MF Global: Another Government-Funded Debacle

I just read about an article about UK hedge fund baby MF Global going bankrupt.  The filings were made back in October, and Congress has decided to investigate the whole thing, in light of the fact that $1.2 billion in client money has gone missing.  What a paltry sum, eh?  No worry.  Just add it to the pile of missing money in America.

If anyone thinks that issues like MF Global going tits-up are unrelated to the central banks and practices that closely mirror fractional reserve banking, they’re kidding themselves.  Unfortunately, central banks like the Fed and the ECB just feed the monsters.  Fractional reserve banking is nothing but a swindle, and this type of investment practice is the same thing: embezzlement.

Let’s start with fractional reserve banking made easy.  This will give you a fair idea of how the system works.  Let’s say I go to Bank A and deposit $100 in cash.  According to fractional reserve guidelines, the bank is required to keep 10% of my deposit on-hand at any given time.  They also make that promise to pay me back all of my deposit, should I ever wish to withdraw it.

We then move on to Mr. Jones, who either borrows $90 that Bank A lends him, or he receives it from another borrowing individual or entity, who pays him the money.  Mr. Jones then goes to Bank B, where he deposits that $90.  Bank B again loans out $81 to Mr. Smith, and the same story keeps repeating on down the line.  $90+$81+72.90+$65.61 = $309.51.  Thus, we can see that four transactions down the line, approximately $300 has been loaned out based upon the original $100 investment.  This is no problem, provided that there are many customers and none of them recall their deposits at the same time (a bank run).  It bears noting that, once the bank loans out a certain amount of money, they are no longer capable of paying back all of their depositors.

Why is this problematic?  Simple.  Banks are creating counterfeit claims to real wealth, which remains unchanged.  Yes, one can make the argument the banks, and therefore customers, are benefitting from interest paid on the loans, but this is a foolhardy notion.  Inflation will eat away whatever is gained through interest payments.  The creation of fake receipts doesn’t create more true wealth.  And if you hold claim to 10% of the real wealth before the loan goes out, you’ll claim even less later, after inflation is through with it.  You can make the argument that the banks are making life more convenient, but it always comes at a price – a cleverly disguised one, at that.

Why is this important to our discussion on MF Global?  Well, they were sort of doing the same thing.  They were putting up assets as collateral against bonds they were buying up – mostly European bonds, funnily enough.  According to Doug French of the Mises Institute, MF Global was using a neat little trick called a “repo,” which is basically putting up collateral that has the same maturity date as the loan. (The assets can be repurchased.)  Therefore, the transaction can be considered a “sale” and moved off of the balance sheet.  Ah, those off-balance-sheet transactions.  God love ’em.  The Fed sure does!

In any case, the customers were essentially taking the risk on the investments while MF Global sat back and collected the money.  French’s article states that the company moved something like $16.5 billion in assets off the balance sheet and went on to expose itself to debt that was worth more than five times the total value of the company.

The company also practices something called rehypothecation – pledging collateral for a loan, similar to a mortgage.  The company uses assets to secure its trading and borrowing.  In the US, companies can rehypothecate to the tune of 140% of the client’s liability to the broker.  This creates liquid capital, but there is nothing behind it, should the house of cards fall in on itself.  And the collateral ends up being promised to multiple creditors.  So what happens when four or five different creditors are fighting over the same piece of pie?

I highly recommend reading Doug French’s article for a clearer understanding of what’s really going.  I hope that MF Global isn’t the new Lehman Brothers, but with some economists predicting that rehypothecation is the newest and most dangerous credit bubble, it seems like that could be the case.  I suggest you look at the numbers in the article, because MF is the new Lehman Brothers, we are going to be in for a world of hurt – more so than we already are, financially speaking.

I think I’ll end this article with a nice little quote from Atlas Shrugged: “Look around you: what you have done to society, you have done it first within your soul; one is the image of the other.  This dismal wreckage, which is now your world, is the physical form of the treason you have committed to your values, to your friends, to your defenders, to your future, to your country, to yourself.”

Check out Doug French’s article “MF Global’s Fractional Reserves” at The Mises Institute online.




About The Lady Libertarian
I am American, currently expatriated but hopeful about getting back home one of these days. Besides reading and writing about politics, I enjoy camping, sailing, canoeing, making pie, and traveling. I hope you'll enjoy this blog and find it informative and accessible.

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