On this beautiful Thanksgiving day, here is another text conversation from our friends Roy and Steve discussing MF Global. As crude as these conversations may be, they represent actual conversations taking place among finance professionals. The names have been changed but the content is real. Enjoy.
Roy: Did you read today's WSJ piece on MF Global: 'Bad Recipe' for Risk Management ?
Steve: I saw it, but didn't read the whole thing. What did it say?
Roy: Interesting article. But one thing struck me. It said "the trade structure allowed the firm to book all the potential yields on the bond purchases at the same time the trades were made." This is odd.
Steve: No way. That's not US GAAP. Maybe they were allowed to accrue rather than mark to market - that's possible.
Roy: I think since it was done as "repo to maturity" (and classified as sale, so off the books), that the difference in bond yield vs. repo was booked up-front. Could that be it?
Steve: No way. I've seen people accrue the difference (banking book) - so you take the repo spread on a daily basis and add a day's worth of spread to the P&L each day.
Steve: So on a 3yr paper it would take you 3 years to take the full spread into P&L. Accrued on a linear basis.
Roy: Yes, that's exactly what I think is the case too. So I'm not sure what that article is referring to.
Steve: Probably the usual uninformed financial media. But ultimately they did mark the paper, right? That's what caused the big loss in their quarterly statement.
Steve: Also I think the lost customer money was used to post collateral on the repo. And the money is gone because it was used to cover losses.
Steve: And I don't think that's illegal. Customer deposit is effectively junior sub debt.
Roy: Yes, I agree about the marks, and the loss of the customer funds. And true, it was perfectly legal to use those funds for that purpose. That's the rule that Corzine fought to maintain!
Roy: The shortfall is holding firm at $1.2B. What a disaster.
Steve: Not sure customers knew the risk.
Roy: It was a well-kept secret. Now all those other FCMs [Futures Commission Merchants] are going to face huge restrictions of the use of these funds. It was a good part of their income. So Corzine just completely f****d their business model.
Steve: Yes. Who are some of the other big futures brokers?
Roy: The biggest independent one now, I think, is Newedge (formerly FIMAT)
Steve: Is it public?
Roy: FIMAT, of course, was a unit of SocGen. FIMAT was combined with the FCM unit of Calyon
Steve: Got it. So no other big standalone futures brokers out there?
Roy: You've got the IDBs [Inter-Dealer Brokers] (Icap, BGC Partners, Tradition, GFI, and TullettPrebon), which have FCM units. But they are not like Newedge or MF Global.
Steve: Right. It's a small part of their business. By the way, Goldman looked at buying MF Global, right?
Roy: You mean before the collapse, right?
Roy: Yes I think they did. Anyway I've got to go.
Steve: Let's touch base Friday. Take care.