Easy Street

Was Jon Corzine Right About European Bonds?

Heidi Moore Dec 13, 2011

Jon Corzine, the former CEO of commodities brokerage MF Global, faced the second of his three Congressional grillings today as the Senate Agriculture Committee . Last week, the House Agriculture Committee had its shot at Corzine, who fell into disgrace by driving the firm into risky trading strategies that eventually led to its bankruptcy. Some of Corzine’s comments and the reactions to them  are collected here.

(If you need more background, check out Easy Street’s primer on MF when trouble started brewing; Marketplace’s conversation when the firm actually collapsed, and our backgrounder on Corzine’s fall from grace because of his outsize risk-taking. )

The most surprising theme of Corzine’s testimony was his impassioned defense of his trading strategy – the same trading strategy that, in most of the world’s eyes, led to the destruction of his firm and reputation. Corzine made it clear that he led MF’s trading strategy, and the media backs him up. He insisted, somewhat strangely, that the firm was never outside its “trading limits” on European debt – and that none of the securities the firm invested in – though he never explained what he meant – and admitted, ruefully, that the only thing he got wrong was his faith in Angela Merkel and Nicolas Sarkozy to save Europe with its bailout fund, the EFSF. “We thought the European community would take more forceful steps to avoid insolvency,” Corzine wryly told his inquisitors. He added later, “Those particular sovereigns we looked at, we thought they were prudent.” Corzine said he invested his own money in MF Global (at least until August), such was his faith in his judgment.

What’s coming through from all the hearings is that Jon Corzine is still convinced that his outsize, indirect bet on European bonds – at least $6.3 billion, or bigger than MF Global itself – was the smart thing to do, even though it led to the market’s loss of confidence in MF Global and the firm’s ultimate demise.

How on earth could Corzine defend that kind of record? It’s easy to write this off as a delusion of the Marlon Brando “I coulda been a contendah” variety – a guy who lost at the poker table, or, more darkly, a prisoner asserting his innocence all the way to death row. It certainly plays as Wall Street hubris: the insistence of a man who cannot believe he’s wrong. Corzine may have been more susceptible to that kind of thinking than most. He came up through Goldman Sachs trading government bonds, and helped save Goldman when a hedge fund, Long Term Capital Management, made a bad bet on foreign bonds and currencies. The time at MF Global was Corzine’s third run-in with government bonds – and even if he was rusty, he was bound to believe he was right. And it’s important to remember that Corzine had a trader’s soul and outlook.  Most people think trading is another Wall Street job – dependent on an Ivy-League education and strong connections  – but it’s different. It’s more instinctual. A good trader has to have information, but more importantly, he needs to know how to read a room – to predict behavior, to know where the crowd is moving, to know who’s bluffing, to recognize who’s trying to throw him off his game. Traders are always hyper-aware of the human emotions behind the movements of stocks and bonds. They’re like market psychologists. Their trades depend on their personal judgment, and that’s why they take the failures of that judgment so personally.

But the strange thing is: Corzine wasn’t hyping himself up. He was telling the truth. He was right about European bonds: they would have been a great investment for MF Global. He may have made a good trade by loading up on them.

Corzine insisted throughout the hearing that the firm did not take losses on the European bonds it bought, that they never defaulted or were restructured. And in fact, the record backs him up on the value of the bonds, which have been barely dented. George Soros bought $2 billion of them in a fire sale, and he’s already made a $130 million profit in a few weeks.  JP Morgan and “a large hedge fund” snapped up a number of Italian bonds cheaply – at 89 cents on the dollar just after the bankruptcy, when MF Global was trying to get rid of $4.5 billion worth, and the going price on the market was 94 cents. The Wall Street Journal notes, wryly, that those bonds are now trading at 96 cents on the dollar.

And remember when Jefferies’ was mistakenly thought to be holding too many European bonds? It sold them off easily. Twice.

All of which indicates that, for now at least, there is still a decent market for European bonds, and not exactly at fire-sale prices.

But here’s where Corzine is in denial, and showing Wall Street hubris. Corzine’s flaw – which is not trivial – was that he didn’t choose that potentially profitable path. He didn’t load up on those European bonds. So, in his many Congressional hearings, he’s defending a strategy he never actually used. In his trading, Corzine chose another, more complicated strategy that only indirectly bet on European bonds. The strategy – called repurchase-to-maturity, or repo-to-maturity for short – treated the European bonds as short term collateral for much bigger bets.

But there’s still a catch in Corzine’s thinking. Corzine was not, of course, betting directly on those European bonds; if he had bought them all up and loaded down the firm with them, that would be one thing. Instead, he used a strategy that involved a lot of debt. It’s not necessary to get into the terminology, but essentially what Corzine did was use a type of credit derivative, according to expert Janet Tavakoli. Credit derivatives usually require a lot of….credit, or debt to you and me. They’re like those funhouse mirrors that balloon your reflection and make you look fat. MF fattened itself on debt using that funhouse mirror of credit derivatives. That caused MF to take on a lot more debt than it would have if it had just bought the bonds outright.

So, Corzine’s right: it wasn’t the bonds that took MF down. It was the firm’s leverage – its high exposure to debt – which caused ratings agencies to downgrade it and lost the confidence of the markets until MF could no longer sustain itself. Corzine hasn’t acknowledged, in his testimony to date, the importance of this leverage in the failure of his firm.

So, even while Corzine was right in front of Congress, he was still wrong. It remains to be seen how much time it will take him to admit it to anyone, perhaps even himself.

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