Did accounting help sink Corzine’s MF Global?

November 1, 2011

By Bethany McLean
The opinions expressed are her own.

On Monday morning, MF Global, the global brokerage for commodities and derivatives, filed for bankruptcy.  The firm’s roots go back over two centuries,  but in less than two years under CEO Jon Corzine, whose stellar resume includes serving as the chairman of Goldman Sachs, as New Jersey’s U.S. Senator, and as New Jersey’s governor, MF Global collapsed, after buying an enormous amount of European sovereign debt. The instant wisdom is that he made a big bet as part of his plan to transform MF Global into a firm like Goldman Sachs, which executes trades on behalf of its clients, and also puts its own money at stake. Although the size of the wager has received a great deal of scrutiny, the accounting and the disclosure surrounding it have not–and may have played a role in the firm’s demise.

In the 24 hours since the filing, more ugly questions have piled up, with the New York Times reporting that hundreds of millions of dollars of customer money have gone missing, and the AP saying that a federal official says that MF Global has admitted to using clients’ money as its problems mounted. Whether this was intentional or sloppy remains to be seen; MF Global didn’t respond to a request for comment by press time.

At the root of MF Global’s current predicament was a simple problem:  the profits in its core business had declined rapidly.  That core business was straightforward, even pedestrian; what the firm calls in filings a “significant portion” of total revenue came from the interest it generated by investing the cash clients had in their accounts in higher yielding assets and capturing the spread between that return and what was paid out to clients. As interest rates declined sharply in recent years, so did MF Global’s net interest income, from $1.8 billion in its fiscal 2007 second quarter to just $113 million four years later. MF Global’s stock, which sold for over $30 a share in late 2007, couldn’t climb above $10 by 2009.

Enter Corzine in the spring of 2010, who had just lost his job as New Jersey’s governor to Chris Christie. He was brought in by his old pal and former Goldman partner Chris Flowers, whose firm had invested in MF Global. Fairly quickly, Corzine accumulated a massive net long sovereign debt position that eventually totaled $6.3 billion, or five times the company’s tangible common equity as of the end of its fiscal second quarter. I’m told Corzine’s move was highly controversial within the firm.  But no one overruled him, maybe because after all, he was Jon Corzine. In a mark of just how much Corzine mattered to the market, in early August, MF Global filed a preliminary prospectus for a bond deal, in which the firm promised to pay investors an extra 1% if Corzine was appointed to a “federal position by the President of the United States” and left MF Global.

Buying European sovereign debt may not have been just a bet that the bonds of Italy, Spain, Belgium, Portugal and Ireland would prove attractive. An additional allure may have been the way MF Global paid for the purchases, and thereby, the way the accounting worked. MF Global financed these purchases, as its filings note, using something called “repo-to-maturity.” That means the bonds themselves were used as the collateral for a loan, and MF Global earned the spread between the rate on the bonds, and the rate it paid its repo counterparty, presumably another Wall Street firm. The bonds matured on the same day the financing did.

The key part is that for accounting purposes, MF Global’s filings say the transaction was treated as a sale. That means the assets and liabilities were moved off MF Global’s balance sheet, even though MF Global still bore the risk that the issuer would default; that means the exposure to sovereign debt was not included in MF Global’s calculation of value-at-risk, according to its filings. And that also means MF Global recognized a gain (or loss) on the transaction at the time of the sale. The filings do not say how much of the gain was recognized upfront.  But if it were a substantial portion, then these transactions would have frontloaded the firm’s earnings.  That, in turn, may have helped cover the fact that MF Global’s core business was struggling.

MF Global’s public filings also don’t say how much this contributed to earnings. But one indication of the size of the repo-to-maturity deals comes in this small excerpt from MF Global’s most recent 10K, under the heading of “Off balance sheet arrangements and risk”:  “At March 31, 2011, securities purchased under agreements to resell and securities sold under agreements to repurchase of $1,495.7 million and $14,520.3 million, respectively, at contract value, were de-recognized.” (“De-recognized” means moved off the balance sheet.) Of that $14.5 billion, 52.6% was collateralized with sovereign debt. One way to get a sense of the ramp-up of “repo to maturity” transactions is to compare the figures to those as of March 31, 2010:  The securities sold under agreements to repurchase increased by some $9 billion.

