3 Harsh Lessons We Learned From the MF Global Bankruptcy

by Jeff Reeves | November 1, 2011 9:52 am

3 Harsh Lessons We Learned From the MF Global Bankruptcy

MF Global Holdings (NYSE:MF[1]) is not long for this world. The financial company’s shares were frozen from trading Monday on news that big losses on risky debt investments had sunk the investment bank and forced it into Chapter 11 bankruptcy protection.

Despite a $3 billion IPO, despite a storied pedigree with U.K. hedge fund manager Man Group plc, and despite the politically connected former Goldman Sachs (NYSE:GS[2]) exec at the helm, the financial firm just couldn’t cut it.

But the real lesson of MF Global is we have so many lessons left to learn when it comes to the risk in the financial sector these days.

Even after the worst banking crisis since the Great Depression and the stark reality of risk taking, MF Global couldn’t control itself. And even after the “smart money” got burned with a roughly 40% market decline in 2008 and a choppy market to start 2011, MF Global leaves some of the biggest investment names on Wall Street to clean up its mess. According to columnist David Weidner’s tally[3], as of Oct. 30, Fidelity Investments parent FMR Corp. owned more than 8% of MF, with other insurance, pension and financial firms making up a big chunk of the rest of the company.

MF Global is not just a story about yet another financial firm that can’t cut it. This justifiably can be called one of the most difficult times on Wall Street in many of our lifetimes. A host of political and macroeconomic issues compete for investor attention, while at the same time triple-digit moves in the Dow based wholly on sentiment seem to be the order of the day.

No, the real story of this defunct financial stock is that there are so many more lessons that investors, regulators and bank CEOs must learn.

Here are a few pointers — some obvious, and some not:

As Investors, We Must View the Negative Impact of Our Actions: It’s easy to make a trade and convince yourself it will deliver big returns. After all, you’re a smart investor who does his research and never throws money around carelessly, right? But sometimes it pays to anticipate a worst-case scenario, too. Wall Street failed to even acknowledge that housing prices ever would decline — and as a result, we still are digging out of the hole created by the subprime mortgage debacle. As MF Global learned, sovereign debt isn’t a 100% sure thing — and those high-yield bonds from the euro zone ended up ruining the entire company. I never advocate living in fear and investing based on the worst outcome possible. But acknowledge the downside of your trades and understand sometimes what can go wrong will go wrong. There is no such thing as a sure thing.

CEOs Continue to Laugh All the Way to the Bank: MF Global Holdings Chief Executive Jon Corzine is entitled to $9 million in severance, though most legal experts expect he will get much less thanks to bankruptcy. But even if Corzine makes a penny, that’s a penny too much for driving a business straight into the ground on reckless and risky gambits on euro zone debt. Corzine stood to make a base salary at MF Global of at least $1.5 million a year with the option to collect 2.5 million shares of the company after March 31 of this year. Although clearly this compensation is not what it could have been — given the fact MF stock soon will dip below $1 and eventually hit zero — the potential for a windfall profit tells you everything you need to know. Compensation of this magnitude implies the leadership at MF was worthy of the pay — with the top three severance deals adding up to $27 million[4], according to Reuters. To think that MF could have paid any of us a fraction of that and we could have used common sense and avoided the PIIGS and kept the company afloat …

Financial Stocks Can Evaporate Overnight: Perhaps the most disturbing lesson for investors is the fact that financial companies can go from good to bad to bankrupt in a matter of months or weeks. In February, Corzine was all smiles and optimism — with plans on how to make MF a true investment bank of the top tier in just five years’ time. Then in August, regulators ordered MF Global to boost its net capital thanks to its European debt exposure. On Oct. 24, Moody’s cut MF debt to almost junk status, and on Oct. 25 earnings showed an ugly fiscal Q2 loss that sparked a share price drop of almost 70% in a week even as the broader market soared. Remember this harsh reality the next time you consider jumping into a financial stock — because like Lehman and Bear Stearns, MF Global seemed like a bargain buy in the long term for many traders just a few months ago. Oh, how wrong they were.

Jeff Reeves[5] is the editor of InvestorPlace.com. Write him at editor@investorplace.com[6], follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.

Endnotes:
  1. MF: http://studio-5.financialcontent.com/investplace/quote?Symbol=MF
  2. GS: http://studio-5.financialcontent.com/investplace/quote?Symbol=GS
  3. David Weidner’s tally: http://www.marketwatch.com/story/mf-global-from-bad-to-worse-2011-10-31
  4. adding up to $27 million: http://www.reuters.com/article/2011/10/31/mfglobal-severance-idUSN1E79U1PK20111031
  5. Jeff Reeves: http://investorplace.com/2011/10/optimism-about-europe-debt-resolution-a-risk-to-market-rally/2011/10/2011/10/2011/10/no-bear-market-for-5-funds-etfs-slv-gld-thd-xrt-fdn/2011/10/author/jeff-reeves/
  6. editor@investorplace.com: mailto:editor@investorplace.com

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