There may be no honor among thieves, but there has always been some small measure of dignity — even respectability — amongst the con men of the equity markets.

Apparently, there is no such corresponding code of honor amongst commodity trading firms.

I refer of course to the debacle that is MF Global. How on earth could $633 million in customer accounts simply disappear?

As it turns out, quite legally.

The regulations governing these customer accounts are 25 plus years old, according to a few insiders I spoke with. They gave the firms an ability to hypothecate (lend) client money, so long as it was only used to legally purchase investment grade sovereign debt.

So that was what MF Global did.

As originally conceived, client monies were only supposed to purchase US Treasuries. However, so as to not offend trading partners (and other reasons), the regs were written so as to include any “investment grade sovereign” in the rules. Hence, AA rated European sovereign debt, despite the obvious fact that in 2011 they are obviously not the equivalent of US Treasuries, technically qualify. Whether this violates the obvious spirit and intent of the law will be for a judge to decide.

Of course, this raises another question: If the corrupt and compromised rating agencies had actually done their jobs — downgrade European junk to what it really was — would MF Global been able to empty client accounts? I suspect not.

Regardless, consider the Con Man’s Lament: The past half century of boiler rooms, accounting scandals, pump & dumps, backdated options, corrupted analysts, IPO spinning, derivative debacles, etc., have all come about for this simple reason: Brokerage firms cannot simply reach into client accounts and take the money for firm use.

This wasn’t a face-in-hand moment — Hey, why didn’t we think of that? — amongst equity criminals. Rather, it was a well understood rule that was enforced without question. “Borrow” money from a client account without their knowledge, go to jail for grand theft.


• If the weasels at Stratton Oakmont or any other ’90s boiler room thought they could merely empty client accounts, they would have. Instead, they had to concoct enormous Pump & Dump schemes to dupe willing rubes out of the money.

• If Merrill Lynch could have merely grabbed billions from Orange County, rather than create an elaborate derivatives scheme that ultimately bankrupted the county, don’t you think they would have done that?

• Instead of the IPO spinning to capture assets and revenues that most of the major bulge bracket firms did int he boom times of the late 90s, wouldn’t it have been easier to merely leverage up client accounts?  Heads we win, tails you lose?

• Would any of the major accounting firms had to do such absurd audits of firms like WorldCom or Tyco? They worked hand in hand with Wall Street to help capture money. (But steal? Never!)

• Consider the side pockets developed by Enron with the help of McKinsey & Co. If there was a way to simply take client money, why would anyone bother going through all that trouble?

• Even the convoluted Lehman’s Repo 105 was a way to hide $50 billion per quarter from investigators and regulators. Had they been able to tap client monies, who knows how their saga might have ended.

Now, that may not sound like much, but it is worth considering. Neccessity being the mother of invention forced the very worst enterprises on the equity side to engage in all manner of deception and duplicity by morally compromised, ethically challenged bad actors. They had to do this, because they could not merely grab monies from client accounts.

It was a point of pride amongst equity con men that they did not merely steal. They cajoled, wheedled, scammed, and cheated, but they never stole.

Hey, what kind of people do you think we are?

Category: Analysts, Legal, Really, really bad calls, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

31 Responses to “The Con Man’s Lament: Equity vs Commodity Firms”

  1. I have more bullet points to add to the above

  2. [...] At least the equity guys come up with an ingenious scheme before they steal from you, these commodity MFs are a whole different story.  (TBP) [...]

  3. Rightline says:

    don’t forget this con man…..

    How Paulson Gave Hedge Funds Advance Word

    By Richard Teitelbaum – Nov 29, 2011 Bloomberg Markets Magazine

    Treasury Secretary Henry Paulson stepped off the elevator into the Third Avenue offices of hedge fund Eton Park Capital Management LP in Manhattan. It was July 21, 2008, and market fears were mounting. Four months earlier, Bear Stearns Cos. had sold itself for just $10 a share to JPMorgan Chase & Co. (JPM)

    Now, amid tumbling home prices and near-record foreclosures, attention was focused on a new source of contagion: Fannie Mae (FNMA) and Freddie Mac, which together had more than $5 trillion in mortgage-backed securities and other debt outstanding, Bloomberg Markets reports in its January issue.

    Paulson had been pushing a plan in Congress to open lines of credit to the two struggling firms and to grant authority for the Treasury Department to buy equity in them. Yet he had told reporters on July 13 that the firms must remain shareholder owned and had testified at a Senate hearing two days later that giving the government new power to intervene made actual intervention improbable.

    “If you have a bazooka, and people know you have it, you’re not likely to take it out,” he said.


  4. TLH says:

    We have more regulations but no enforcement of present laws. Jon Corzine should have already been brought in front of a grand jury. Obama had a chance to right the wrongs of Bush administration. Instead he put his seal of approval on the greatest robbery of all time.

