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November 20, 2011

Editorial: Inside The Failure of Jon Corzine and MF Global


Jon Corzine, the former head of Goldman Sachs, United States Senator, and governor of New Jersey, is currently at the center of the business headlines, but for none of the above titles. Following a career in politics, Corzine accepted the position of chairman and CEO of MF Global. When Corzine was first hired, I was very concerned.

Why would an organization hire someone who practically bankrupted the state of New Jersey?

Turns out, MF was banking more on Corzine's Goldman Sachs experience than on his political/fiscal failures. Someone should have told Corzine that things have changed in the business world since 2008.

From what I'm hearing, Corzine backed a strategy that involved being the middleman in the European debt trade. MF would deal government debt at a discount and if the counterparty the debt was sold to made money, MF would get a share of the profits. On the other side, if the value of the bond fell below the price it was sold, MF would have to fork up the collateral loss and pay the counter-party.

For some reason, this was deemed to be a 'virtually risk free' trade inside of MF Global. To me, however, I see it as a creative twist to a credit default swap. If the price of the bond remains high, you reap the profits, just as if a stock price or investment remains high, the CDS originator can continue to collect fees. If the price falls below the threshold, you now have to pay the difference between the sale price and the new price, similar to the insured value of an investment if it fails.

Now, when I hear that MF felt this was risk free, I know that they loaded their books with this type of transaction. In fact, their leverage ratio was 40 to 1, meaning for every $1 in equity they had, there was $40 in debt. This is the same leverage ratio that Lehman Brothers had when it failed in 2008 and accelerated the financial crisis. Haven't we learned anything from the financial crisis?

Any trading or brokerage house that exists today needs to take a lesson from MF Global and diversify. Additionally, they need to run disaster scenarios that involve unprecedented market conditions as opposed to historical trading ranges. This type of 'out of the box' thinking can raise red flags long before the market does. Hopefully, senior management will be competent enough to react to these studies.

As for Jon Corzine, he should retire after this mess. It scares me to think (as you can see in the below video) that he is teaching students at Princeton. What does he have to contribute to young, impressionable minds? He failed in the public sector, he failed in the public sector, therefore, he simply needs to go away and let the professionals handle the mess he's created.

Anyone "smart" enough to hire him after this....? Probably Congress.

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