The death of MF Global and JP Morgan’s role in its demise is starting to look like a beauty contest between Cinderalla’s ugly sisters. As much as most market savvy observers are convinced that there is no explanation for how MF Global made $1.2 billion in customer funds go poof that could exculpate the firm, JP Morgan’s conduct isn’t looking too pretty either.
Reader Michael C sent a link to a Reuters investigative piece on the MF Global collapse, and it’s a doozy. While in proper journalistic form it is careful about reaching firm conclusions on a post mortem that is still underway, the pattern it has uncovered is not surprising to those of us who are onto JP Morgan. As many, including this blogger, have pointed out, it was JP Morgan that did in the doomed Lehman by withhold $7 billion of cash and collateral. And we’ve written how it used one of its best private clients, billionaire investor and industrialist Len Blavatnik, as a stuffee for toxic subprime debt in summer 2007, when every financial firm was desperate to offload US housing dreck.
The short form of the Reuters story is that JP Morgan, by virtue of being both a lender to MF Global as well as clearing its trades, has a big information advantage and could see how distressed the firm was. MF Global drew down the full amount of a newly-syndicated $1.3 billion credit facility, a huge warning sign.
The Reuters story makes clear that JP Morgan went into “possession is 9/10ths of the law” mode, calling for full compliance with transaction procedures when normal business practice was to be more forgiving. The New York bank offers up the excuse that it lost money to MF Global, but that is not the issue. Any creditor to a bankrupt company will lose money. The issue is whether JP Morgan did anything irregular or impermissible to cut its losses, which in this case appears to have come in no small measure out of the hides of customers.
The story is worth reading in full, but this incident gives a picture of the sort of behavior JP Morgan was engaged in:
MF Global also decided to sell $1.3 billion of IOUs known as commercial paper. The short-term debt was part of some $7 billion of securities the firm sold that week. But this sale was critical, people familiar with the situation said, because MF Global had used customer funds to invest in the short-term debt and now badly needed to liquidate the IOUs and move cash into the customer accounts to meet their demands. The investments in the IOUs were allowed by industry regulations, these people said.
For help, Corzine turned to his old employer, Goldman Sachs, which specializes in trading the short-term paper. Corzine phoned Goldman President Gary Cohn to ask him to buy the IOUs, offering a slight discount, according to people familiar with the situation.
Cohn agreed, and Goldman traders made the purchases, these people said. Because it needed the cash immediately, MF Global sought to settle the deal that day, according to Corzine’s testimony in Congress.
JPMorgan, in its role as middleman, was able to control the speed with which MF Global’s asset sales were processed, according to people familiar with the situation.
Two people familiar with the transaction say that JPMorgan was slow to process the trade…It remains unclear exactly whether cash from the sale was ultimately routed to MF Global.
This was not a time of generalized market stress. Goldman was clearly good for the trade. JP Morgan hanging on the money had nothing to do with that trade and everything to do with it trying to lower its credit exposure. I don’t know why there isn’t more noise about how this situation illustrates the dangers of having a bank be both a major clearing firm and a lender (ex via clearing exposures) to the same customers. Either JP Morgan should hive off its clearing business or there needs to be much stricter regulation about these conflicts of interest.
It’s also pretty clear that a lot of customer money is sitting at JP Morgan, but JP Morgan will argue in bankruptcy court that it should not have to disgorge it (it almost doesn’t matter what the facts are, JP Morgan will lawyer up to make the case). Unfortunately, since most of the counterparties hurt don’t have the political clout of TBTF bank, JP Morgan is unlikely to take a reputational hit anywhere close to what it might deserve.