Felix Salmon

This is beginning to feel like 2008, complete with all the rumor and chaos and volatility we saw back then. MF Global is a bit like those Bear Stearns hedge funds which went bust — an isolated datapoint in one respect, but ominous in many others. And right now the best case scenario is that Greece ends up being Bear Stearns, rescued by an international community petrified of what might happen in the event of a chaotic collapse.

But Greece being Greece, of course, a chaotic collapse has to be pretty much an inevitability at some point.

Of the many ways in which the euro project was fundamentally misguided, this might be the proximate cause of its demise: it was never robust to the messy world of political reality. And in the real world, people — including heads of state — make stupid decisions all the time.

So it’s a bit silly, frankly, second-guessing George Papandreou’s fateful decision to call a referendum on the latest Greece bailout. It might not have been the most statesmanlike thing to do, but the fact is that, judged by the standard of most Greek prime ministers, Papandreou’s pretty much the best that Europe could reasonably hope for. (Just think: Greece could be run right now by someone more like Silvio Berlusconi. Or, for that matter, Jon Corzine.)

In Greek tragedy, humans don’t rise above events to triumph; rather, they are crushed by forces greater than themselves. (It’s one reason why The Wire was such an innovative piece of television: it reached back past that great humanist, Shakespeare, to his Greek antecedents.) The architects of the eurozone displayed classic hubris: they saw the increasing economic ties between the various countries and locked themselves in to a momentum trade where such ties could only ever strengthen and never weaken.

And in the event it took much less time than even the skeptics had anticipated before that hubris resulted in the inexorable nemesis.

There is a decent chance that the G20 summit will somehow muddle through in Cannes. There’s even a possibility that Greece will manage to extract itself from its current political mess, implement the reforms that Merkel and Sarkozy are insisting on, and live to collapse some other day.

But at this point I see no sign of the pan-European unity at the head-of-state level which is needed to preserve the eurozone project over the medium term. Commeth the hour, commeth the backbiting and finger-pointing and recriminating. Greece is going to default and leave the euro; the only question is when. And when it does, the EU will find that its protections against contagion are about as effective as that $1.6 billion tsunami breakwater in Kamaishi.

Greece can fall and the eurozone can still survive. But Italy — which is just as politically dysfunctional as Greece — can’t. Which is why those Olympian forces will ultimately spell the end not only of Greece’s membership in the euro, but also of European monetary union more generally.

Morgan says its exposure to Spain is $500 million; a regulator says its $25 billion — Bloomberg

“Faced with two unappetizing choices, Greece seems intent on choosing neither” — New Yorker

Joe Weisenthal thinks this chart explains a lot about Greece — Business Insider

Why were people giving their money to MF Global in the first place? — Brad DeLong

Almost a third of jobless Americans have been out of work more than a year — Pew

15% of all Americans are on food stamps — WSJ Real Time Economics

Do more arts and humanities grads mean that college is oversold? — Marginal Revolution

Inside the transnational organ-selling gangs — Bloomberg

Big brands are just now learning that they can use Facebook for free — WSJ

Groupon spent nearly as much on marketing as Visa — AdAge

And AOL’s traffic is barely higher despite acquiring the Huffington Post — AllThingsD

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”.

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.

Moving assets and liabilities off your balance sheet to make yourself look less risky? That’s a very Lehman move, redolent of the notorious “repo 105” trades.

But I’m not convinced by this story.

Firstly, the debt of Italy, Spain, and Belgium might be getting a lot of headlines right now, but in terms of price action it’s not actually as volatile as you might think. These assets weren’t actually significantly more volatile than the rest of MF Global’s balance sheet, and so including them on the balance sheet would not have increased MF Global’s value-at-risk very much. In fact, it might have reduced it.

Now that doesn’t mean, of course, that the assets weren’t riskier than most of the rest of the balance sheet. They were. They were sovereign bonds being held to maturity, in most cases at the end of 2012. And a lot can happen between now and then. That’s what the markets were worried about, rather than any immediate mark-to-market losses on the bonds. In fact, it’s not clear that there were mark-to-market losses on the bonds. But if you’re holding a bond to maturity, that’s an inherently much riskier position than if your prop desk is holding it as part of a bond position which it can sell at any time.

