The Really Bad Thing MF Global Did

Perhaps the worst thing MF Global did wasn't lose a pile of money speculating in hinky European sovereign debt, although that was a pretty astounding belly flop for a firm run by a former Chairman of Goldman Sachs. It was that the firm evidently tapped hundreds of millions of dollars of client funds for its own use as its fortunes tumbled. See http://www.marketwatch.com/story/mf-global-tells-officials-clients-money-used-ap-2011-11-01 and http://www.cnbc.com/id/45122955.

The financial markets have, since the Middle Ages, been built on trust. Without trust--especially by customers of financial institutions--the financial system couldn't exist. Brokerage firms such as MF Global are required by law to segregate customer assets and keep detailed records of customer accounts, so that the other people's money with which the firm is entrusted remains intact. When a firm uses customer funds for its own purposes, it violates the most fundamental principle of the customer-broker relationship: that the firm will be a faithful custodian of the customer's assets.

MF Global's customers appear to have primarily been big, fast money players, hedge funds and the like that can move their accounts at a moment's notice. MF Global also appears to have financed its activities with short term credit--financing that can evaporate faster than frontrunner status among GOP contenders for the Presidency. Running a firm with short term financing and professional money managers for customers is like drinking with a bunch of Good Time Charlies. If the bar stops running a tab for you, your drinking buddies will duck out the door muy pronto.

With the news about MF Global indulging in some helpings of customer money, a lot of hedge funds and other customers will be giving their brokers sidelong glances, looking for any flinching, eye shifting, throat clearing, hand rubbing, feet shuffling, or other signs of uncertainty. Lawyers up and down the length and breadth of Wall Street are preparing customer requests for withdrawal of accounts in draft form, ready to be delivered by e-mail, courier, snail mail, Pony Express, and even carrier pigeon at the first hint that a broker is in even a scintilla of trouble.

By casting a dark shadow over the trust between customer and broker, MF Global may have done far more damage to the financial system than its proprietary trading losses and whatever ripple effect that may have with the firm's counterparties. Now, every broker on the Street is suspect. Prudent money managers may presume that their brokers are guilty until proven innocent. The chances of further instability in the financial system has increased. Tighten your seat belt, because the ride could get rockier.