This article was originally published on by Mark Melin. For additional behind the scenes insight, see commentary provided in the last paragraphs.


If there is one commonality among all the major financial disasters of the last twenty years it is that improper derivatives management has overwhelmingly been involved. As a July 3 New York Times editorial bravely pointed out, the “heightened vigilance of derivatives in particular” is a familiar issue that continues to remain a source of concern. But today is a moment in history where losses among hedge funds and banks who improperly managed their derivatives exposure somehow has become pedestrian. After Long Term Capital in 1998, followed by Enron, Amaranth and ultimately Bear Sterns and Lehman Brothers that led to the 2008 financial crisis, allowing the financial elite to put at risk the world economy is oddly mundane. But something occurred in 2011 that “shocked” even deep derivatives industry insiders, a report from Hilary Till and Richard Heckinger observed. How could those with derivatives experience at Harvard Management Company as well as the Chicago Federal Reserve Bank be so “shocked” at MF Global but not at the lack of accountability for derivatives “debacles” of the past?

The case was cold before the primary suspects were questioned and red flags of fraud lingered

When the Commodity Futures Trading Commission declared actions at MF Global “unlawful,” a term Till and Heckinger likewise use in a recently published white paper to describe the “debacle,” the extent of that behavior remains largely unreported. Some of the unexplained issues are: How can an “official source” involved in the investigation indicate the case was cold in winter of 2012 when in Congressional testimony in spring the public learned the primary suspects hadn’t been questioned? How does such a claim get made in the face of false documents that were submitted to regulators that hid illegal asset transfers amid warning alarms being sounded by bank counterparties? This occurred after the investigation was first documented blocked, a fact revealed in December, 2011 Congressional testimony but generally unreported.

What might be “shocking,” is that unlike tolerance of improper or questionable derivatives management techniques in the past, MF Global involved tolerance of “unlawful” behavior and documented blocked investigations – all that threatened one core pillar upon which derivatives markets operate under, the sanctity of customer segregated funds.

Till and Heckinger don’t go into the weeds regarding the lightly reported whisper topic of blocked elite investigations and the ability of a major US political figure to avoid media scrutiny. What they do is examine a host of improper derivatives management principles that, until Jon Corzine came roaring into the industry, had never been undertaken by such a large independent brokerage firm entrusted to hold customer segregated assets. In fact, many of the exotic “repo” trades locked the company into risky sovereign bonds until they matured, which resulted in a race against time.

Jon Stevens Corzine was bigger than life

When Jon Stevens Corzine took over the reins of MF Global in March 2010, he cut a dashing figure across a derivatives industry that was then mostly ignored. Some in this Cinderella universe afforded Corzine celebrity status, as was said to be the case during his many visits to the starstruck CFTC.

The tall and gregarious Corzine had a bigger than life reputation built on the trading desk at Goldman Sachs, where he had a knack for making big bets and withstanding nauseating losses that would ultimately turn into major winners. He was kissing frogs but waking up with a princess. After service as head of Goldman – where he profited handsomely by taking the private firm public – he sought to entertain his fancy for politics, ultimately winning elections to be US Senator and then Governor for the state of New Jersey.

But Corzine’s most audacious bet might have come with MF Global, where he wanted to remake a sleepy “third tier” derivatives brokerage of questionable lineage into something that could compete with Goldman Sachs. In an industry known for tight risk controls and respect for regulators, Corzine dramatically expanded risk and exhibited a degree influence over regulators that arguably had never before been witnessed.

Most material to MF Global’s ultimate demise, however, was a move that came against the documented advice of the firm’s chief risk officer. The compliance stickler was later replaced by a more compliant compliance man and the firm embraced what was known as “Corzine’s trade,” the bold purchase of exposure to sovereign debt of risky nations. This was in an environment when the notion of a government defaulting on its debt would ultimately hit the front page when Standard & Poors downgraded the rating of US debt August 5, 2011. It was against this overwhelming headwind that Corzine bet the future of MF Global on European bonds using a complex investment method known as a “repo-to-maturity” strategy, as Till and Heckinger note:

MFG’s liquidity risk was based on the need to fund its positions through the full maturity of the securities of which most were one year or less, thereby vacating the opportunity to sell the securities before maturity to take a profit or loss. The use of repurchase agreements (i.e., the sale of securities with an agreement to repurchase them at a later agreed upon date) exacerbated this “lock-in” aspect of MFG’s strategy to affect the so-called repo to maturity (RTM) strategy. With an RTM, the maturity of repo funding matches the maturity of the security being financed.
In other words, Corzine was all in without any opportunity to exit the trade.