Secondly, it’s extremely unlikely that MF Global recognized a gain on this transaction at the time of sale. The bank bought this debt on the open market, and then immediately put the bonds up as collateral, getting cash in return. We don’t know who lent MF Global the money, taking the bonds as collateral. But whoever it was had no reason whatsoever to value the bonds at more than their market price. So there’s really no way that MF Global could have recognized a gain on the sale: much more likely, in fact, that it would have registered a modest loss. (In a repo transaction, it doesn’t matter if you sell the bonds for less than they’re worth, since you also contract to buy them back at a pre-set price later. So long as the repurchase price is also low, it’s fine if the initial sale is done at a low price too.)

And finally, there’s no indication that taking this trade off balance sheet helped to significantly hide the size of MF Global’s assets, or to understate its actual leverage. Here are the numbers from MF Global’s quarterly filings:

What I’m charting here is the total size of MF Global’s assets, in green; its equity, in blue; and the ratio between the two, in red. Obviously, the leverage ratio is ludicrously high: there are more than $40 billion of assets being supported by just $1.2 billion of equity.

But can you see, in this chart, where Jon Corzine joined the company? (It was in March 2010.) And can you see where MF Global brought the European sovereign bonds back onto its balance sheet? (It was in the final numbers, for September 2011.)

The fact is that MF Global’s leverage ratio — and its total balance sheet — was higher before Corzine arrived than it was at any time afterwards. And that when the European sovereign-bond trade was brought back onto MF Global’s balance sheet, the total size of that balance sheet actually fell.

In other words, the trade which brought down MF Global, even if it had been on the balance sheet all along, would never really have been visible on the balance sheet, or in the leverage ratio, or in the value-at-risk figures. I’m not clear on why the trade was moved off balance sheet in the first place. But I think it’s a stretch to say that accounting brought down the bank.

Sheila Bair aims her fire squarely at Europe’s banks and their regulators today, contrasting the high degrees of leverage and low degrees of capital in Europe to the safer banks we have here in the US.

The U.S., which has tighter rules governing how FDIC-insured banks determine the riskiness of assets, requires well-capitalized banks to hold capital equal to at least 5% of total assets, regardless of how risky they think the assets are. So for any asset, be it cash, U.S. Treasury securities, or supposedly safe mortgages, banks must hold at least 5% capital against it. European banks do not have this kind of “leverage ratio,” and Basel II has allowed them to treat sovereign debt as having zero risk. That is one of the main reasons they have loaded up on nearly $3 trillion of it…

European regulators should supplement this [9% common equity capital] requirement with the Basel III 3% leverage ratio — or even better, the U.S. 5% requirement, adjusting for accounting differences. The EBA should also use realistic loss estimates more in line with those of the IMF and private analysts. If banks have to accept dilution of their stock or temporary nationalization, so be it…

U.S. regulators made many mistakes, but because we maintained our leverage ratio and delayed Basel II implementation, FDIC-insured banks have remained much more stable than other financial institutions. Bank capital standards should not be an insider’s game. The public deserves better. Bank regulators should do their job, and it is their job, not the job of conflicted bank managers, to set minimum capital levels.

I’m sure that Bair feels that it’s her intrinsic toughness and common sense which resulted in US banks being held to tougher standards than their European counterparts. And she’s absolutely right that when it comes to capital and leverage, US regulators came out of the crisis looking better than European regulators. But not by much. US investment banks were allowed to increase their leverage and decrease their capital as much as they liked — which is one reason why Bear Stearns and Lehman Brothers collapsed so quickly. And other countries, like Canada and India, were much tougher even than the US.

The fact of the matter, however, is that all regulators are captured by banks. Or, to be a little more precise, all legislatures are captured by banks, and all regulators do what the government tells them to do.

In countries like Canada and India, there’s a very small number of strong, well-capitalized banks with a vested interest in maximizing barriers to entry. So they’re happy with very tough standards. In Europe, national banking systems are also concentrated, so in theory they could go the same way. But European banks are more likely to have cross-border and global ambitions, and in any case as a matter of contingent fact they’re not very well capitalized. So they get the regulation they want — which allows them to grow fast without having to raise lots of expensive new equity capital.

And then there’s the US, which is pretty much unique among major economies in having thousands of pretty vibrant small banks. Those small banks have a lot of political clout in Congress, and they hated Basel II, because they’re not nearly sophisticated enough to take advantage of it. So they essentially bullied Congress into keeping the old Basel I standards, for fear that otherwise they would be at a massive competitive disadvantage with respect to the big US banks like JP Morgan Chase. Congress obliged, and used the FDIC as its chosen mechanism for blocking the adoption of Basel II in the US.