Once the regulators and rating agencies began to zero in on all of this, it didn’t matter that the trade itself may not have been that risky. (The debt all matured by the end of 2012, and MF Global, of course, had financing in place until it matured.) But it was European sovereign debt, after all, and the trade was huge—and it appears that part of the concern may have been the accounting, and certainly the lack of disclosure. On September 1, MF Global said in a filing that the Financial Industry Regulatory Authority (FINRA) was requiring it to “modify its capital treatment” of the European sovereign debt trades.  According to an affidavit filed by MF Global’s president on the day of the bankruptcy, FINRA was “dissatisfied” with the September filing and  “demanded” that MF Global announce that it “held a long position of $6.3 billion in a short-duration European sovereign portfolio financed to maturity.” Words like “dissatisfied” and “demanded” aren’t good in the context of a regulator!

By the time the market opened on Monday, October 24th, MF Global’s stock had already fallen 62% from its high of almost $10 following the announcement that Corzine was joining the firm. Then, Moody’s downgraded the firm’s debt, citing MF Global’s “inability to generate $200 million to $300 million in annual pretax earnings and keep its leverage within acceptable range.” In other words, Moody’s was concerned about the real profitability of the business. The next day, MF Global reported its $6.3 billion position, per FINRA’s demand, and also reported that it had lost almost $200 million in the quarter ended in September—in large part because the firm had reduced its deferred tax assets by $119.4 million, a sign that the accountants were saying there wouldn’t be a return to big profits any time soon. By the end of the week, all three rating agencies had downgraded MF Global debt to junk. Moody’s wrote that its downgrade “reflects our view that MF Global’s weak core profitability contributed to it taking on substantial risk in the form of its exposure to European sovereign debt.” MF Global’s stock finished the week down 67%.

The actual details of the run aren’t clear yet, but according to the CFO’s affidavit, the ratings downgrades “sparked an increase in margin calls,” which drained cash. Plans to sell all or part of the business fell through, reportedly because of the discovery of the missing cash. Another part of the explanation might be that potential buyers found out just how weak the core business was.

Of course, if Corzine made the trades for an accounting play, there’s a deeper question of why he would feel the need to do this. And isn’t that always the question in situations like this?

PHOTO: Jon Corzine, MF Global Holdings Ltd. CEO, leaves the office complex where MF Global Holdings Ltd have an office on 52nd Street in midtown Manhattan, October 31, 2011. REUTERS/Brendan McDermid


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

The CME and the CFTC are the ones who really need to be investigated.

Posted by gruven137 | Report as abusive

Very well written article. I am a layman when it comes to financials and I was able to follow this quite thoroughly. Welcome to Reuters! I think I will look for an app to add this to my Ipad.

Posted by MrDc | Report as abusive

I find it amazing that Americans can be so highly critical of Corzine’s billion dollar gamble using investor’s assets . . . while condoning trillion dollar gambles by our government . . . using your money and mine.

Posted by neilc23 | Report as abusive

It is sickening to see trusted big heads and agencies let the boat sink and start scratching their heads. The words used in describing the transactions and activities (except that we know they were financials involving investors money – investors who had no idea what these activities by MF G would lead to)do not make any sense to even financial professionals at times and were evidently planned to be that way. May be NOBODY knew what they meant anyway. A bunch corporate chiefs and some suordinates and some from FINRA, CFTC and auditing firms (where were they while the drain was unplugged)had a great time supporting luxury business of wining and dining. What would we have done if those support jobs were not supported by these folks? Let us wise up every one. Shed the greed and ask questions up font!

Posted by slnsimhan | Report as abusive

Yes. Mr Corzine was once in the Government and a Billion is a small change compared to what he could have done with your money and mine. Govt provides good training may be.

Posted by slnsimhan | Report as abusive

[…] Or the woman who wrote “The Smartest Guys in the […]

Posted by FT Alphaville » Further reading | Report as abusive

[…] Bethany Mclean over at Reuters — who has an excellent explanation of the accounting advantage of booking these trades as repo-to-maturity — notes how once the […]

Posted by FT Alphaville » MF Global and echoes of Repo 105 | Report as abusive

Always enjoy McLean’s work. What really is astonishing is that the top echelon of Wall Street so blithely engages in what is nothing more than fraud with a fancy accounting name attached to it.

Posted by lhathaway | Report as abusive

Its very obvious that accounting gimmicks led to the downfall. Hiding very leveraged very risky “bets” off the balance sheet is akin to an alcoholic hiding a bottle of vodka in their desk: Sooner or later it would be found out. The idea that this man could risk the solvency of the firm on whether or not the EU member nations could come to and implement a very controversial plan is mind numbing. MF Global’s profits had dropped,.. so what. Rates would have eventually gone back up and profits would pick up again. This was simply a case of ego and greed.

