MF Global and Corzine's Folly

MF Global Holdings (NYSE: MF) became the first U.S. casualty of the European sovereign debt crisis, filing for Chapter 11 bankruptcy on Monday. Chairman and chief executive Jon Corzine has yet to acknowledge shared culpability leading to the financial ruin of the commodities, equity and financial derivatives broker-dealer. And whether he will abandon contractual claims to millions in potential severance payments owed to him is still unknown.

A past senator and governor from New Jersey, Corzine took the helm at MF Global in March 2010. He immediately set out to reverse a string of quarterly losses by transforming a company previously known mainly as a traditional commodities and derivatives dealer (dependent on third-party trading volumes and commissions) into a global investment bank. Accustomed to risk-taking, the erstwhile co-chief at Goldman Sachs (NYSE: GS) reset MF Global’s business strategy, shifting firm resources disproportionately toward proprietary trading, including gambles on distressed European sovereign debt.

Road to Bankruptcy, Driven by Corzine

Prior to bankruptcy, MF Global maintained a net long position of $6.3 billion in a short-duration European sovereign portfolio financed to maturity (repo-to-maturity). Simply put, Corzine used leverage to magnify gains, betting big that coupon yields on distressed debt would outstrip interest on margined holdings until Europe recovered — at which point the bonds could either be held to maturity or sold for outsized profits. As of September 30, 2011, Italy, Spain and Portugal accounted for 51%, 18% and 16% of total sovereign debt held, according to regulatory filings.

“We remain confident that we have the resources and expertise to continue to successfully manage these exposures to what we believe will be a positive conclusion in December 2012,” reported Corzine on the company’s second-quarter earnings release on October 25.

Corzine’s judgment that European leaders would resolve the euro crisis, leading to a rebound in the value of MF Global’s holdings, proved dead wrong. As European Union leaders worked last week on a signatory deal to rescue the euro, it became apparent that bondholders (like MF Global) would be forced to eat big losses on held debt.

“The structure of the transaction themselves essentially eliminates market and financing risk,” Corzine coolly lectured analysts on the conference call last week. Wrong — highly leveraged, with limited liquidity, MF Global was unable to meet margin calls or the demands from regulators to boost capital reserves. An eleventh-hour attempt last weekend to raise more capital or find deeper pockets (a buyer for the entire company) failed, leaving protection under bankruptcy the only viable option.

In hindsight, credit agency Moody’s noted that “weak core profitability” led Corzine to order his traders to increase the firm’s speculative exposure in recent quarters.

Multimillion Dollar Severance Package

Incredibly, despite decimating the company, had Corzine succeeded in selling MF Global to a third-party, he would have been entitled to a $12.1 million severance package, according to the terms of his employment contract. Ironically, thanks to the last Republican in the White House, George W. Bush, Corzine is unlikely to receive any going-away gifts.

“Occupy Wall Street” — are you listening? In April 2005, then President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act, which among other things, severely limited a Chapter 11 debtor’s ability to make severance and retention payments to insiders. As a practical matter, Corzine can no longer collect more than a fraction of his “golden parachute.” Nor is he eligible to receive a $1.5 million retention award (payable in March 2014). Ergo, as of November 1, like JPMorgan Chase (NYSE: JPM) and Deutsche Bank (NYSE: DB), Corzine became just another unsecured creditor.

Board’s Role in Oversight?

The board has alleged claw-back policies are in place to discourage excessive risk taking, according to proxy info from its compensation committee. Sadly for shareholders and creditors alike, it appears that actual oversight and compliance at MF Global was nothing more than another case of the fox watching the henhouse:

• The company knowingly permitted Corzine to direct proprietary trading that established a portfolio of $6.3 billion in European sovereign debt — without parallel trades in foreign currency or derivative hedges, save for $1.5 billion in shorted French bonds.
• Directors professed little concern for risk mitigation as Corzine’s buying spree strained an already leveraged balance sheet. MF Global’s sovereign risk exposure was more than five times shareholder equity of $1.2 billion when the curtain came down.

Instead of reigning-in the new chief executive’s lust for risk taking, the board encouraged it: Corzine received a sign-on bonus of $1.5 million in March 2010 and 2.5 million stock options (worth an estimated $11 million, though now worthless). He received reimbursement, too, for $384,000 in attorney fees spent on negotiating his employment contract.

Citing Corzine for his “exemplary performance” in 2010 and 2011, the board also authorized payment of another $1.25 million in incentive cash bonuses back in March 2011. Ergo, given tacit and sometimes explicit endorsement of Corzine’s aggressive trading strategies, it is doubtful the board will enforce existing recoupment measures.

Corzine is another Obama Democrat, a multimillionaire (like Nancy Pelosi) with a penchant for delivering “class warfare” speeches. In a talk before students at Princeton University last September, Corzine echoed hackneyed calls for better wealth distribution. “The staggering redistribution of wealth (concentrated among the richest Americans),” said Corzine, “created a pretty toxic sense of inequity and a spiraling appetite for debt in our society.”

“The build-up of debt will have long-term economic implications,” Corzine then went on to say. “We’ve pretty literally been raiding our grandchildren’s inheritance.” When it comes to unchecked financial leverage and ruining inheritances, Corzine spoke of what he knows best.

David J. Phillips