Corzine firm's collapse shows need for tough Wall Street regulation

November 06, 2011|Jay Hancock

Last week's collapse of MF Global, the investment banking company led by former New Jersey Gov. Jon Corzine, probably won't plunge the world into a new financial crisis. The firm is supposed to be too small to cause much damage.

But the scandal foreshadows a future crisis unless negligent and clueless policymakers learn the lessons of the Great Recession.

How obvious does it have to be? MF Global employed the means and methods that caused Lehman Brothers and Bear Stearns to blow up, and we're still arguing about whether to ban or control those methods.

Billions borrowed to make speculative financial bets? Yep. Risky assets bought with short-term debt that would be impossible to renew if things got bad? Check. Borrowing equal to dozens of times the firm's capital? Yes, sir.

That tiny bit of capital itself put at risk, making the firm an instant bankruptcy candidate if markets moved even slightly against it? That, too.

If last month's debate about the so-called Volcker rule put you to sleep, let the MF Global spectacle serve as smelling salts. Named after former Federal Reserve Chairman Paul Volcker, who proposed it, a properly implemented Volcker rule would sharply limit big firms from gambling in the markets with their own capital as MF Global did.

It used to take decades for investors and policymakers to forget the admonitions of history and commit the same follies as their grandfathers. The Great Depression made good regulation and conservative portfolios bywords for two generations of Americans.

But thanks to deregulation, computerized trading and hamster-sized memories, today's Wall Street bankers have shrunk the stupidity cycle down to a couple of years. Under Corzine, once chief of investment banking giant Goldman Sachs, formerly stodgy MF Global reportedly bet heavily on Spanish and Italian bonds on the assumption that European financial authorities wouldn't let those countries default.

Whether those securities become the 2011 equivalent of subprime mortgage obligations remains to be seen. Neither Italy nor Spain has gone bust. But their bonds plunged in value, causing MF Global to report a huge loss and prompting investors, clients and rating agencies to lose confidence, forcing the bankruptcy.

With more capital and less borrowing, MF Global would still be in business, biding its time and waiting for the European Central Bank to rescue Italy and Spain. (The company is also alleged to have mixed client money with the firm's — a separate, very serious problem. Corzine resigned late last week.)

Of course, with more capital and less borrowing, any gambler's potential profits will be substantially lower. That's why Wall Street is fighting to weaken the Volcker rule — passed as part of 2010's Dodd-Frank financial reform — with all the resources it can muster.

What should have been a simple rule-making process gave birth last month to 300 pages of proposed Volcker-rule regulation, with loopholes, exceptions and vague definitions.

Big banking companies complain about the complexity — but they're the ones that caused it. Funny you don't hear backers of a clean and simple flat tax, which would allow the well-off to pay income tax at the same rate as the middle class, advocating a clean and simple Volcker rule.

In any event the Volcker rule, scheduled to take effect next year, would not have affected MF Global. The regulation restricts hedge-fund investments and trading with a firm's own capital only for financial companies allied with depository banks, which MF Global is not.

But the larger lesson is that Wall Street's appetite for gambling hasn't abated. The big firms that do own depository banks — Goldman, Citi, Bank of America, JPMorgan Chase, Morgan Stanley — are in many cases bigger than ever.

If they were too big to fail in 2008, they're more so now. And they're pushing the Volcker-rule envelope to the breaking point. They argue they should be able to use firm capital to hedge against risks and to back ready purchases or sales of securities for clients — so-called market making. Those activities could easily be tilted toward seeking big, short-term capital gains for the firm and bonuses for its employees.

Among other holes, the Volcker rule as implemented would allow trading in currencies and some government bonds — just the kind of candy that often gets traders in trouble.

Don't be fooled by the fact that some big banks have already rid themselves of operations that make bets using the company's capital. They're likely to be back in business in a different form once they've drilled enough gaps in the new rules. MF Global shows that, these days, the only thing likely to keep Wall Street from quickly repeating the crazy mistakes of the past is solid regulation.

The Occupy Wall Street folks brandish signs that say "Robin Hood Was Right" and "I'm Mad As Hell." I suggest: "We Want A Tough Volcker Rule Now!"

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