Posted by hughrhodes | Report as abusive

Enter Corzine in the spring of 2010–

Everything in this paragraph is a f**k you to middle America by the money keepers and the government.

Posted by ex-fungi | Report as abusive

The reason Why is there is a fundamental disbelieve on Wall St, et al, in Efficient Market Hypothesis. Even writing the name of the theory here is going to provoke the rant of nay sayers.

Yes, I know you beat the market, I beat the market, but neither of us do it consistently, and over time there is regression to the mean, especially when you factor in risk. If you are producing average results over time, you have a very hard time justifying the insane fees that you charge, and worse, you face the possibility that you are just an average joe. So Hubris and Greed, time tested explanations for lots of behavior.

Time and again I have gone in and looked at the returns on hedge funds, where the numbers have been available. Starting with LTCM, by the time they were toast their average return over the life of the ‘experiment’ was between 9% and 11%, about what I have gotten from an asset allocated collection of ETFs from Vanguard.

It is REALLY, REALLY hard for a guy[s] like Corzine to live with that. When these guys can’t cook the books, or do deals of dubious legality, they might as well go back to flogging load mutual funds or ‘hot stock picks’. That will not make you legendary.

Posted by ARJTurgot2 | Report as abusive

The real problem is linkage between customers’ “segregated” accounts and the company’s assets.

In 1997 the CFTC amended rules to permit securities to be moved between segregated accounts and non-segregated ones – ostensibly to reduce bookkeeping costs. The company was supposed to keep enough money in segregated accounts to indemnify customers against loss, but how often were they audited?

Nowadays, segregated accounts can be used as security for loans entered into to underwrite financial dealings in the company’s interest without the customer’s knowledge or consent. This puts customers’ money at risk solely for the benefit of the company.

Apparently, even the CFTC is in the pockets of the “big boys”.

The OWS protests are beginning to make sense.

Posted by loyalsys | Report as abusive

Investors need to treat companies headed by Democrat operatives as dead men walking. The stink of corruption and doom surround these crooks and all that they touch. These grifters do not care about growing companies and creating wealth for investors and security for their employees. These parasites fly in, steal what they can, reward their political masters, and when their victims die they crawl under the rocks.

Posted by DanPhoenix | Report as abusive

Thank you Bethany McLean, for a great article. Is this another nail in the coffin of the concept of “moral hazard”? I’m sorry for all who lost their shirts in this scheme. Thank goodness for the regulators at FIRMA. Had Corzine gotten away with this I’m sure we’d be looking at the collapse of an even bigger scheme down the road.

Posted by LEEDAP | Report as abusive

[…] and echoes of Repo 105 – FT Alphaville European bet triggered MF Global’s demise – FT Did accounting help sink Corzine’s MF Global? – […]

Posted by FT Alphaville » Re-recognised in 2011 | Report as abusive

Just wanted to add kudos to Bethany McLean for the well written article. Clean, well laid out, and simple enough for almost anyone who is interested in the subject to understand it. Yet, it asks good questions, treats the reader as an intelligent person, and provides pertinent details that allows them to begin forming their own opinions and analysis. Seriously…very good stuff and thank you.

Posted by realeconomics | Report as abusive

[…] //]]> accounting | banking Bethany McLean has a theory: that accounting helped to sink MF Global, and that the $6.3 billion long position in […]

Posted by Was MF Global brought down by an accounting play? | Felix Salmon | Report as abusive

[…] Bethany McLean has a theory: that accounting helped to sink MF Global, and that the $6.3 billion long position in European debt was made “for an accounting play”. […]

Posted by BullseyeMicrocaps.com » Was MF Global Brought Down By An Accounting Play? | Report as abusive

Bethany…a correction:

You state that the trades may not have been all that risky because they were repoed-to-maturity (ie financed to maturity). This is simply false. The trades are very risky, as risky as the underlyings (the bonds themselves).

As the Euro 2012 notes were under increasing stress due to the evolving crisis, they would no longer serve as sufficient collateral for the loans (due to market prices as well as credit downgrades). Margin calls on the loans no doubt were increasing, and my guess is that is where some of the clients money went. Either directly or in buying more of the bonds and posting them as collateral.

Posted by Ernesto11 | Report as abusive

In addition to Chairman, Senator, and Governor, soon he’ll be getting a new title—Defendant.

Posted by 31morgan | Report as abusive

[…] of MF Global’s wager on European sovereign debt has received a great deal of scrutiny, the accounting and the disclosure surrounding it have not–and may have played a role in the firm’s demise, writes Vanity Fair’s contributing […]

Posted by M & A wrap: Looking at MF Global’s accounting | DealZone | Report as abusive

Corzine was running Major Fraud Global just like Goldman, this time he didn’t get to parachute out before the sh!t hit the fan.

