Will other banks go the way of MF Global?

October 27, 2011
John Carney wonders whether MF Global might turn out to be simply the first of many banks to go bust in a European financial crisis.

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John Carney wonders whether MF Global might turn out to be simply the first of many banks to go bust in a European financial crisis.

All the very serious people on Wall Street keep saying that the problems at MF Global are “isolated” or “unique.” It’s not a bellwether or a canary in the coal mine, they say.

I’m not so sure. There were lots of firms that were supposedly not canaries in coal mines in 2007. Heck, even the entire subprime market was supposedly not a canary in the coal mine for the broader housing market.

There’s a lot of sense here. Banks are reliant on trust — it doesn’t matter whether or not they are insolvent. All that matters is whether the market thinks that they might be insolvent. In fact, all that really matters is whether market participants think that other market participants might think that they might be insolvent. Whenever you think there’s a risk of a run to the exits, the smart thing to do is to run to the exits before everybody else does. And runs kill banks.

Which is one reason why Morgan Stanley, for instance, went to the length of carefully spelling out its European exposures in its third quarter financial supplement (see page 13 of the supplement, 14 of the PDF).

If you take its numbers at face value — and Morgan Stanley does mention that they’re unaudited — then the bank has $287 million of exposure to Greece, $1.8 billion of exposure to Italy, and negative exposure to Portugal and France, thanks to all the hedges they’ve put on. They’re fine!

But of course, if Italy and/or France suffered a major financial crisis, there is no chance at all that US banks — including Morgan Stanley — could emerge unscathed. It’s very worrying to me that Morgan Stanley is putting out these kind of numbers — it implies that people at the bank actually believe that they have no exposure to France. While the real exposure is something that can’t be hedged away with a bit of counterparty-hedging and some judiciously-chosen credit default swaps.

To give one example of how country exposure is incredibly hard to calculate, check out this article from December 2001, when Argentina was imploding.

Citigroup may also have to face losses in Argentina, where Citibank has been active since 1918. The country is nearly bankrupt and has frozen assets at most of its big banks to halt a run on deposits. Though Argentina is an integral part of Citigroup’s Latin American strategy, it contributed just 2% of the company’s overall earnings at the end of the second quarter.

In an absolute worst-case scenario — one where the peso is devalued and the country’s government debt defaults — some analysts estimate Citigroup would lose just $200 million. “The fact that emerging markets are volatile is not a new idea for us,” says CFO Thomson. In fact, Citigroup could ultimately gain business, he says: “In volatile times, customers often leave their local banks and come to Citigroup.”

Citigroup’s losses in Argentina would end up somewhere north of $2 billion, not including a huge hit to the bank’s reputation in the country and across the region. (Depositors, as Thomson said, had fled to Citigroup as a flight-to-safety trade, but all their dollars at Citibank got converted to pesos all the same, and Citigroup refused to make them whole, saying that Citibank Argentina was a subsidiary for which it had no particular responsibility.)

MF Global is, narrowly, just a bank which took on too much risk and too much leverage in the fixed-income space, and which imploded on the watch of a former Goldman Sachs executive who turned out to be much less capable at managing risk than Goldman Sachs is. It’s not the first bank to fit that description: the same can be said of Citigroup (Robert Rubin), Merrill Lynch (John Thain), and Wachovia (Bob Steel).

But more broadly, dominoes are falling right now, as a result of European sovereign-debt exposures. Dexia was first; MF Global is second. No one can say with any certainty how many more there will be. But once the cascade has started, it can be very hard to stop.


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