From Corzine’s perspective, there were several reasons to like the trading strategy. MF Global could increase leverage usage due to how the repo was accounted for, and it could book profits on the trade up front because it sold the security first, purchasing it back at the bond’s expiration, a common short volatility strategy. (In listed derivatives, short volatility CTA strategies are not allowed to book profits on such options trades except on a marked-to-the-market basis, but the FCM was not subject to the same accounting standards.) Till and Heckinger explain the details:

Two reasons motivated MFG to use the RTM strategy. First, the firm could use the cash generated by the repo (minus the margin haircut, which is the amount held back from the repo to cover the risk of the deal) to fund further positions, thereby creating leverage. Second, MFG realized profits on the RTM immediately because the accounting rules characterized the securities in the repo positions as “sold.” The other leg of the repo transaction (i.e., the repurchase from the RTM counterparty at the maturity of the repo) was characterized as a forward purchase agreement (a derivatives transaction) that was marked-to-market with variations recognized as current profit or loss. Regardless, the consequence was that MFG was committed to using its capital to fund the strategy for the full duration. In effect, this strategy was akin to a

MF Global was going to succeed dramatically or fail in similar fashion with no turning back

Unfortunately, Corzine’s bet turned south on a “marked-to-the-market” basis and the losing positions drained liquidity in the stickiest part of the summer of 2011. Savvy MF Global customers such as the Koch Brothers pulled funds after a bond offering in August 2011 revealed obfuscated leverage disclosures. The resulting howl from insiders only grew. As Halloween approached, Moody’s Investors Service and Standard & Poor’s downgraded MF Global to junk status October 24 and 27 respectively. Corzine was receiving margin call demands from bank counterparties, who Till and Heckinger note had unique access to information when the hammer came down:

Simply put, some actual or potential providers of liquidity to MFG, such as commercial banks, reduced their liquidity provision at the same time that counterparties demanded additional collateral from MFG by increasing their margin requirements. MFG used multiple sources of liquidity, and, in some cases, the liquidity providers and the demanders were the same firms. Such arrangements are common in broad-based client relationships between, say, banks and their commercial customers.

Those banks directly involved saw the train wreck coming and all made demands for collateral at the same time, which resulted in heated discussions between bank counterparties and MF Global executives and ultimately led to customer segregated funds being illegally transferred. One such transfer originated from a designated MF Global customer segregated funds account and went directly into an MF Global house account, both managed at the same bank. This resulted in a direct phone call from the bank’s compliance department to Jon Corzine, all with a corporate lawyer present as a witness. But it was all too late.

MF Global came crashing down early Halloween morning at a then little-known non-public meeting among a small group of regulators. (CFTC sources are on the record saying there was scant information coming from Gary Gensler, the politically connected CFTC Chair who took charge at the time and was most recently head of finance for Hillary Clinton’s presidential campaign.) It was here that “shocking” behavior, in part, occurred, and it involved not following a traditional regulatory process.

There is a standard process for safely transferring customer segregated accounts from a failing to a healthy Futures Commission Merchant (FCM) that had a history of success.

“Even during the 2005 collapse of the FCM, Refco, and during the worst of the global financial crisis (GFC) of 2007-2008, the transfer of futures customer funds and positions to healthy FCMs occurred smoothly and almost flawlessly,” the report pointed out. “Not so with the MF Global bankruptcy.”

Clouding the “unlawful” behavior in the form of documented illegal asset transfers was the bankruptcy, which accounting sources said did not need to occur when it did. The firm had the liquidity to last weeks if not a month longer.

It wasn’t enough time, however. MF Global failed and Corzine settled with the CFTC, agreeing to pay a $5 million fine out of his pocket and never trading futures for a customer again. In the aftermath, all MF Global customers received their assets back in full and creditors received 95 cents on the dollar. However, losses to businesses that were impacted by the event, such as hedgers unable to hedge or manage their positions, are among many business losses that were not part of the bankruptcy proceeding settlement.

The irony of MF Global is not so much that Corzine now walks free and brags in a New York Times piece about his political connections. The real irony might just be those risky bets that sunk MF Global ultimately turned into winners, paying out in full. Corzine might have come within an eyelash of achieving the amazing goal of turning a frog into a prince and having MF Global compete with Goldman Sachs. It was the ultimate high stakes challenge, a bold gamble taken by arguably one of Wall Street’s biggest derivatives gamblers.

Till, Hilary and Heckinger, Richard, Famous Debacles in the Commodity Markets: Case Studies on Amaranth and MF Global (June 30, 2017). Available at SSRN:


Insight / Analysis / Opinion:

Why is it that an investigation into a major political figure can be blocked and documented in the public domain and this gets no media attention but Bernie Sanders wife’s FBI investigation is consistently in the news? Strange.