Jon Corzine’s unbelievably swift fall is a classic story of Wall Street arrogance.
Just a few months ago, the Obama administration was considering Corzine as a possible successor to Treasury Secretary Timothy Geithner. Investors in the bonds of his firm, MF Global, demanded the right to an extra percentage point of interest if he left as its CEO and chairman.
Nobody else on Wall Street makes a promise like that to buyers of its bonds. Not even JPMorgan Chase, run by Jamie “King of Wall Street” Dimon. Corzine had come to be regarded as a demigod, a divinity in the mortal world. Hercules with a trading desk.
And no one believed the myth of Corzine as much as Corzine himself. When explaining to associates and investors that he wasn’t preparing to leave to become treasury secretary, he never for a moment let on that he had any doubts that he could — and probably should — be running the highest economic office in the land.
Meanwhile, Hercules was pushing his firm to take on more Euro-debt risk — even as most Wall Street firms were shrinking their exposure to the sovereign bonds of troubled nations on Europe’s periphery. In filings with the Securities and Exchange Commission, MF Global claimed that the market was wrong about Europe — and MF Global knew better.
“Volatility in the European sovereign debt markets created occasional dislocations in the cash and repurchase markets for certain short-dated securities, providing more trading opportunities in the quarter ending June 30, 2011,” MF Global said in what turned out to be its final quarterly report.
Except those “trading opportunities” turned out to be deadly. To paraphrase the British economist John Maynard Keynes, the market in European government bonds stayed dislocated longer than MF Global could stay solvent.
Corzine & Co. thought they’d developed a genius method of investing in the European sovereign bonds. In a trade called a “repo-to-maturity” on Wall Street, MF Global would borrow money from big banks, use that cash to buy bonds coming due in the next year or so, then use those very bonds as collateral for the loan. The bonds and the purchase loans matured at exactly the same time, so there was no risk of having to find new financing for the positions. In Wall Street parlance, there was no “refinancing risk.”
The trade was also supposedly free of what Wall Street calls “credit risk” — the risk that a borrower will not repay its loans. All of the bonds were protected by the European Financial Stability Facility, which wasn’t due to expire until after the bonds were paid off.
In fact, the EFSF lacked the funds to make good on this promise. Arrogant European bureaucrats had simply assumed that merely making the promise would put a halt to the “dislocations” — and Corzine seems to have assumed exactly the same thing.
This works great — until it doesn’t. As part of the repo-to-maturity deals, Corzine’s gang had to promise to put up more collateral for the loans if the prices of the bonds fell too far. And, despite the EFSF, prices did keep falling — requiring MF Global to pony up ever-larger sums to its trading partners.
(The firm’s books are a mess, but it now seems that it actually resorted to secretly using $1.2 billion in customer funds to cover its shortfalls — an illegal and appalling violation of its fiduciary duties.)
Investors, customers, and regulators grew anxious about MF Global’s financial health, shattering the Corzine myth. This wasn’t the son of Zeus at the head of a trading desk. It was a guy who’d put his trust in financial engineering (still, even after the lessons of 2008) and the ill-conceived bailout plans of European governments. The mortal blow for MF Global was the realization that Corzine was just a mortal man.
It’s tempting to blame “Wall Street greed” for Corzine and MF Global’s missteps, but something deeper was at work. Corzine has described himself as an “unabashed liberal.” His liberalism included a faith in the effectiveness of government and a suspicion that the best and the brightest know better than markets.
The ancient Greeks would have recognized this as hubris — thinking that you are equal to or greater than the forces of nature and the Gods. For the authors of the Greek tragedies, hubris always ends in ruin.
The collapse of MF Global and the ruin of Corzine’s reputation have taught us that the old lessons of the ancient Greek playwrights are still true — even on Wall Street.
John Carney writes CNBC’s Wall Street Web site, netnet.CNBC.com.