How to duck regulation, MF Global edition

June 5, 2012

Is 12,500 words on the demise of MF Global, courtesy of Fortune, not enough for you? How about 275 pages on the subject from James Giddens, the official trustee? They’re both tl;dnr as far as I’m concerned, so many thanks to Dealbook for picking up on one particularly salient theme of the trustee report: an MF Global subsidiary called MF Global Finance USA Inc, or FinCo.

The main thing you need to know about FinCo is that it was completely unregulated — it was basically an off-balance-sheet vehicle where Jon Corzine could park risk outside the purview of regulators. So when regulators started asking him to raise more capital against his risky European bond positions, he just moved a chunk of those positions out of MF Global proper and into FinCo:

While MF Global did move some cash around to protect against losses, the firm also transferred its roughly $3 billion in holdings of Italian bonds from the brokerage arm of the company to the “FinCo,” according to the report. By doing so, the firm met its requirements without having to raise money… The Italian bonds represented about half the firm’s risky European position.

Now I have to admit that I’ve been scouring the report this morning, searching on terms like FinCo and “net capital” and “Italian”, and I can’t work out what bit of the report Dealbook is talking about here: it would be great if they could use their DocumentCloud technology to show us rather than just tell us exactly what Giddens is saying. But assuming that the report says what Dealbook says it says, this seems incredibly damaging to Corzine.

The start of the financial crisis, remember, was in large part brought on when big banks like Citigroup started seeing enormous losses in their off-balance-sheet vehicles, and then were forced to recognize those losses by bringing them on balance sheet. Corzine, here, seems to have taken the decision that moving risk off his balance sheet was a great idea — even after having seen how dangerous it could be.

Meanwhile, that other rockstar banking CEO, Jamie Dimon, is testifying to Congress next week, and Andrew Ross Sorkin has a list of very good questions that he should be asked. To that list I would add one more: why was most of the Chief Investment Office’s activity based in London? The CIO’s investments were very much on JP Morgan’s balance sheet, of course, not off it. But they were pretty much out-of-sight, out-of-mind as far as regulators were concerned: the US regulators didn’t see them, and the UK regulators didn’t care about them.

The fact is that the CIO did most of its risk-taking in London for much the same reason that AIG Financial Products was based in London: regulatory arbitrage. Which is a problem regulators are always going to face, when dealing with big international banks. What MF Global did was far, far worse than what JP Morgan did. But the motivations were similar. And right now, regulators are simply not equipped to deal with such shenanigans.


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