Too Many Cooks (and Crooks) in the Crisis Kitchen: A Briefer on How We Got to MF Global

Corzine: Some explaining to do.

We’ll talk MF Global in a minute.  First, let’s look at some (very brief) recent financial American history, and then look at how it got us where we are today.

As we covered in our recent podcasts on the swaps market (which you can check out here and here) and in Dylan’s upcoming book Greedy Bastards, banks over the last thirty years have gone through a bit of an identity crisis.

Way back in the paleolithic era, when dinosaurs walked the earth and E*Trade didn’t exist, consumers had no choice but to use a stockbroker.  Brokers made money in a pretty straightforward way — they set two prices on stocks — the “bid” and the “ask,” or the price they were willing to pay for a stock, and the price they were willing to sell it for.  Traditionally, brokers would always set their bid and ask at least 1/8th of a dollar apart, meaning they made at least twelve and a half cents for every share they bought or sold for a client.

Nice business, right?  Then, two little problems came along.

In 1975, the brokerage industry deregulated commissions, acting on a SEC mandate. For the first time in more than 180 years, trading fees were set by market competition.  In the mid 1980’s, Bloomberg LP terminals offered buyers the same statistical information about stock and bond prices and performance that brokers and dealers had always been able to keep to themselves.  The same data was available for everyone.

By 2001, the New York Stock Exchange was fully computerized, and the traditional spread for stockbrokers was wiped out.  Just like swapping MP3’s meant we didn’t have to drive to drive somewhere to buy CD’s from brick-and-mortar stores, stockbrokers were no longer necessary middlemen to make trades.

The game was up, and there was much less easy money to be made.  That means that banks had to get creative and find another way to make money,  The easiest ingredients to get back into the profit game were two things: leverage and the credit default swap. As Dylan recently wrote on leverage:

Leverage matters on a systemic level because it is the mechanism that links your financial condition to that of your debtors and creditors.  You might look solvent, or even wealthy, but if one of your debtors goes under can’t pay you back, suddenly you are broke too.  And then your own creditors might also be broke, and on up the chain.

That brings us back to MF Global.

At the helm, Jon Corzine — a former Senator, a former New Jersey Governor, and the former CEO of Goldman Sachs is now in the spotlight for “misplacing” huge amounts of customer funds.  Until recently, Corzine was one of the most respected and prestigious businessmen in American society.  But, in the finance world, things change quickly.  He along with two other executives spent yesterday on Capitol Hill answering questions about the collapse of MF Global — and more importantly — the loss of more than $1.2 billion (yes, BILLION) in client money that by law should have been kept separate from company funds.

Here’s the basics: MF Global literally — and illegally — moved customer money into its own casino-game-playing endeavors and made a highly leveraged, crazytown bet on the bond debt of potentially bankrupt countries in southern Europe and elsewhere.

As Peter Brandt explains, this is quite a big deal, historically:

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.

As Corzine carefully stated at yesterday’s hearing, “I never gave any instructions to misuse customer funds, I never gave instructions to anyone at MF Global to misuse customer funds… I was stunned to learn that hundreds of millions of dollars in funds were unreconcilable  on the evening of October 30th.”

STUNNED! Shocked! Amazed.  But not too worried.  If recent history is any guide, it doesn’t appear that there will be any consequences for Corzine, at least not personally.  As Nomi Prins (a former investment banker turned journalist) pointed out on Democracy Now this morning:

We’re listening to someone try to dodge his way out of responsibility and accountability, which is very much what all the CEOs have done through the subprime crisis and through past crises.  When you see 5,500 arrests across this country for the Occupy movement and you see zero on the part of CEOs and senior executives from Wall Street who took trillions of dollars out of our economy, out of the European economy, [and] are going around the world doing the same thing to Asia now, it is absolutely heinous.

Dylan and the Megapanel had the chance to talk to Mike Mayo, bank analyst and author of Exile on Wall Street: One Analyst’s Fight to Save the Big Banks From Themselves.

He uses MF Global as a prime example of the failures of both the big banks and our regulatory agencies.  “How many looked over their shoulder – the accounting firms, the rating agencies, the regulators?  They all failed.  But you know what the root cause is here? How much skin in the game did Jon Corzine have?” asks Mike.

“If you want to accumulate risk, you have to have your own money on the table. How much did he have?” Dylan asks. “Not much!” says Mike. “If you had 90% of your net worth in that company, would you take those sorts of debts? That’s not capitalism. Capitalism didn’t get us where we are today — but a lack of capitalism, and the root of that is ill-conceived incentives.  He was not incentivized to act as a steward of this company so it would last for generations.   What he needs to do, and what CEO’s need to do, is act as stewards of something bigger than themselves,” says Mike. “What I’m talking about is holding the board of the biggest banks accountable today,” he added.

We can only hope that’ll be the case when it comes to prosecuting the allegedly illegal use of customer funds at MF Global.  But if recent history has taught us anything, it’s that we won’t see any of these people in jail anytime soon.

Watch as Dylan, Mike and the Megapanel talk about the collapse of MF Global:

Meg Robertson is a digital producer for Dylan Ratigan.  You can follow her on Twitter @megrobertson, or email her here.