Your Money Safe at Merrill Lynch and Fidelity?
by Robert Wenzel: Council
on Foreign Relations Asks if Ron Paul Has a Foreign Policy Problem
The MF Global
debacle has clearly shaken people up. Despite devoting one
major post to the safety of investment accounts, I continue
to receive email questions about the safety of specific firms including
Merrill Lynch and Fidelity.
As a follow
up to my initial post, here are a few thoughts.
Is your money
safe at Merrill Lynch and Fidelity? Most likely, yes.
BUT, I would
have said the same thing about the commodity brokerage firm Lind-Walldack,
which was owned by MF Global and where client accounts are now frozen.
The blow up
of MF Global is not an unusual event. Many hedge funds have blown
up in recent years (e.g. Long Term Capital Managemnet), and brokerage
firms have blown up (e.g. Lehman Brothers), but it is rare for supposedly
segregated funds do be involved in such blow ups.
In the case
of hedge funds, they usually don't own brokerage firms. In the case,
of brokerage firms, they usually don't dip into segregated funds
because that is a major violation (read: jail time). You need someone
pretty desperate and not thinking very clearly do so.
conducted an audit of segregated funds on October 24. According
to several published accounts, this review was completed that
same day. At that time, the CME says, MF Global was in compliance
with its segregation requirements....On October 27, Thursday,
as a result of the earnings call, Moodys reduced MF Global
two more steps to Ba2 and put it under review for more possible
cuts. Bloomberg reported that the company had exhausted all of
its credit lines the night before.
This is most
likely when the real desperation kicked in. Bankruptcy should have
been filed right then, but instead, a decision was likely made to
use client segregated assets to meet margin calls, insanely hoping
that markets would turnaround in a day or two and the assets would
be put back in client accounts without any clients aware of the
major violation that had occurred, or perhaps hope it would buy
time to sell the firm.
a very strong plausible theory on how the thinking would have gone
down, if Corzine was hoping to sell the firm:
given those who executed the nuclear option to save
MF Global the benefit of the doubt. I believe those executives
used all available legitimate means to raise cash first, including
trying to sell proprietary assets, as CNBC reported, and exhausting
existing credit lines. When margin calls on the repurchase agreements
and account closure demands from strategically important clients
not the bread and butter individual traders and smaller
investors and money managers who got rubber checks kept
coming, they hit the wall.
Why do I
believe MF Global executives transferred customer assets not cash
to house accounts? Because missing cash would be noticed
immediately. Their clients were still trading and clearing and
cash was required to settle. Securities such as U.S. Treasury
Bills, blue-chip equities such as CME Group stock held by many
exchange members, and physical assets such as gold, warehouse
receipts, and other certificates of title are less active. They
would not be missed Thursday through Monday.
MF Global do once these assets were moved to a house
account? I believe they pledged the customer assets as collateral
for a short term loan...Corzine planned to sell the company not
no time to monetize the assets by selling them outright. That
would have made replacing them quickly, in kind, much more difficult.
A privately arranged line of credit, secured by a basket of assets
discounted by up to 50% due to the risk of default and the firms
desperation, could be unwound as soon as a deal to sell the firm
was struck. All the assets could go back into the customer accounts
and no one would be the wiser.
willing to lend $300-400 million for a week or so against approximately
$700 million of customer assets was certainly wise enough to require
recourse to those assets in the event of a bankruptcy. Some of
the assets, like CME stock, were sure to drop in value if the
Global filed for bankruptcy midday on Monday October 31, 2011,
the lender owned the customer assets.
is the pledged assets were immediately liquidated.
In other words,
this was a situation that developed over a very short-term period
that an outside accounting firm would have little chance of catching.
type of thing happen at Fidelity or Merrill Lynch? Very unlikely.
Fidelity is an entirely different operation with no leveraged hedge
fund activities that I am aware of. Merrill Lynch is owned by Bank
of America, a bank that seemingly is considered TBTF by the government,
This probably also means Merrill.
we live in very unusual economic times. It's hard to see how Fidelity
or Merrill would get themselves into such a desperate financial
situation with desperate man at the top making very desperate decisions
, but it can't be ruled out. The best thing, as I pointed out in
my first post on this topic, is to diversify your assets over many
different firms, and where possible take delivery of certificates,
gold and cash.
with permission from Economic
Economic Policy Journal
Best of Robert Wenzel