Greeks, Italians, and MF Global….

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Almost on cue, within mere days of the announcement of the EFSF terms in Europe, a wrench was thrown into the works.

Greece’s current Prime Minister, George Papandreou, has opted to take the terms of ongoing Greek aid to the Greek voters through a referendum.  He is going to ask the Greek population to agree to additional austerity measures to continue receiving aid.  The Greek population doesn’t like this plan because they’ve enjoyed the long ride of doing very little and living very well, almost exclusively on deficit spending and borrowing.  The time has come to pay off their credit card, and they want to continue in denial.   If the population were to vote down the plan it’s back to the drawing board, so to speak.  If this vote were to happen it would likely be sometime in December.

Fast forward just a bit and now the rumor is that Papandreou is very close to offering his resignation.  There’s no immediate way to know if this would be a good or bad development.  I believe the world’s patience has been tried to an extreme by Greece, so perhaps a new leader would be welcome.  For now all we know is that things in Europe are still predictably unpredictable.  The expectations in the financial community are that, one way or another, the Greeks will come to realize they either need to take two steps back or many more; and eventually they’ll make the decision to cooperate with whatever austerity measures are required to avoid the need to rebuild their economy from scratch on their own.  I don’t know if that is what they’ll actually choose, but that is the expectation of the marketplace at the moment.


Italian Mario Draghi is now a very important man.  He is the man taking over for Jean-Claude Trichet as the head of the European Central Bank (ECB).  Think of this role as similar to the one Ben Bernanke is responsible for here in the US.

An American-trained economist, Mr. Draghi had previously been president of the Bank of Italy. He was backed by Nicolas Sarkozy, the president of France, and clinched the job of Head of the ECB when he won the support of the German chancellor, Angela Merkel, after convincing her of his commitment to fiscal soundness.

This is his first week on the job.  One of his first orders of business was to cut the region’s benchmark interest rate by 25 basis points (1/4 of one percent) to 1.25%.  His predecessor was widely criticized for raising rates a few times recently in the face of such economic headwinds.  Draghi is more willing to risk future inflation in hopes of avoiding a renewed harsh recession.  Trichet’s approach was to more vigorously defend against inflation since economic growth was not explicitly stated as a mandate for his job but price stability was.  Draghi’s opinion is that price stability won’t be jeopardized at lower rates and that hopefully the rate cut will provide at least a little buffer against the region’s current anemic economic conditions.  By contrast, Bernanke has brought our target interest rate to a range of 0 to 0.25% and promised to hold the rate on the floor for a couple years.  It wouldn’t be surprising to see Draghi cut rates at least once more in the coming months.  Doing so would only bring interest rates back to where they were prior to Trichet moving them up.

Mario Draghi is a name I’m sure we’ll be seeing plenty of in the year’s ahead.  Let’s see if Merkel has indeed found someone with whom she can partner to successfully resurrect Europe’s economy.  It would be great for the world, not just the Euro-zone, if she has.

MF Global:

And this from the world of the preposterous and profoundly stupid…..

Jon Corzine, former big wig at Goldman Sachs and former governor of New Jersey, is now also the former head of investment and brokerage group MF Global (MF).   In what is being reported by Bloomberg as the eighth largest bankruptcy in US history, MF Global filed for Chapter 11 protection earlier this week.

This is truly a travesty.  It makes me shake my head to see how supposed institutional financial geniuses can be so dumb.  Please understand that I’m not vilifying Corzine alone.  My criticism here applies to many at MF.  Decisions like what they made aren’t made by just one leader of an organization.

What brought MF to ruin?  Leverage. 

I’ve seen comments that MF’s failure is the first that can be attributed to the sovereign issues throughout Europe.  That’s not my opinion at all.  Yes, MF held substantial positions in those bonds; but they held these – and billions of other assets – on an enormously leveraged basis.

Various reports show that the firm bought $6.3 billion of debt from countries including Spain, Ireland, and Italy.   Total assets of the firm equaled roughly $41 billion.  This implies only a 15% exposure to this asset class and illustrates why I don’t believe it is fair to say that MF failed solely because of Europe.  To my way of thinking, the geographic region that ruined MF wasn’t Europe, it was their own boardroom.

The problem is that the firm had only $1.23 billion of equity as of the end of September.  This is big time leverage – over 32 to 1 leverage by my rough math.  This is nuts.

This means that routine volatility on any given day can wipe out the firm’s equity.  The math is that a dip of just 3% wipes out equity entirely.  Who does this type of thing?   It’s lunacy.

I don’t believe Corzine and his group did anything illegal (at least not based on news that has emerged thus far), but they sure did act unethically in my opinion.  There’s no sense of prudence whatsoever in this approach.  There’s no sense of stewarding their client’s or their shareholder’s capital.  It was simply an approach that stood to land them billions of dollars by speculating with other people’s money.  Yes, the shareholders had the chance to get rich alongside them.  But they didn’t have nearly the same risk/reward ratio as MF’s top brass. That management team would have walked away with pristine reputations for being geniuses – when in reality it would have been much more luck than skill.  Here is an example of no thought being given to the consequences of being wrong, if only temporarily.  The irony is that the portfolio they constructed is very likely to produce nice gains over time.  But that wasn’t nearly good enough.  Instead, they had to have the gambler’s mentality that I referred to a little in my last email.

Personally, I’m glad it worked out this way.  It’s unfortunate that the stock and bond holders of MF are going to lose their capital; but it has to be assumed that they knew exactly what they were getting into.  It has to be assumed that they researched the company and were willing to gamble on Corzine and Co.  As capitalism dictates – had the gamble gone well, they’d have seen very large profits.  It didn’t, so instead they see large losses.

Incidentally, according to Dealbook (the New York Times’ business blog), Corzine will receive roughly $12.1 million in severance.  Again, not illegal…..but also just not right.

Commentary by Jeff Winn, Financial Advisor – Orlando FL


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