  5. klhoughton says:

    A friend reminds me–frequently–that the last time this happened (38 years ago, when the market was saved only by a coincidental Presidential assassination, the commodity brokers immediately made certain their customers were made whole.

    Until I hear otherwise, I’m blaming globalization for the delay this time. If American investors aren’t the cote of your business, you don’t need to worry so much that they might quit you.

    I wish the above paragraph were clearly a joke.

    Btw, the change to allowing Sovereign debt was, iirc, slipped inti the 2005 Bankruptcy Bill.

  6. klhoughton says:

    Oops. Meant 48 years ago, of course. Richard Nixon was not assassinated. (Nor, sadly, was he taken down by two high school girls and their brother’s brownie mix.)

  7. dead hobo says:

    Fortunately, all of the brinksmanship going on in Europe concerning debt is really an honest expression of economics in action and not banks gaming for bailouts or hedge funds trying to engineer a default so they can buy otherwise good debt at an exceptionally steep discount.

  8. Conan says:

    We always hear about confidence in the market. What kind of market are we going to have when there is a serious widespread lack of confidence in brokers, in counter parties ability to pay, in government enforcing laws, in government rewriting laws to favor the banks

    I think we are not only going to see wholesale write offs of consumer, corporate and government debt, but what if added to this is a large lack of confidence in personal, business and government dealings?? Some how I think the latter maybe more dangerous!

  9. rd says:

    The equity and bond investment community is allowed to legally defraud people if they smear a thin veneer of lawyers over some unsavory products.

    The commodity market has made it legal to simply steal their clients money directly without needing a middleman.

    And the professional investment community is scratching their head trying to figure out why the “dumb” money (small investors) have been fleeing the markets.

    Once the small to mid-size semi-pros realize that nobody is going to jail at MF Global and the money isn’t coming back, they will be right on the heels of the small investors.

    At that point, the real fun should start as the TBTF companies try to figure out how to bankrupt each other to get their money since nobody else is left to fleece. The most stable ones (least insolvent?) almost succeeded by accident in 2008, but they will make a full-court press this time to accomplish what was left undone then.

  10. Moss says:

    Not just the equity markets. The fundamental premise of many financial participants is t0 ruse, obscure and otherwise trick the counterparty for the sole purpose of benefiting… at the expense of the other.

    There is little honesty as this would lead to a more level playing field.

  11. 873450 says:

    “The past half century of boiler rooms, accounting scandals, pump & dumps, backdated options, corrupted analysts, IPO spinning, derivative debacles, etc.,”
    - Don’t forget Milken’s junk.

    It’s amazing how GOP presidential candidates maintain a straight face claiming Social Security is a government operated ponzi scheme that should be privatized and entrusted to their finance industry sponsors.

    “Hey, what kind of people do you think we are?”
    - Stupid sheep with no memory of events taking place before 01/09. Like natural resources, we exist to be exploited and led to the slaughter.

  12. dead hobo says:

    It’s not just equities vs commodities. Don’t forget the idiots who bought and sold CDO insurance. This isn’t real insurance because it’s not backed by reserves like property and casualty insurance is. To be more specific, it’s idiots who buy CDO insurance and potential fraudsters who sell CDO insurance. Or, then again, it’s idiots who also sell CDO insurance if they actually have assets that can be seized if the policy has to pay off.

    If CDO insurance did not exist except in cases where actual reserves are sufficient to cover a payout … without requiring a public bailout … then the European debt theatrical crisis would be far less of a problem.

    Don’t even get me started on synthetic CDO insurance, which is really just a side bet between two parties, neither of which are either lenders or borrowers. Who really cares if either or both of these goofballs blows up financially. I don’t.

  13. BusSchDean says:

    There is no such thing as a level playing field because the players are inherently unequal (i.e., IQ, emotional IQ, education, DNA, etc.). However, pursuing the goal of achieving a level playing field provides many benefits. Rules help not to just prevent eggregious behavior but to remind us of why we have rules — that we collectively share in how well markets and politics work (or not). Rules are the ectoskeleton of a more precious, more vulnerable social organism. Currently our ectoskeleton is breaking down.

  14. RC says:

    Wow, just wow!!! I had no idea that this is what happened at MF. Firstly thanks BR for this post shedding light on what actually happened. My jaw dropped when I read it. It is amazing how much of a wild west the world of commodities is. Astonishing!!!

  15. tippet523 says:

    As I sit here today doing 5 hours of CE which any monkey could get a 95% (70% needed) it drives me crazy that we spend hours regulating CE and how much we spend at lunch but let Man F leverage up 40-1 and use clients collateral in dubious ways.

    Lets spend the limited supervisory dollars we have to avoid billion dollar losses.

