"Greece and MF Global - Shades of the Same Spectre"

Sydney M. Williams

 Thought of the Day

“Greece and MF Global – Shades of the Same Spectre”

November 2, 2011

The lesson from both the European sovereign debt crisis and the MF Global bankruptcy is that debt, while indispensible, has a very sharp edge. While the two crises differ in their origins, they are born of a similar hubris. There are, however, other differences. MF Global is bankrupt and knows it. Greece is bankrupt, but hasn’t admitted it.

In the halcyon days of the 1990s and in the balmy mid 2000s, debt securities were worth accumulating. Interest rates had been in decline for more than a decade and the trend looked like it would persist ad infinitum. In the 1990s, default had become uncommon. It paid, as Jon Corzine discovered at Goldman Sachs to take big bets and leverage them. Declining interest rates and rising confidence allowed “risk on” bets to generate big profits. The concept of risk appeared to have been eliminated from investor’s handbooks. Borrowing short and lending long paid big bucks. The trader with the largest brass gonads arrived at the top with huge paydays; skeptics were relegated to dusty closets.

At the same time, in Europe, a social contract had bound people together for the half century following World War II, into an idyllic world of living well today with little concern for the morrow. Economies prospered, wages rose, universal healthcare was provided and retirement was early and easy. “What, me worry?” was the continent’s dominant attitude. Seemingly, nobody bothered with calculating the costs of entitlements, nor did they factor in a declining and aging population. For actuarial purposes, the assumption was that recent spectacular returns to both bonds and equities would continue, despite a rational person recognizing the ephemeral nature of those returns.

This Eden-like world began to wobble in late winter/early spring of 2000. While the greatest market extravagances had been in the internet tech sector, within two and a half years the S&P 500 had declined fifty percent. Globally, equities dropped anywhere from fifty to eighty percent. High yield corporate bonds followed suit. Risk-on became risk-off. Treasuries and other sovereign debt rallied, as investors sought safety. The period from 2003 until 2007 was comparable to what we, growing up, referred to as Indian summer – a brief interlude in early autumn when the warmth of the sun gave people a glimpse back at the summer now past. Continuing speculation was encouraged by a Fed that kept rates unnecessarily low, fearful of the effects of a cold hard winter.

It has been less than two years since Mr. Corzine took control of MF Global in March 2010. In the nineteen months since he took charge of this firm, whose roots go back two hundred years to a sugar brokerage in London, he leveraged it forty times, and then bankrupted it. For this, he is supposed to receive a $12 million severance package. Admittedly, the firm was losing money when he took the reins; nevertheless, the payment seems egregious given the losses he generated. And certainly the payment will do little to extinguish the flame of populist anger, in spite of his Democratic credentials.

MF Global’s bankruptcy is a manifestation of why such trading firms were safer as partnerships (both to themselves and to the rest of us) than they are as public companies using other people’s money. (Not surprisingly, Mr. Corzine was the architect of Goldman Sachs’ converting from partnership to a public company in 1999.) The bankruptcy also raises the question: Where were the CFTC and SEC? What about Dodd-Frank? Weren’t regulators supposed to prevent this sort of thing? There have been allegations that the firm commingled clients’ accounts with firm funds and the FBI is now investigating. If that is true, Mr. Corzine should be charged with fraud.

Mr. Corzine was infected with the disease that political entities were not subject to the rules governing businesses, no matter the purported risk; debt ratings did not matter. It appeared that he believed that bankruptcy, or even a renegotiation of debt, was not an option – that somehow, somewhere money would be found and the obligations honored. Pardoning the pun, bankruptcy should be the governor that stems irrational behavior – to believe it does not harms free capital markets. Didn’t he understand, there is not enough money? It was the reckless use of capital that destroyed the firm.

Greek Prime Minister George Papandreou surprised financial markets when yesterday he called for a referendum on his country’s bailout. This upset his party members and roiled the financial markets. The Greeks have become the poster child of what is wrong with the unaffordable promise of Socialism. It does not work. It is not a question of empathy or feelings. It is a question of math. There is not enough money. In Europe today and in Greece specifically there are too many retirees, too few workers and too many demands. As unlikely as it may appear, violent protests by strikers risk a totalitarian response. Mr. Papandreou was placed in an impossible position. Accepting the bailout, which Parliament had agreed to, was not agreeable to public sector workers. They, faced with layoffs, reduced benefits and pay cuts, continued their protests and strikes.

Mr. Papandreou must have felt that the only way to get the Greek public to commit to the agreement would be to vote ‘yes’ on the referendum, or be responsible for dropping out of the Euro. As recently as September 25, 2011 a poll among Greeks conducted by the Athenian newspaper, Kathimerini News showed that 63% had a positive opinion of the Euro, while 66% said they would oppose re-adoption of the Drachma. Mr. Papandreou’s options have been further limited. Six members of the ruling party have called for the Prime Minister to resign. (In my own opinion, the demands and limitations commensurate with staying in the Euro have become so onerous that the Greeks may be better off reverting to the Drachma.)

Both Greece and MF Global are the consequence of a fraud, either deliberate or otherwise – the state against their citizens in the former, and management against their clients and shareholders in the latter. Borrowing what you cannot afford is no different than promising what you cannot pay. Referring to Greece yesterday, Vince Farrell wrote: “The good and necessary thing that will come out of this is a fiscal/tighter union.” I hope that is so. One should infer that the same lesson should be learned from MF Global’s bankruptcy. However, I am not so sure. Jon Corzine did not learn from Lehman. Dick Fuld did not learn from Bear Stearns. Alan Schwartz did not learn from Long Term Capital. How can we have any conviction that the lesson of restraint and prudence has been learned?