Felix Salmon gives us the potted story: my aim is to try and explain the background to what happened. No, not to excuse anyone, just to set the scerne for what then transpired. Felix:
The CFTC complaint we were waiting for has now arrived:
MF Global , Jon Corzine, and MF’s former assistant treasurer, Edith O’Brien, have all been charged with misusing — stealing, effectively — almost $1 billion in customer funds. They took the money out of customer accounts knowing that they weren’t allowed to do so, and they failed to repay it, and they also failed, naturally, to tell the CFTC what they were doing.
And now the background. MF Global handled futures trades for people. They did the boring but necessary work of actually handling the trades and the paperwork. Of making sure that there was sufficient collateral from each client: someone has to do this so that the person on the other side of the trade also knows that there's collateral there. It's all, actually, a very boring indeed matter of being an extremely efficient filing clerk. Companies like this are not advising on futures strategies, not trading them for their own account. They're really supposed to be execution only brokers: there to handle and perhaps automate the flow of paper that trading generates.
Given that it's such a boring business then why would someone like Jon Corzine be so interested in running such a firm? The answer is the float. There's a vast amount of money that washes through such companies in the form of that collateral that those trading must put up. The broking firm gets to invest that money and then keep the profits of that investment itself. Please note, this collateral is different from the client funds. This investment is done in much the same way that an insurance company gets to invest your premiums for whatever time they have them before paying out on a claim.
Now, the returns from such investments are such that that's the real reason people want to own and run such businesses. So much so that competition between them for custom means that the actually broking side just about breaks even or sometimes makes a loss: the profits on investing the collateral are such that it makes sense to run a company this way. All of which is just absolutely great: until interest rates fall to nearly nothing. Meaning that the amount that can be made by investing the float is also nearly nothing. For of course, they're not actually allowed to go off and put that collateral on the 3.30 at the racetrack: they're only allowed to put it into certain safe (supposedly safe at least) bonds and similar investments.
So, interest rates went to near zero after the crash and MF Global was desperate to increase the amount that it earned from investment of the float. Which leads to some very interesting (perhaps that should be "interesting") investments in European government bonds. These are paying higher interest rates than US Treasuries and they're still government bonds so they're still safe. Sorry, defined as safe. For of course that bond trade ends up not working and it has to be unravelled at a loss: which is where all the subsequent troubles start.
We know what is alleged Corzine did at that point. But all of the troubles really did stem from the above sketch. Broking firms like MF Global make and made their money by investing the float. With interest rates at near zero they went looking for higher yield. Other things being equal, higher yield means higher risk and this one was sufficiently risky that it blew up. At which point the only real question left is how are you going to clear up the mess? Hopefully, not the way it is alleged that Corzine did.