  16. riley says:

    The end result might be the same, but your Brokerage examples are of firms intent on stealing client money. Was Corzine intending to steal client money or did he just think he was so smart that his bet was going to pay off. In the end Corzine stole client money. However, the bigger problem is what would have happened if his bet did pay off. With a successful bet, margin would have been returned to MF, client money would have been returned to the appropriate account and nobody outside of MF would have known that the firm used client money leaving them free to “borrow” even greater sums the next time.

  17. SOP says:

    The Five Stages of Collapse –

    With MF Global and the latest news on Hank Paulson, (see rightline’s post above)

    Stage 1: Financial collapse.

    Stage 2: Commercial collapse.

    Stage 3: Political collapse.

    Stage 4: Social collapse.

    Stage 5: Cultural collapse.

  18. HarleyHoward says:

    Regulation without enforcement = Anarchy.

  19. Shaq Fu says:

    little is being said about the 400 accounts that were on the equities/securities brokerage side. a close relative had an acct with MF and has received nothing back so far, and almost no information.

  20. Gibbon says:

    Integrity is a late 19th and early 20th archaic term. Like virginity once lost it can never be recovered.

  21. bagjoe says:

    UBS’s domestic retail and global wealth management businesses are a valuable source of funding.

  22. [...] It goes without saying that futures firms need to be more closely regulated.  (Big Picture) [...]

  23. readerOfTeaLeaves says:

    Righteous post.
    MF Global is moral cowardice, driven by 40:1 leverage.

  24. realgm says:

    There are way too many loop holes in the regulations that only the big corporations could get exceptions. That’s why the medium size and small size firms are having tough times as the big corp got all the advantages in the regulations.

    There should be simpler regulations making clear rules with no exceptions for big corp to abuse.

    It’s true that regulation and good regulators could have prevent MF Global for doing what it did, but it’s a much stronger message if Corzine and his criminal friends are put into jail for lifetime. So far, there are obvious frauds involved and yet, not anyone is arrested.

  25. Marc P says:

    MF Global not only invested client funds, the more important point is that they invested on a highly leveraged basis. As with the klepto-banks, the real issue is the level of leverage. With enough leverage even very safe assets such as Italian debt can sink a firm.

    Let’s think about what really happened. I haven’t read a report that any of the MF Global bonds actually defaulted. MF Global went bankrupt [apparently] because interest rates merely changed two or three points. How much leverage would it take to kill the firm with that minor change?

  26. klhoughton says:

    Did MF Global invest client funds, or just post them as collateral against sovereign debt?

    My working assumption has been the latter.

  27. Scott F says:

    Barry, wrt your post—and note you say in the comments that you’re adding a couple of bullets, a few things to consider, these emanating from a discussion I’ve been having over the last day with another group. James Turk notes that sweeping customer accounts and investing the daily sweep in short-term UST is the common practice. Where MFG departed was not simply in moving from T-bills or the like to European sovereign debt, but as importantly in leveraging the transactions—that 1974 rule as written never envisioned leverage. Another friend though questioned James’ characterization, on the grounds that MFG was posting collateral against the trades they had on, so that it wasn’t simply an overnight sweep trade. Our discussion was instigated by a new (I think.) Celente note, below in case you missed it.

  28. bear_in_mind says:

    Whether a result of previous administration(s) de-fanging regulatory and enforcement staff due to political convictions, redeployments or budget cutting, folks in Washington D.C. have got to wake up to the anarchy unfolding on Wall Street. If there’s no consequences to theft, fraud and other forms of law-breaking, it’s going to encourage more folks to engage in that behavior.

    One has to wonder if Jon Corzine viewed the lack of prosecutions from 2005-2010 as a green light to use MF Global accounts as a “Monopoly” money. If someone with Corzine’s high-visibility stature couldn’t curb his risk-taking adventures, should we not be concerned about what other shenanigans are playing out in the deep recesses of Wall Street firms?!

    I say, rather than spend $7.4 billion on 187 F-22 Raptor stealth fighter jets, why not cut that order in half and take the extra $3.7 billion to hire a legion of investigators, prosecutors, judges and staff attorneys to enforce the RULE OF LAW on Wall Street?!

  29. Marc P says:

    Doing a little research, I read claims that MF Global didn’t speculate with client money. Instead they use client money and client securities as collateral for a loan. The client assets were $700 million and the loan was for $350 million. It was a last-chance effort to save the firm.

    According to this account the loan was short-term, MFG defaulted, and the lender took the $700 million in collateral. The key is that according to this, MFG did not speculate with client assets, but instead used client assets for a loan to cover losses from speculation. It might be legal, but if so then Congress should waste no time in changing it.

  30. philipat says:

    You’re being kind to Lehman regarding Repo 105. The fact is, there was NO money. It was a shell game. WHy criminal convictions have not been lodged is beyond me. Although, maybe not.