Posted by Maxwells | Report as abusive

I’m pretty sure that the premise for this article is false. The assets and liabilities under repo accounting are accounted for as a sale and thus de-consolidated from the balance sheet. But, the company simultaneous records a forward resale/repurchase commitment — which is held at fair value and accounted for as a derivative on the balance sheet. McLean makes no mention of that, and does not seem to understand how this accounting really works.

Please see page 99 of the 3-31-11 MF 10-K (Note 3: Collateralized Financing Transactions):

“These [repo-to-maturity] transactions are accounted for as sales and purchases and accordingly the Company de-recognizes the related assets and liabilities from the consolidated balance sheets, recognizes a gain or loss on the sale/purchase of the collateral assets, and records a forward repurchase or forward resale commitment at fair value, in accordance with the accounting standard for transfers and servicing. For these specific repurchase transactions that are accounted for as sales and are de-recognized from the consolidated balance sheets, the Company maintains the exposure to the risk of default of the issuer of the underlying collateral assets, such as U.S. government securities or European sovereign debt, consisting of Italy, Spain, Belgium, Portugal and Ireland. The forward repurchase commitment represents the fair value of this exposure and is accounted for as a derivative.”

Unlike other high profile cases, the language in the 10-K is also very clear that MF retains economic ownership.

Posted by pco225 | Report as abusive

Not accounting that ruined MFG. It was the no-account CEO, Jon Corzine.

Posted by ejhickey | Report as abusive

[…] other words, DeLong (correctly) says that MF Global faced two risks in its repo-to-maturity trade: risk that repo haircuts increased during the trade (risk in what DeLong calls stage one); and […]

Posted by Deus Ex Macchiato » Remember collateral support default | Report as abusive

In addition to the bath taken by investors in MF Global, there are the losses by futures traders who were obliged to liquidate their holdings at market price on Monday.

Also, the customers accounts have a shortfall – presumably to be covered by insurance – which came about because CFTC (yielding to pressure from clearing houses) decided in 1997 it was okay to move money between segregated and non-segregated accounts to finance the companies’ risky deals.

It looks like some of the bigger customers will have access to their money sometime next week and the little guys will have to wait a little longer, but there is something unsettling about this whole business.

We need more effective regulation – not less.

Posted by loyalsys | Report as abusive

[…] After MF Global filed for bankruptcy this week, the instant wisdom was that CEO Jon Corzine had made large failed bets in his drive to transform the company. But the accounting and disclosure surrounding these wagers may have played a role in the firm’s demise as well.  Full Article […]

Posted by News of Japan » Blog Archive » Insomnia tied to depression risk in Japan | Report as abusive

Hehehe…I have to agree with MarketForce.
Bethany McLean is smart, writes well, and above all, is even more cute now than in the “The Smartest Guys in the Room” documentary…

Posted by VonHell | Report as abusive

Remember this type of manuveuring when the next time Walls Street says regulatory disclosure is burdensome, hurts profitability and is unnecessary.

But for FINRA, MF Global would still be in the business of deceiving investors and constructing an even taller house of cards.

Wall Street hates sunshine, but it is the only disinfectant. Even then, we have to have properly empowered, properly funded regulators, who are unafraid and are supported politically, to take on the profit mongers, who have billions at their disposal to fight regulations, lobby Congress and contribute to political campaigns.

Dodd-Franks and the Volker Rule are just appetizers for the full course dinner that is required.

Posted by dtschuck | Report as abusive

[…] its repo-to-maturity transactions? Maybe – but repo transactions offer the possibilities of both more opaque accounting (regulatory arbitrage) and a more receptive/less sophisticated investor base to stuff with the […]

Posted by In Which BoNY Mellon Maybe Understands Derivatives A Little Too Well — Clearing and Settlement | Report as abusive

[…] Yet despite all the good press, we’re not feeling all that reassured. We’re not quite certain that, after the latest round of regulatory efforts, whether all the information is readily available (and decipherable enough) to ensure there are no transactions lurking out there that might blow up in our faces — just as MF Global’s repo-to-maturity trades did. […]

Posted by FT Alphaville » The butterfly effect: spotted in the financial industry | Report as abusive

FINRA has nothing to do with Dodd-Frank….it’s about a typical politician (Corzine) and overpaid blowhard (Corzine) using leverage to buy crap assets and not disclose it.

We don’t need regulations — we just need disclosure.

Posted by ck427 | Report as abusive