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MF Global - canary in the (financial) coalmine?

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The October 31 collapse into bankruptcy of MF Global, the US brokerage firm with investment bank appetites and ambition, was the eighth largest corporate bankruptcy in US history, behind Lehman Brothers, Enron and Washington Mutual but ahead of automaker Chrysler. As with any bankruptcy, clients are scrambling to recover their money, but large sums have gone missing.

Brokers are supposed to segregate client money from the money they use to fund their own trading, but apparently the walls were breached. This has triggered investigations for regulatory and, just possibly, criminal misconduct, and a great deal of media interest.

It will take time to unravel the books, but that's not the compelling story The salient lesson of the MF Global collapse is how well it illustrates the extent to which nothing has fundamentally changed, despite all the talk about regulation since the great meltdown of 2008. All the essential features are there: enormous leverage,  government subsidies for pure speculation, the revolving door between finance and government and the transformation of buyout houses into omnivorous financial conglomerates.

MF Global was originally the brokerage division of UK hedge fund Man Financial, and operated out of a tax haven - Bermuda - even after going public. In 2008, huge losses on commodity derivatives nearly sank them. Private equity house J.C. Flowers rescued the company with money raised, in part, from public employee pension funds.

J.C. Flowers had become a star financial player through a deal involving the Long-Term Credit Bank of Japan, a 'too big to fail' bank which was drowning in bad debt after Japan's property bubble burst. In 1989. LTCB was nationalized and delisted from the Tokyo stock exchange. In 2000, J.C. Flowers was part of an international consortium which bought the bank and relaunched it as Shinsei Bank of Japan. Goldman Sachs collected big fees for advising the Japanese government on the deal, which included a 3-year government guarantee to buy back bad loans.

The new owners used the guarantees to dump the bad debt back on the government, eventually leaving it on the hook for over USD 46 billion. In 2004, J.C. Flowers made a 600% return on its initial investment when the bank went public, and paid no Japanese taxes on the gain.

In March 2010, another Goldman Sachs alumnus, former CEO Jon Corzine, took over as MF Global boss after failing to win reelection as governor of New Jersey. In February this year, Corzine announced his intention to transform the company into an investment bank within five years. The vehicle for that transformation was to be leverage - debt.

At the end of September, MF Global's balance sheet showed equity of USD 1.23 billion and assets of USD 41.05 billion - a staggering leverage ratio, like the ones that sank Bear Stearns and then Lehman. They were betting on mortgages, Corzine on eurozone debt. Like the other failed institutions, MF Global was boosting leverage through derivatives and funding long-term bets with short-term borrowing.

Corzine had placed a huge wager of USD 6.3 billion earlier this year on debt from shaky European governments, betting that they would be bailed out and the bonds redeemed at face value. As the asset values sank, the company faced escalating calls for cash collateral, calls it couldn't make because the bailout failed to arrive in time. This was a replay of the scenario which sank insurance giant AIG. When AIG was bailed out, Goldman Sachs was repaid in full by the US government for the bets it had placed through AIG.

MF Global doesn't qualify for government support, because it is not a retail bank. But its biggest client, JP Morgan, does.

The more things change, the more things stay the same.

Global finance remains addicted to stratospheric leverage levels, while profiting from a revolving door in which elected officials and regulators are more or less indistinguishable from those they are supposed to be regulating. The current chairman of the US CFTC, one of the regulatory bodies responsible for companies like MF Global, has removed himself from involvement in the investigation into MF Global's missing funds on the grounds of conflict of interest. He worked together with Corzine at Goldman Sachs…

Does MF Global's collapse signal more and bigger failures to come? Undoubtedly. But to call it the canary in the financial coalmine does a disservice to the coalmine. For all its hazards, coal provides a source of energy. The same cannot be said of derivatives linked to sovereign debt.

The frantic effort to rescue European government bonds has never been about supporting livelihoods and services - it is about bailing out investors who are buying government debt at a fraction of its face value and collecting astronomical interest payments. While unemployment soars and public services are dismantled, unprecedented sums of money continue to flow into instruments designed for one purpose only: to guarantee income streams to financial investors. If MF Global had won its bet, not a single worker anywhere would be better off. But win or lose, we pay.

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