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Oftentimes, the
significance of truly historic events is not fully appreciated at the time
they occur. I think we are at one of those times with the bankruptcy of MF
Global. There’s no question that the news and overall circumstances of
the demise of the large commodities brokerage is widely known, but the
significance of the event is not yet fully understood. While I would classify
the event as an unmitigated disaster on many levels, I have hope that it
might result in some long-overdue and necessary changes in the commodities
regulatory structure.
The disaster is
that for the first time in modern financial history, the main guarantee of
the clearinghouse system has completely failed its most important constituent
– the customer base. The underlying promise to every participant in the
futures market is that your money and open positions are safe from theft and
default. This is the very glue that holds the future market together, namely,
that all market participants can depend upon strict regulation and oversight
to safeguard against fraud and theft. That’s what has made the US
organized futures exchange system the envy of the world. Until now. For more
than a week, almost all of the 50,000 commodity customers of MF Global are in
limbo as to the access and status of their funds on deposit and open
positions. This is unprecedented and beyond bad. For these 50,000 customers,
it’s the equivalent of discovering your bank just went out of business
and there is no assurance all your funds will be returned. (In the interest
of full disclosure, my background is in futures, having started as a
commodity broker at Merrill Lynch some 40 years ago. But I have not traded
futures for years and am no way personally involved in the MF Global mess;
I’m strictly an outside observer and independent analyst).
Let me cut to
the chase here and pinpoint the real problem – the CME Group. I know I
have continuously criticized the CME, even calling it a criminal enterprise
on many occasions, but in truth I may have understated the case. Yes, I would
agree that the immediate cause of the MF Global bankruptcy was MF Global
itself; but what turned it into a disaster of unprecedented proportions was
the CME Group. The CME Group was the front line regulator for MFG,
responsible for auditing and insuring the safety of customer funds and for
guaranteeing those funds in a worst case scenario. The CME failed at every
turn. Not only did its auditing fail miserably, the CME failed to step up to
the plate to safeguard customer funds after it was discovered that $600
million was missing. This is like a case of paying premiums for years on an
insurance policy only to be denied coverage when presenting a claim for the
first time. I know that the federal commodity regulator, the CFTC, has been
negligent in the case of MF Global as well, but that does not mitigate the
CME’s failures.
Of the twin
failures by the CME in the MF Global bankruptcy, clearly of more significance
is its failure to stand up and guarantee that all MFG customers would be immediately
made whole by the clearinghouse system run by the CME. The clearinghouse
system, a consortium of financial firms whose collective finances stand
behind every trade, has been the main backstop to all futures trading for
many decades. It was widely understood by all market participants that if a
clearing member failed, all the other clearing members and the exchange
itself would step in to guarantee customer funds and prevent contract
default. The CME boasts on its web site that
anywhere from $8 billion to $100 billion in protection is available in the
event of a clearing member failure. If it was telling the truth, it would
seem $600 million should be no problem.
Instead, we all
have a very big problem, thanks to the CME Group. Our financial and credit
systems are based upon trust and belief. The word credit itself comes from
the Latin word “credere” or to believe.
What the CME Group has done by not immediately guaranteeing all MF Global
customers and positions is to undermine belief in the futures market clearing
system. So important is this issue that I am at a loss to explain how the
CFTC hasn’t yet mandated that the CME do the right thing. And I have been
somewhat dumbfounded that the analytical community and media haven’t
been all over this, but there was an article in today’s NY Times that
discusses the CME’s failures for the first time. In addition, there was
a well-written article on
the Internet that did describe the problem and the CME’s role. Please
pay particular attention to the comments submitted on both articles.
Worst of all,
even MF Global customers who held no open futures positions and only cash and
unencumbered assets, like registered warehouse receipts for silver, gold and
other commodities, have found those assets under the control of the
bankruptcy trustee. If you do own warehouse receipts on silver or other
commodities that are tied up in the MF Global bankruptcy, you must run, not
walk, to a securities attorney to secure your legal rights to your property.
This is not a matter of what is right or wrong, as the unauthorized
appropriation of private property is never correct. This is a matter of law,
which sometimes is not the same as what seems right or wrong. Please
don’t delay. The CME is to blame for all of this, but blame must be
saved for later.
If there is any
good that might come from this whole sordid affair it is that it may shine
the light on what needs to be done. What needs to be done is that the CME
Group must be stripped of any regulatory powers it has. As I have long
contended, there is a clear conflict of interest in having a for-profit
entity set its own rules and regulations, especially an entity that shows
nothing but contempt for its own members at large and its customers. The CME
Group spends all of its energies encouraging artificial trading schemes, like
High Frequency Trading, designed to increase trading fee revenue and not on
market integrity and customer protection. The CME Group has just demonstrated
to the world its contempt with its failure to stand behind MF Global
customers even though it promised to do so beforehand. Next time you watch
the CME Group commercial that runs incessantly on financial TV that proclaims
how farmers and airlines come to the exchange to hedge their price risks,
please keep in mind that the CME just abandoned those farmers and airline
customers who were MF Global clients.
One other small
bonus that has emerged from this disaster is that the event has revealed as a
lie all the nonsense that CME leaders have publicly proclaimed about the
integrity of their markets. For the past few years, the smug and arrogant
leaders of the CME have testified publicly before congress and the media
about how the exchange’s clearinghouse system withstood and avoided the
failures of the non-clearinghouse financial system as typified by AIG. CME
officials trumpeted the advantages of it being a Self-Regulatory Organization
(SRO), quite capable of handling regulatory matters without the need for
further government regulation. Unfortunately, even high officials of the CFTC
were apparently sucked in by the appearance of financial strength and
integrity portrayed by the CME’s clearinghouse system of guarantees and
the wisdom of letting it continue to regulate itself. That has now all been
shown to be a lie. What good are guarantees if they are not honored when need
be? What good is self-regulation if it leads to the wholesale abandonment of
the customers’ financial interest?
Fortunately,
there is a simple remedy to the calamity of distrust growing in our market
system as a result of the CME’s failures. The CFTC must immediately
force or persuade the CME Group to do what it has promised and should have
done on its own, namely, immediately guarantee that all customers of MF
Global are made whole. Let the lawyers battle it out as to who is ultimately
liable after all the customers have been made whole. That the CFTC
hasn’t done this yet is bizarre. If the Commission delays longer what
is now clearly a primary failure at the CME will soon become primarily a CFTC
problem. We need adult supervision right now. Clearly the CME Group is not up
to the task. If the CFTC doesn’t take over responsibility and force the
CME to do the right thing, God help us all.
Another thought
in closing. The CFTC’s recent official affirmation that
it is continuing its three year old silver investigation shines another
spotlight on the CME. The investigation of silver by the CFTC clearly
involves the CME, as the world’s leading marketplace for silver is the
COMEX, owned by the CME for the past three years. Yet the CME has never said
one word about the ongoing silver investigation as it has been content to
hide behind the CFTC and pretend there are no allegations of a silver
manipulation. I guess that is to be expected from an entity that regulates
itself.
I’m
purposely confining my comments to the emergency at hand. There is no change
in the silver outlook. It is still a crooked market destined to go much
higher in the long run. The sooner the CFTC cracks down on the CME and then
addresses the silver manipulation, the sooner those higher prices will come.
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