Jon Corzine’s appearance before the House Agriculture committee was a yawner and yet breathtaking. By candidly not pleading the 5th Amendment the testimony was completely lacking in fireworks. But the substance of it, pleading whatever amendment gives you the right to say “I dunno”, left everyone cold. As much as $1.2 billion is missing from MF Global – but Corzine has no idea where it is.
As the poster child for more financial regulation, MF Global has a lot to teach. It was nowhere near “Too big to fail”, but it was big and messy. This will highlight the laws we have in place and what happens when failure is an option.
One thing we can be sure of in this case is that lawyers will be all over it. Investors will get back as much money as they possibly can from the company and, more importantly, the insurance carried to personally protect the board of directors. The financial industry is far from self-regulating in any appropriate way, but you can bet that between their lawyers and insurance companies there will be a drive to tighten up standards based on precedents coming from MF Global – even if Congress does nothing new.
The next obvious question is how the auditor, Price Waterhouse Coopers (PWC), signed off on this company. They might yet be held liable as well, triggering a different kind of self regulation. Audits in the US are paid for and held at the direction of the company being audited, meaning they are not reliably independent and full of conflicts of interest. There is definitely a place for new laws and/or standards to change many of these practices, but again a team of lawyers and a big settlement might do the trick on its own.
There is also the likelyhood of criminal penalties including jail time for MF Global’s executives. We are about to see if personal responsibility for running a company into the ground is possible with the laws we have in place. While some institutions might be “Too big to fail”, there’s no reason people can’t be strung up and made into an example for the industry.
Corzine’s testimony, largely hinging lack of awareness of what went on, may be little more than a legal strategy. It could also have the advantage of being true. He has only been at the head of this company for 18 months, and the level of fraud and mismanagement appears to be so broad and deep that it could not possibly be the work of one person. The autopsy on MF Global may open up the smelly guts of a lot of industry practices that should prove enlightening.
It’s not as though “Too big to understand” is hard to accept. Financial “innovations” are often created with little care as to their broader implications in the market and sold by advisors who really do not understand what it means to their clients. Regulation of this process is almost certainly going to be impossible, since new products can be crafted around any well-loopholed law. That is why a broader framework is probably much more helpful.
Consider for a moment the Federal Deposit Insurance Company (FDIC) and its role in banking. This agency is self funding, getting its operating capital by charging an insurance premium to member banks. When there is a failure, the team from the FDIC swoops in quickly, often on a Friday afternoon. Their team might work through the weekend to clean up the mess and determine just how much capital the operation needs to guarantee all deposits and then arranges to have it open under new management on Monday morning. To depositors, it’s usually as if nothing happened at all.
This model might prove useful for investment houses as well. The insurance premiums would go up and down based on the relative risk of industry practices and the results of an audit directed and paid for by this agency. There would be incentive to self-regulate built into the system while allowing for innovation. And if the pool of capital proved insufficient for a big investment house, a loan from the government or the Fed could tide it over until it was repaid with higher insurance premiums going forward – stiffing the industry, rather than taxpayers, with the tab.
The examination of MF Global will tell us if a model like this might work and generally make failure an option – possibly even on a very large scale.
The story of MF Global will play out in courts for many years. The main purpose of a regulatory structure is quick action that could stem a system-wide meltdown and yet allow failure to occur when it has to. This could be where we learn just how to make that happen if we pay attention.