The fastest growing segment of the financial services industry was the one hardest hit by MF Global’s suspicious demise and overt fraud at Peregrine Financial Group (PFG).
The managed futures industry, which had grown from $14 billion under management in 1991 to over $329 billion to end 2012, was a shining star of the new economy. Offering the unique ability to zig when other investments zagged, the lack of correlation and performance during crisis were key points of attraction. This attraction came to a screeching halt with the MF Global and PFG criminal incidents. Not only were investors getting acquainted with the asset class shocked to learn their accounts were looted of assets, but more troubling criminal behavior appeared the cause - casting a shadow over all participants.
“There is a severe loss of trust, a loss of confidence. There is incredible anger and frustration. Things need to change,” said Diane Mix Birnberg, president of Horizon Cash Management. Her firm just released a study, The Aftermath of MF Global and Peregrine Financial Group Meltdowns: A Crisis of Trust, showing that a whopping 91% of respondents believed there was a breakdown in audit procedures.
The study themes that emerged included:
The laws and rules that govern the industry need to have ‘teeth’ â€“ and those involved in fraud and theft need to be punished.
Customer segregated funds must either be kept completely out of the FCM and/or be verified in real-time by regulators.
A strong and rare female voice inside a Type A male dominated industry, Ms Birnberg’s firm, Horizon Cash Management, has become the top cash management firm for participants in the managed futures industry. Starting in the 1970s as a secretary in a stock brokerage firm in Atlanta, where “women generally didn’t think about career aspirations,” she later joined Lehman Brothers in the bond business. After moving to New York City to work on Wall Street, she was recruited in 1980 by investors to operate a cash management firm in the futures industry and in 1991 founded Horizon Cash Management, which currently has $2 billion under management.
In MF Global “there was very little institutional leadership (from exchanges, regulators and major firms),” she said. “This resulted in rumor, innuendo and ultimately a lack of trust. The void in leadership is terrifying.”
Looking back on the MF Global and PFG disasters, Ms. Birnberg has the experience of witnessing 10 FCM implosions. “In every FCM implosion it has negatively touched the CTA / CPO segment of the industry.”
“Think about a plane crash,” she said. “When it happens? Key issues and facts are addressed by the airline, the FAA and even the US president. Information is available regarding what happened, why it happened and steps being taken to address the problem.”
With MF Global a plane crashed and there was silence.
This is the first part of a two part article.
Mark Melin is author of three books and taught a managed futures course for Northwestern University’s Executive Education program. To read additional blog posts visit www.UncorrelatedInvestments.com (requires free registration).
The euro zone needs to move quickly toward closer fiscal and political integration or risk falling off a cliff, says NYU economist Nouriel Roubini. European leaders understand this, but that doesn’t mean they’ll make the right choices, says Roubini. (more…)
Michael Novogratz, principal and director of Fortress Investment Group LLC, talks with Bloomberg Television’s “Market Makers” program about the European debt crisis, investment strategy and financial regulation.
Are we really heading towards Armageddon or is everything being a bit overdone? There was certainly a sense of barely-contained panic in the air on Thursday and Friday as we headed into the make-or-break Greek election.
With Greece undoubtedly the focus event, the state of the Franco-German axis is also weighing on minds.
It’s getting more and more fractious as Angela Merkel and Francois Hollande trade increasingly barbed comments on a range of issues, from moves towards fiscal union with centralized budgetary control, and the policies and policy mix required to turn the EU economy around, to the knotty issue of euro bonds, euro bills, the debt redemption fund and a banking license for the ESM that will enable the rescue fund to up its firepower by borrowing from the ECB.
Beyond that, French parliamentary elections, and the results of Spain’s government-commissioned bank audit â€“ which will determine the scale of the country’s bail-out lite â€“ are also on the agenda. Who’d be an investor in the face of so many cross-currents?
As luck would have it, leaders of the G20 along with observers from the IMF, ECB et al will at the very least all be together as a Mexican beach in Los Cabos, site of the G20 Summit, becomes the nerve centre of emergency policy response if it’s required.
Back to my opening question. I have a feeling that the panic and disaster scenarios have all been a bit over-engineered. Talk of the Greek bailout agreement being torn up; Greece exiting the euro; restrictions on ATM withdrawals and capital controls introduced; banks being shut; a destructive transmission effect that forces Spain and Italy into bailouts that are beyond the capability of the bailout mechanism to cope with, given the magnitude of the task: it’s pretty scary stuff.
I could be completely wrong, but I have a sneaking suspicion that trading into the start of the coming week and beyond could be a bit of an anti-climax. For a start, central banks worldwide have acted in a quasi co-ordinated way to stop the rot and are standing by to pump liquidity into the system and basically do anything that’s needed.
