What Really Killed MF Global
No one doubts that former New Jersey governor Jon Corzine helped destroy MF Global (OTC: MFGLQ). But if you think that his strategy to transform the futures and commodities broker into an investment bank was stupid, you're wrong.
Don't believe us? Look at the data:
Operating Income Margin
Net Income Margin
Return on Equity
|INTL FCStone (NAS: INTL)||5.8%||3.7%||1.5%|
|Penson Worldwide (NAS: PNSN)||14.4%||8.4%||10.3%|
Source: S&P Capital IQ. MF Global data for March fiscal years ending 2006 to 2008. MF Global return on equity has been excluded because it was a public company for only one reporting period covered; pre-IPO shareholders' equity does not reflect the capital requirements of the stand-alone company. FCStone data for September fiscal years ending 2005 to 2007. Penson Worldwide data for December fiscal years ending 2005 to 2007.
Now look at the same figures for some of the major investment banks:
Operating Income Margin
Net Income Margin
Return on Equity
|Goldman Sachs (NYS: GS)||36.6%||24.3%||24.7%|
|Morgan Stanley (NYS: MS)||22.1%||19.4%||14%|
|JPMorgan Chase (NYS: JPM)||34.3%||21.4%||11%|
Source: S&P Capital IQ.
Why wouldn't Corzine want what his former firm, Goldman Sachs, had? Any sane evaluation of the environment in which MF Global was operating shows that brokers were getting pinched by cutthroat competition. Corzine's best bet for growing earnings was to return to the investment banking model he grew up with.
Here's how he explained the rationale at a Sandler O'Neill investment conference in June 2010: "I think we have missed a significant opportunity to deepen our relationships with our clients because we're not in the principal risk-taking activity in a market-making sense, not in a proprietary book sense, but in a market-making sense with respect to our clients."
He followed up a year later at the same Sandler O'Neill conference, saying:
We have been transitioning over these 14 months into a broker dealer, and we have every intent on [becoming] an investment bank in due course. ... I think actually this diversification is showing that we are actually building multiple streams of income, which actually makes us less risky. That's one man's opinion.
Bet big or go home
There's no mistaking Corzine's thinking. He believed remaking MF Global into a principal-risk-taking investment bank in the image of Goldman Sachs would be safer. Former MF Global employees we've spoken with agree the firm had little choice but to diversify, though for the sake of profit rather than risk reduction.
Reporting by The Wall Street Journal corroborates this view. In a piece published earlier today, the newspaper quotes anonymous sources who point out that Corzine viewed big bets from a principal trading desk as the key to returning MF Global to profitability following years of losses.
But unlike larger peers, MF Global under Corzine lacked a series of checks on the CEO's bets. Only the board had oversight. Chief Risk Officer Michael Stockman, meanwhile, played the role of helping Corzine present his trading strategy to the board, the Journal reports.
Could it be he was swayed by the math behind the new business model? Corzine described the profit opportunity in detail at the June 2010 Sandler confab:
You look at principal transactions [that] are only 14% and we do that mostly unmatched. You find the buyer and the seller, put them together and that's a principal transaction. If we run trading books, that 14% could easily be one-third of our earnings. I think [if you] look at some of the bulge bracket firms [they put up] significantly higher numbers, [there is] plenty of room for growth there.
In other words, based on what he knew about the trading operations of big investment banks, Corzine rightly saw a potential windfall within MF Global's grasp. He crafted a strategy to take advantage.
Executed by execution
Yet even good strategy coupled with poor execution will always produce poor results, and that seems to be what happened here.
Again, consider oversight. The systems and culture for properly balancing risk and reward at an investment bank take time to develop, and judging by the Journal's reporting, MF Global never took the steps needed to create the sorts of controls common to larger peers -- including Corzine's former employer, Goldman Sachs.
Corzine had to know this was an issue. He spoke publicly of the need for tight controls at MF Global after joining the firm in March 2010: "Making certain that you don't have the kind of car crash that this organization experienced back three or four years ago is essential by having tight controls, tight compliance, and making it part of the culture. And that's the kind of people we're hiring, and that's the kind of culture we're building."
The quote seems to refer to a $141.5 million loss incurred in February 2008, when a so-called rogue trader named Evan Dooley made a bad bet on wheat futures. Was Corzine's thinly vetted bet on European debt really so different? Systematic oversight appears to have been lacking in both instances.
A cold cup of comfort
Corzine's desire to turn MF Global into an investment bank made sense on several levels. But he was rash about the process. Checks and balances were pushed aside when he became CEO, big-money trader, and risk manager.
It's as if hubris on a Greek scale allowed Corzine to believe he could make the shift happen more quickly than history and his own experience as an investment banker would suggest. Yet the board, regulators, auditors, and fellow executives did nothing to stop it. Shame on Corzine, but shame on them, too.
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At the time this article was published Fool contributor Tim Beyers is a member of theMotley Fool Rule Breakersstock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Fool contributor Matt Koppenheffer didn't own shares in any of the companies mentioned at the time of publication.The Motley Fool owns shares of JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of The Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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