Does that make the FDIC particularly virtuous? No: it makes the FDIC just as beholden to the banks as any European regulator. Look at the banks’ contributions to the FDIC insurance fund, for instance: they fell to zero, for no good reason, just because the banks didn’t like making those payments.

So Bair is hopelessly naive if she thinks that European regulators — or even American regulators — can really ever force banks collectively to do something they don’t want to do. The only reason the FDIC has any teeth at all in terms of capital requirements is that it’s in the small banks’ interest, and those small banks have a lot of political influence. There really aren’t any small banks in Europe, and European taxpayers are now on the hook for much bigger potential financial-sector losses as a result. That’s bad for Europe, and the world. But the US, and Bair, are in no particular position to deliver lectures on this subject.

Just a few of the many links on Counterparties.com today:

“It’s all over. The government is about to collapse,” says one Greek official — Guardian

Tim Duy wonders if the EU deal just collapsed — Tim Duy’s Fed Watch

Hundreds of millions of customer dollars are missing from MF Global — Dealbook

China’s PMI manufacturing index is at its lowest level in almost three years — Bloomberg

Credit Suisse plans to get rid of 1500 more jobs — Bloomberg

New York federal prosecutors are seeking $2.5 billion from Allied Home Mortgage — Reuters

Fannie and Freddie execs will take their bonuses now, please — Politico

Bruce Feld: Racism is alive and well in Silicon Valley (or at least US military installations) — Feld

And Meredith Whitney went as Puss in Boots to her office’s costume party — Dealbook

It’s Bank Transfer Day on Saturday, and some unknown number of people are going to transfer their money from their too-big-to-fail bank to a friendly local community bank or credit union. Good for them! Unfortunately, Bank Transfer Day is happening the week that MF Global declared bankruptcy, with the possible loss of some $700 million in client funds. And the net effect of the two is almost certainly going to be money flowing in to TBTF banks, rather than out of them.

Matt Levine has a fantastic post today explaining why it doesn’t make sense to be the customer of a small-enough-to-fail institution. This doesn’t apply to small depositors at retail banks, of course, who are federally insured. But for institutional clients, whose funds are uninsured, the moral-hazard trade here is clear:

If you were trading commodity futures in the last few years, a lot of things could have gone wrong. Like, your commodities could have moved against you. One thing that you were probably less focused on was that your CME member, CFTC regulated, SIPC insured futures broker would not only file for bankruptcy but also maybe forget where it put your money. In the future, you’ll be focused on it…

The main fallout will probably be that if you have the choice to work with a too-big-to-fail bank or a just-small-enough to fail bank, on a whole variety of things, you’re going to go too-big-to-fail. Sure, there are lots of small brokers who are well capitalized and take the time to get the little things right, like segregating customer accounts. But how can you know unless you do a lot of diligence? Easier to just trust that a megabank squarely in the regulators’ sights will get it right – or, if they get it wrong, won’t be allowed to blow up in a way that blows up customers.

This is one reason why the big banks are blithely unconcerned about people withdrawing their funds on Saturday. (Which in reality won’t actually happen overnight: first you open up a new account at a credit union, then you move some of your funds over, while leaving the old bank account open, then you start changing your direct-deposit and direct-debit instructions, and eventually, after a month or two, you feel safe closing down the old account.)

And the big banks don’t particularly want all those retail-deposit funds — they’re getting precious little interest on them, and they come with all manner of expensive obligations to mail out statements and provide smiling service at teller windows and generally do the whole customer-service thing, which as we all know big banks are very bad at. Historically, they’ve done what they have to do on that front because they’ve been able to extract all manner of overdraft fees and interchange fees and the like, but that fee income is shrinking now, thanks to Dodd-Frank, and the fact is that millions of small bank accounts are actually unprofitable now for the big banks, and those banks won’t shed many tears if those customers go off to a credit union instead.

Meanwhile, the big-fish customers — large corporations, and municipal governments, and the like — are moving their millions to the TBTF banks, using a kind of “no one ever got fired for buying IBM” logic.

So while I think it’s great that people are moving to smaller banks and credit unions, I’m not kidding myself that doing so is going to harm the big banks at all. In fact, it might even help them, at the margin.