The Swiss National Bank and the Bank of Japan are poised to intervene heavily in currency markets to prevent their currencies soaring on safe-haven flows, in the process curbing speculative behavior. The Bank of England is kicking off its Extended Collateral Term Repo Facility on June 20 (monthly auctions: minimum Â£5bn at 75bp) and along with the UK Treasury will unleash a Â£100bn scheme to pump medium-term credit into the UK economy.
Meanwhile the European Central Bank will lend liquidity support to EZ banks as required, while ECB president Mario Draghi also implied the bank was willing to cut rates. The Bank of Greece has the facility to inject cash into Greek banks via the Emergency Liquidity Assistance scheme.
The amount of official firepower out there to keep things orderly actually pushed equities, the euro and peripheral government bonds higher on Friday, with Spanish 10-year bonds falling back below that 7% barrier of unsustainability.
Also helping sentiment was talk that even if the Syriza party does come out on top in the Greek elections, the result is more likely to be a negotiated flexibilisation of terms than a redo of the deal’s core requirements. I suspect that Alexis Tsipras’ pledge at his last rally, “The memorandum of bankruptcy will belong to the past on Monday,” is likely to be political rhetoric.
Not surprisingly, there was a lot of position-flattening into the weekend as investors, spooked by all the talk of euro exit firestorms, sensibly took money off the table and covered short positions.
Here’s a thought, though: markets can and often do exhibit perverse and contrarian behavior. The results of the Greek election could well be inconclusive; and there’s going to be a grace period of at least 100 days in any case while the new government is formed and figures out its stance on a whole range of issues.
If, at the same time, the Spanish bank audit shows that capital requirements are at expected levels or even lower, and the â‚¬100bn bailout isn’t taken up in full; and if the G20 at least makes some progress towards agreeing goals and a way forward on key issues at its Summit, we could get a rapid if opportunistic about-turn in sentiment and a pop in prices over the course of the next few days.
It’ll be a classic short-run fast-money trade, but on the basis that things are never as bad as they seem or indeed could be, I reckon the overwhelmingly bearish overall sentiment could well be played here for some flighty gains.
And last word on Jamie Dimon. I was shocked by the performance of the JP Morgan boss’s interrogators at the Senate Banking Committee hearing into the credit derivatives losses. But this isn’t about the losses. For a bank the size of JP Morgan, they’re insignificant. The losses destroyed a chunk of shareholder value, but that’s an issue for the bank and its investors.
What the hearing failed to get to the bottom of was the egregious (to use a Dimon word) failure of internal controls at the bank. Dimon was happy enough to explain that the losses were the result of traders not knowing what they were doing, a risk committee that wasn’t independent enough, management that failed in its duty, and a broken chain of command.
That’s the terrifying aspect of this saga. What the Senators failed to ask and Dimon failed to mention was: why?
U.S. banks may have little exposure to Greek troubles, but all it takes is one financial institution to start wobbling and credit markets could seize up in the blink of an eye says Sallie Krawcheck, the former Bank of America and Citigroup executive. (more…)
We find ourselves living in historic times along many fronts.
At a recent campaign event, presidential hopeful Mitt Romney took a hard look at the reality of government debt, noting that the thorny crisis caused by perpetual can kicking will likely be faced by our kids in the near future.
While Mr. Romney is right to address the seriousness of the government debt issue, he may be slightly off on the timing of this trade. While he anticipates the debt crisis to require attention “by our kids,” mathematical logic might indicate the problem could fester in the very near future â€“ potentially in three to five years in the United States, according to some projections. The mathematical logic indicates that the over expansive monetary policy that lead governments to embrace expenditures significantly higher than their revenues is coming to an end. Greece is example A of a society that received a natural margin call. With debt to GDP breaking into triple digits, investors might take note that all governments will likely receive their “margin call” at some point. The question is, when?
Republican Congressman Paul Ryan (Wisconsin) may have corrected Romney’s timing. Speaking on Meet the Press on Sunday, May 20, Representative Ryan called for a potential US debt crisis in two to four years. This coincides with other credible projections. “We could have a debt crisis in (the US in) 2-3 years absent action,” observed David Walker, former US Controller General and head of the Government Accountability Office (GAO). “There is a lot of irony and hypocrisy in Washington’s desire to make sure that JP Morgan has proper risk management practices,” Mr. Walker added, noting a general lack of appropriate risk management in government regarding deficit spending and leverage usage. Mr. Walker has been the early leader in speaking to the mathematical logic of a coming debt crisis, a message that few care to hear.
Making the required difficult and unpopular political decisions required to fix the debt problem will require significant political will. David Gregory of NBC’s Meet The Press noted this in his May 20, 2012 grilling of Republican Congressman Paul Ryan and Democratic Senator Dick Durbin. This is because over-leveraged governments have really two choices, neither of which are positive. In other words, there are no easy answers to the debt problem, only “worse and worser,” as author John Mauldin is so fond to point out the harsh reality.
