The Astonishing Collapse of MF Global

"You can't just look at what is good in the moment, what feels good, what works for today may not be the answer that actually helps ... two years down the road or five years down the road. You have to make decisions with a longer-term perspective."
-- Jon Corzine

Prior to stepping into the role as MF Global (OTC: MFGLQ) CEO, Jon Corzine had a penchant for saying all of the right things when it came to how a financial company should be run.

During his first earnings conference call as the broker's CEO, Corzine, a former New Jersey governor, U.S. senator, and chairman of Goldman Sachs (NYS: GS) , reassured Wall Street analysts and the company's shareholders that taking on huge risks wasn't going to be the answer to turning around MF Global:

But the goal here is not to be a [proprietary] trader. ... I don't think that we will be in a risk-taking position, substantial enough to have it be the kind of thing that the rating agencies would say, "Holy cow, these guys have got a different business strategy" than what we told them we had.

And yet, in late October 2011, the country's eighth-largest futures broker filed for bankruptcy, a collapse that was precipitated by a $6.3 billion bet on European sovereign debt championed by Corzine himself.

MF Global is the United States' eighth-largest bankruptcy by assets -- larger than both Chrysler and utility giant Pacific Gas & Electric. At the end of August, the company held more than $7 billion in U.S. futures customers' funds, more than Barclays (NYS: BCS) and Morgan Stanley (NYS: MS) . And as the company is wound down through the bankruptcy proceedings, more than 2,000 employees stand to lose their jobs.

And as if the collapse itself wasn't enough, in the wake of the bankruptcy it was also revealed that $1.2 billion of MF Global customers' funds were missing, putting thousands of farmers, ranchers, independent traders, and fund managers in financial jeopardy.

Digging in
More than a month after the company's bankruptcy filing, the story continues to unfold and evolve, but there is much that is already clear. In the wake of the bankruptcy filing, The Motley Fool undertook extensive research that included scouring thousands of pages of primary-source documents and interviewing current and former MF Global employees, clients, lawyers, regulators, and other experts and industry participants. We've pieced together a picture that is in many ways uncomfortably familiar. Yet it also brings new lessons that highlight an urgent need for the industry to make changes.

MF Global was a futures broker with roots tracing back more than 200 years. Despite its longevity, the company was deeply struggling just as the financial crisis reached its fever pitch. The broker had been spun off from its U.K. hedge-fund parent and was the victim of poor internal controls, likely stemming from the merger with a rival that had been crippled by fraud.

The weakened company then fell under the spell of two Wall Street "masters of the universe" -- two former Goldman Sachs stars: the much-lauded private equity investor J. Christopher Flowers and Jon Corzine. Each fueled by a need for redemption, Corzine -- who was brought in by Flowers to run the company -- tailored a high-risk strategy for MF Global, surrounded himself with others unlikely to question his decisions, and turned himself into the supreme "CEO trader." Extreme leverage and a huge concentrated bet on European debt eventually led the company's counterparties to run for the hills, leaving the broker to collapse.

Other than that, Mrs. Lincoln...
But it turned out that the bankruptcy of MF Global was only part of the story. In the final days of MF Global's solvency, it was exposed that a huge chunk of supposedly protected client funds had vanished from its books. In the wake of that revelation, U.S. account holders were frozen out of their accounts as regulators moved in to sort out the mess.

We spoke with many of those affected by this act of the MF Global drama. Southwest Minnesota farmer and father of four Dean Tofteland ended up with $250,000 locked up by the broker. Without access to those funds to post margin for his open positions, all of his crop hedges were liquidated. He was also unable to start buying seed for the 2012 growing season, thereby missing out on early purchase discounts and top seed varieties.

Tofteland was not alone. Don Miller, a futures trader we spoke with, had $2 million frozen and was scrambling to pay his daughter's college tuition bill; Elaine Knuth, the owner of a commodity-trading advisory, had to completely shut down her business; and Joe Thomas, a small Tennessee cattle rancher, believes he may lose $30,000.

The fiasco at MF Global put all of these individuals and their livelihoods at risk, but as we look to the bigger picture, the confidence blow it dealt the futures market has the potential to harm the broader economy. Efficiencies gained through the use of futures by both producers and users of commodities are often passed on to us as consumers. As such, a loss of confidence in the safety of those markets could hit the already-shaky U.S. economy right where it hurts -- in consumers' wallets.

Read on
In the chapters ahead, we will lay out the unraveling of MF Global, from the first major alarm bells heard during the 2008 wheat trading scandal to the broker's dying days and the revelation that a significant amount of customer money had disappeared. We'll show how a once-venerable broker was thrust into a risk-heavy strategy by a deeply conflicted leader who was trying to play both CEO and chief trader. We'll explore why internal risk controls, the company's board of directors, and outside regulators failed to curb the company's reckless direction and protect its customers. And, finally, we'll discuss the lessons that can be gleaned from this collapse, as well as the changes needed to prevent a similar disaster.

The global economy has worked its way out of the crater created by the 2008 financial crisis, but the demise of MF Global is exactly the kind of disaster we weren't supposed to see again. The financial industry was supposed to have learned its lesson.

And yet, here we are again.

In the next chapter, we detail MF Global's problems before Jon Corzine. Click here to read all about it.

At the time this article was published Motley Fool newsletter services have recommended buying shares of Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Fool contributor Matt Koppenheffer owns shares of Barclays, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a pointy stick in the eye.

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