Dan Ferber’s 3,500-word article on Vehicle-to-Grid is far too long for you to read, especially when Greece is busy imploding, but it’s a very important idea. So let me give you the shorter version, starting with four facts about the energy industry.

• The 146 million cars, SUVs, and pickup trucks in America, between them, produce seven times the power of all US power plants combined.
• The supply of energy is volatile, and will get more so as we move to renewables like wind and solar. Those sources only produce energy some of the time.
• The demand for energy is also volatile, going up during the day and when it’s hot outside.
• Storing energy, by doing things like pumping water uphills into reservoirs, is expensive and cumbersome. And those energy sources can’t provide the small bumps in power needed to ensure that AC electricity is running at 60 hertz at all times.

All of which opens up an amazing opportunity for owners of electric vehicles — be they electric, hybrid, or fuel cell. Those vehicle owners can basically become baby energy traders, fueling up their cars at night, when electricity is cheap, or at the pump. And then plugging their cars into the grid, where they can sell energy back to the grid for much more than they paid for it.

Willett Kempton of the University of Delaware has already set up his electric Scion to do just that; it’s been earning him $300 a month since 2009.

This is a fantastic idea, and it’s a no-brainer, really, that all electric cars should have the ability to power the grid, rather than just drawing power from it. The number and size of power plants is a function of peak electricity demand; if electric-car owners collectively can help meet peak demand, then that means we need fewer power plants. And, the revenue from selling that electricity would help offset the extra cost of buying an electric car in the first place.

The batteries in electric cars are expensive and valuable pieces of technology which go unused for most of the time. Let’s put those things to use, and make money doing so! The only real question is why this isn’t happening already.

A week or so ago, Matt Richtel wrote a long and glowing profile of the Waldorf School of the Peninsula, looking into the apparent irony that a Silicon Valley school is decidedly low-tech; he quoted one parent, Alan Eagle, a senior Google employee, as saying that “I fundamentally reject the notion you need technology aids in grammar school”.

But there’s more to technological progress than iPads. And I wonder what Alan Eagle would say if he knew that fear of life-saving technology at the Waldorf School is exposing his children to a much-heightened risk of painful, untimely, and easily-preventable death.

The first thing to say about this tragic chart is that both Los Altos city and Santa Clara county have extremely low immunization rates. The right level of immunization is 100%, and rates of 90% or 94% are very dangerous indeed.

But 23% is positively evil.

This is a very dangerous level of immunization–the level where herd immunity gets lost, disease reservoirs are established, and children emerge from their school to infect infants, immunocompromised adults, and people whose vaccinations didn’t take or have waned, with potentially fatal diseases.

No responsible parent would ever let their child attend a school with a 23% immunization rate. And indeed there’s a strong case to be made that public-health officials should simply refuse to allow any such school to open its doors unless and until that rate improves. I’ll be charitable here and assume that Richtel didn’t know this number when he wrote his piece — but still, the NYT owes its readers something of an apology here for leading them to believe that there might be something admirable about this sinkhole of highly-dangerous fear and ignorance.

By far the best book on this phenomenon is The Panic Virus, by Seth Mnookin; I can highly recommend it. He tells of how when public-health officials try to work out which areas are at highest risk of fatal outbreaks, one thing they do is look at a map of Whole Food stores — it’s the crunchy-granola college-educated liberals who are by far the worst offenders when it comes to putting their own children and everybody else’s at risk. And they love to eat up pseudoscientific claptrap about “immature thymus glands” when it’s published by outlets like the Huffington Post.

It’s a statistical certainty that children die, unnecessarily, when immunization rates fall. The Los Altos parents sending their kids to the Waldorf School of the Peninsula are at best misguided and at worst downright malign. No matter how skeptical they are of technology, school administrators have an overriding moral duty to do something about this. Now.

Update: I should have put this in the original post, sorry, but the chart comes from the Bay Citizen’s immunization pages, which show that “at Waldorf School Of The Peninsula, 72.73 % of kindergartners weren’t fully immunized in the 2010-11 school year due to their parents’ personal beliefs”. The data comes from the California Department of Health.

Update 2: A fascinating comments thread, which is worth reading, or at least skimming through. Thanks in particular to LaraR, who notes that kids can’t enroll in public schools in Santa Clara unless they’re immunized. Which seems to have had the unintended consequence that parents who don’t want to immunize their kids all end up sending their kids to the Waldorf School, with potentially disastrous consequences. There’s already a pertussis epidemic in the county.

