Thursday, November 3, 2011

Euro Crisis Fells First US Victim: MF Global

November 2, 2011

MF Global filed for bankruptcy this Monday (Nov. 31, 2011), primarily because of losses caused by its bets in EU debts. It is the biggest failure by a securities firm since Lehman Brothers Holdings Inc. filed for Chapter 11 in September 2008.

Relevant investigation is still going on, and some details about the European debt trade that destroyed MF Global are exposed gradually. Ms. Izabella Kaminska, a financial journalist, has done a very good job at describing how this trade works in her article MF Global and the repo-to-maturity trade. And she called MF Global’s “repo-to-maturity” laddered trades as an “overnight repo Black Swan” event.

Often in a traditional repo-to-maturity, when the bonds matured, the purchaser of the repo bonds would receive the final payment directly from the issuer of bonds. He would then net out the amount of the original repo loan plus interest, and hand the rest of the payment over to MF Global. Because the loans matured in 2012 and the European Financial Stability Facility was backing them through that date, there really wasn’t much issuer risk involved. The only real risk was contained in the contractual obligation on the part of MF Global to provide additional collateral if the market value of the sovereign bonds dropped by more than the original haircut prior to maturity. What happened here is that MF Global’s regulators worried the firm didn’t have enough capital to meet likely margin calls and demanded it raise more capital and disclose more about the size of its positions. These disclosures worried the ratings agencies, which downgraded the company. Which made the creditors demand more collateral. Senior Editor Mr. John Carney from CNBC also gave a detailed analysis with this process.

MF Global filed for Chapter 11 protection in the Southern District of New York, leaving behind more than $2.2 billion in debt, held mostly by JPMorgan Chase, with more than $1.2 billion in bonds, and Deutsche Bank with about $1 billion. This breaking news may give the Street a hint that it would better be more cautious when making decision involved with global investments, since global opportunities also mean global risks that could be more unpredictable and harder to manage.

Lorena Li

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