As Halloween arrived for some, the US futures industry celebrated the two year anniversary of the death of MF Global.  MF Global, a major global financial commodities broker, filed for chapter 11 bankruptcy protection on October 31, 2011.

The firm, run by former New Jersey governor and Goldman Sachs CEO, Jon Corzine, was undone by a large bet directed by Mr. Corzine on European sovereign debt.  A few days after the bankruptcy, MF Global reported a quarterly loss of $191.6 billion, according to Politico.  In addition, an estimated $1.2 billion in customer funds went missing at the time.

Under the law, futures brokers firms like MF Global are required to keep customers’ funds separate from their own funds.  At the time, that shortfall seriously hurt the traders, farmers, and commodities farmers that dealt with MF Global.  Mr. Corzine, for his part, has testified to the United States Congress that he never intended for anyone at MF Global to misuse customer funds.  “I simply do not know where the money is, or why the accounts have not been reconciled to date. I do not know which accounts are unreconciled or whether the unreconciled accounts were or were not subject to the segregation rules. Moreover, there were an extraordinary number of transactions during MF Global’s last few days, and I do not know, for example, whether there were operational errors at MF Global or elsewhere, or whether banks and counterparties have held onto funds that should rightfully have been returned to MF Global,” said Corzine.

However, according to reporting done by the Wall Street Journal and many other publications, Jon Corzine was attempting to transform MF Global from a “sleepy commodities broker into a Goldman-like investment-banking powerhouse.”  Thus, the decision by Corzine to go big on a $6.3 billion bet on European sovereign debt is becoming easier to understand.  Mr. Corzine was willing to take on so much risk, that, according to the Wall Street Journal, he was roaming around the trading floor openly encouraging traders to make large bets.  Mr. Corzine said to these traders not to worry about the large gamble they were making.  In addition, Mr. Corzine started to place greater emphasis on trading riskier assets such as mortgage backed securities and acquiring newer, riskier businesses.  He also created an incentive structure that rewarded risky gambling.  Mr. Corzine openly supported larger bonuses for those who engaged in successful risk-taking.  Some may also indicate that his easy-going manner and personality allowed Corzine to get along with other traders.

Ultimately, the time had come for Mr. Corzine to put his grand plan into place.  Faced with falling revenue and anxious credit rating agencies, Corzine’s firm needed an instant boost of revenue.  Thus, he devised a strategy to bet on high-yielding European sovereign bonds.  The trade included a “repurchase to maturity clause”, which meant that MF Global would be able to record profits on the trade immediately and keep a lot risk off its balance sheet.  Initially, the bet was paying dividends.  According to the WSJ, MF Global collected about $39 million in revenue in the second half of 2010 on the European trade.  However, the trade was built on a risky assumption.

Since the European continent was experiencing economic troubles during 2010, the yields on those bonds was going higher.  That means that investors were demanding higher interest rates from countries like Greece in order to make investments.  Even though the countries weren’t defaulting, MF Global was being hit with large margin calls from its lenders in order to hedge the risk they were taking.  That development, combined with the drop in the value of the bonds, (interest rates on bonds move inversely to the price of bonds) was further hobbling MF Global in its final days.  If at any time one of those countries were to default, MF Global would be up the proverbial creek.  Mr. Corzine, however, was confident at the time that European leaders would not let that happen.

Yet there were some red flags popping up quickly.  FINRA (Financial Industry Regulatory Authority) was warning investors that they did not know enough information about MF Global’s trade.  FINRA then realized that Corzine’s bet had grown to more than $6 billion.  This revelation set off a series of warnings to MF Global requiring them to set aside more collateral in case the trade failed.  Eventually, MF Global conceded and set aside close to 150 million to satisfy FINRA, according to the WSJ.

In the end, MF Global was rocked by the precipitous breakdown of European sovereign bonds.  As investors dangled the possibility that some Europe countries may default, the trade on MF Global soured.  In other words, interest rates on the bonds continued to march higher and the price of those bonds continued their precipitous drop.  MF Global was forced to cancel the trade and deal with a mass exodus of customers, cash, and resources.  Since then, MF Global is in the process of returning the cash to its customers.  The company has so far returned about 98% of the missing cash to customers, according to CNBC.  The Commodities Futures Trading Commission has sued the firm over the alleged misuse of customer funds.  The CFTC is also seeking trading bans for Corzine and his deputies.

What the episode at MF Global represents is not poor management so much as reckless management.  Mr. Corzine and his firm dipped into customer accounts that are supposed to be segregated from the firm’s money in order to pay off their debts.  That is simply wrong and against the law — forget the fact that MF Global made a huge bet that ultimately went sour.  That’s not the biggest problem of MF Global.  The bigger problem is that they reached into someone else’s money to pay for their mess.  However, as Matt Taibbi at Rolling Stone has argued, the articles written about MF Global since it demise are too kind.  As Taibbi explains it, almost every article written since October 2011 has said that there was “chaos” and “bookkeeping challenges” in the firm’s final days.  As if that is too overwhelming for mere human beings to handle, writes Taibbi.  Taibbi openly wonders whether the firm could bet $6 billion on bonds but then somehow lose track of $1.6 billion in customer money.  The numbers just don’t add up.

Therefore, this is the right conclusion to be drawn from this episode during the two year anniversary.  Is it necessary for some financial firms to be managing this much risk?  Should there be greater safeguards in the futures industry, particularly from the CFTC?  Must there be a radical change in the way we trust public officials with money?  These are all appropriate questions to be asking in the wake of these disasters.