What is the mathematical and practical logic behind a two to three year debt crisis projection?
Here is the reality, the wakeup call: In the United States, a demographic shift in three to five years is about to strain budgets as the government continues to spend nearly double its revenue. This is well documented in a Bloomberg BusinessWeek article written July 27, 2011. This demographic shift occurs when baby booming seniors retire in historic numbers, straining government benefits. This strain may occur the same time interest rates have risen, as a once infallible fiat currency discovers its fallibility. This strains a budget just when expenditures are running nearly double revenues. That’s the mathematical logic, one potential outcome. But the undeniable truth is that deficit spending such as being exhibited by government would be alarming on any balance sheet, but the fact that it isn’t even being addressed in a serious fashion is troubling, the root cause of the debt crisis.
Consider Greece from the basic perspective of their out of control leverage usage, with government spending well beyond revenues for years. When asked to face the economic problem and address the core structural issues through austerity â€“ the widely unpopular `political choice â€“ politicians prefer to kick the can down the road. The problem Greek political leaders face is they have just discovered the limits of how far the can kicking can last.
Is Greece a “One Off?”
When investors take a pure mathematical look at the structural problems, similar core issues appear in other over-leveraged western societies. Portugal, Spain, Italy, France, to name a few, all have the same structural spending problem, which could come to a head shortly. And from a mathematical perspective similar problems exist with the government who currently holds the reserve currency of choice status. At a basic level an understanding needs to take place that the root of the difficult problem is spending must be cut and revenues need to be increased. This will become a political football, a tug of war of epic proportion.
Will False “Growth” Through Easy Monetary Policy Solve the Problem?
In the past, the easy solution for government has been to stimulate growth through quantitative easing. Such tactics of “adding liquidity” typically work well early in a debt cycle but have less impact the more they are used. An example of this in the US can be found by examining the significant impact of an easy monetary policy during the 1980s and contrasting this to the relatively diminishing return on “growth” that today’s quantitative easing has on the economy. If one were a trader looking at the debt crisis they might conclude the significant risk of adding leverage to the government debt trade might not be worth the diminishing reward.
The key for investors is to recognize that the market environment to which western economies are headed may require difficult political solutions, which will not be easily solved without volatility. This could lead to a very different economic environment to which investors should be prepared to defend against. Economic environments that perhaps could be punctuated with bouts of volatility with strong market price trends emerging both positive and negative.
About the Author: Mark Melin is host of the internet video show Uncorrelated Investing and editor of Opalesque Futures Intelligence, a newsletter written for professional investors that covers investments in the futures and options industry. A futures industry practitioner and consultant, Mark has taught managed futures as an adjunct instructor at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark has worked as a consultant to the Chicago Board of Trade and OneChicago, the single stock futures exchange. He was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009. Mark worked with Peregrine Financial Group until 2011.
Risk Disclosure: This article is intended for educational and informational purposes. Past performance is not always indicative of future results. There is risk of loss when investing in futures and options. Managed futures investing can involve volatility and may not be appropriate for all investors. The opinions expressed are solely those of the author, they are not appropriate for all investors and may not have considered all risk factors.
Axel Threlfall talks with Breakingviews Editor Hugo Dixon about the likelihood that the euro egg can be unscrambled without provoking the mother of all financial collapses.
One woman, Catherine Dobbs, has made a proposal in response to the Wolfson Economics Prize question: “If member states leave the Economic and Monetary Union, what is the best way for the economic process to be managed to provide the soundest foundation for the future growth and prosperity of the current membership?” (more…)
First Business’ Bill Moller talks with Janet Tavakoli, president of Tavakoli Structured Finance, about her new book, The New Robber Barons, a compilation of articles and other pieces she wrote about the global financial crisis.
“What we’ve learned from this crisis is that when you throw trillions of dollars on the table, nobody tells the truth and everyone plays for keeps,” Tavakoli says.
Europe is wrong on austerity that may sink the global economy deeper into the 1930s-style depression which has already begun, Nobel Prize winner Paul Krugman tells Reuters in an exclusive interview.
“There will be a need to rein in the debs eventually, but right now it’s just a spiral,” Krugman says. “It’s like a medieval doctor who â€¦ you’re sick so he bleeds you and you get even sicker so he bleeds you some more. It’s just not working.”
European Union Commissioner Ollie Rehn told Reuters he thinks a resolution to the Greek debt crisis is close, as the government and private sector bondholders continue negotiations.
“They are working on, and I am working on, and I believe we will succeed in agreeing on a voluntary deal, voluntary agreement,” Rehn said. “First, there needs to be a deal on private sector involvement and then, in a way, after that but intertwined to that, interlinked to that, there’s going to be an agreement on the key parameters of the new program.” (more…)
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