MF Global made a massive leveraged bet on European debt, and then it died. That seems to be the conventional wisdom at this point, but it’s a bit oversimplified. A more accurate story would be to say that MF Global got involved in a complex liquidity-management trade, and that it didn’t have risk managers with the power or ability to cap the trade before it got too big.

Izabella Kaminska has the wonky details of MF Global’s repo-to-maturity trade. It’s not easy to follow, but here’s the general gist. MF Global buys a bunch of European debt. The bank’s explanation of the trade says that the purchases were “entered into repurchase and reverse repurchase transactions to maturity, which are accounted for as sales”. This is the repo-to-maturity trade.

In order to understand what that means, you first need to understand that banks like MF Global used to do nearly all their borrowing on an unsecured basis. But in recent years, that’s changed: nowadays, if you want to borrow billions of dollars for what MF Global calls “client facilitation and principal activities”, then you’re going to need to put up collateral.

So as soon as MF Global bought those bonds, it turned around and pledged them as collateral when it was borrowing money. That’s the repo.

Now here’s the trade: the rate at which it was borrowing money was lower than the coupon payments on the European sovereign bonds. And because this was a “repo-to-maturity”, MF Global was essentially locking in the difference as profit. It got to keep all the coupon payments, while it had to pay out something less than that in interest.

There were two risks with this trade. The first risk was that the European sovereigns would default, and that MF Global then wouldn’t have the resources to pay back in full the money it had borrowed. That was a solvency risk, but MF Global had a hedge there — a $1.3 billion short position in French government bonds.

And then there was the liquidity risk. As the MF Global slide notes, “MF Global retains obligation to post margin”. If the people lending money to MF Global started getting worried, they could require MF Global to put up more money.

And that seems to be exactly what happened. When questions started being raised about MF Global’s ability to continue as a going concern, its counterparties probably started asking for more collateral if they were locked into repo trades to maturity in 2012.

But MF Global, leveraged to the eyeballs, didn’t have that kind of extra money lying around. And so it needed to find a partner with deeper pockets who did. Corzine put the firm up for sale — and at one point it looked as though Interactive Brokers might be interested in buying the company at a fire-sale price. (Even after taking into account the fact that such a sale would generate an automatic $12 million check for Corzine.)

That sale didn’t happen, for a very good reason: there seemed to be $700 million missing from the bank accounts of MF Global’s customers.

MF Global, then, had two huge risk-management strikes against it. It had no way to manage the risk that its counterparties would ask for extra collateral, and it had a very weak grasp of where its customers’ money was.

In both cases, the buck stops with Jon Corzine.

At MF Global, Mr. Cohan asked: “Who in the world was going to stand up to Jon Corzine? Nobody. They didn’t have the compliance or the culture.”…

In the case of Mr. Corzine, at MF Global, he was the chairman and chief executive. Given that he was directing the investment strategy, he might as well have been the compliance officer too. The only people with any authority who could have meaningfully pushed back were the board.

The first job of the chairman of an investment bank is risk management. But Corzine has always been an aggressive trader; even at Goldman Sachs, with its legendary risk management, there were major trading losses under his watch in 1994.

For traders, risk managers are always the enemy; Corzine was a poacher who was never going to be comfortable in a role as gamekeeper. The Goldman culture kept him in check, to some degree, before it pushed him out; on his own, he was — literally — out of control. And as a result, thousands of his employees are now out of jobs. It’s a truly ignominious end to Corzine’s career.

Here’s Corzine from an earnings conference call just last week. This should be his epitaph.

“The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as the structure of the transaction themselves essentially eliminates market and financing risk.”

Here are a few of our links today from Counterparties.com:

The 30 year return on bonds is higher than equities for the first time in 150 years — Bloomberg

Brad DeLong is not a huge fan of the ECB — Project Syndicate

Germany has $78 billion more than thought after discovering an accounting error — Der Spiegel

Bill Gross wonders how one can solve a debt crisis with more debt — PIMCO

Prince Charles has been offered the veto over 12 UK government bills since 2005 — Guardian

The Treasury Department will hold off on selling more of its 77% share of AIG for now — WSJ

Here’s a good, long piece on the changes Jon Corzine made at MF Global — Reuters

And here’s his MF Global employment agreement — SEC

The more important (but less covered) Herman Cain scandal of the day — Journal Sentinel

Together for a year, Newsweek and the Daily Beast are (surprise!) still not profitable — Adweek