S. government drove the get-away car.
7. You now find out the maneuver that allowed the company to illegally make you an unwilling counterparty to its bet in foreign debt instruments are not just limited to futures market firms, but could affect hedge funds, annuity contracts and other financial transactions.
8. In effect, what happened is that money disappeared from a J P Morgan segregated bank account right under the noses of federal regulators, and you are left holding the bag.
9. The current administration is ignoring what happened because it is not in favor of the type of business endeavor you were conducting. In other words, it is allowing you to be mugged because it thinks you deserve it.
10. The loss of confidence in the financial transaction involved will mean that farmers and businesses interested in fixing its costs and profit markets through the use of forward contracts will be greatly jeopardized.
11. This may be the first time in modern history that customer funds sitting in a supposedly safe bank escrow accounts were stolen by a third party right under the noses of government regulators. The government failed to properly supervise the escrow account, and now you are left holding the bag. The government is making no attempt to correct its incompetence, and in fact, is spending most of its time and effort covering its own rear end.
12. The fact that customers whose funds were in segregated escrow bank accounts were robbed without the government intervening and making the customers whole is an indication that NOTHING has been done to resolve the abuses of the mortgage crisis. In fact, the MF Global situation is the leading edge of a collapse of the global economic marketplace.
In a nutshell, this is “MF Global for Dummies.”
- You deposited funds in a protected segregated bank account with J. P. Morgan to serve as an escrow for trades in regulated markets to be cleared by a futures commission merchant (FCM).
- The FCM was not allowed to access your escrow funds for its own trades in use.
- The FCM stole your escrow money and lost it in a bet on European debt.
- The Commodity Futures Trading Commission has the resposibility to insure that this very thing never happens.
- You are left holding the bag as the default counterparty to the FCM’s bets, without your approval or knowledge and in violation of the very laws the U.S. government is responsible to uphold.
- The U.S. government is taking no responsibility for what happened and is expecting you to take the loss.
- The fact you are holding the bag harms the integrity of the entire market structure. It is the hole in the dike that will eventually flood the city.