With all eyes focused on Jon Corzineâ€™s testimony relative to MF Global Thursday, perhaps it might be time to consider that MF Global might only be one act to consider in this multi-act and often undisclosed tragedy.
The whispered story of private citizen Corzineâ€™s toppling of a regulator at the Commodity Futures Trading Commission (CFTC) is something to which light should be shown.Â In fact, the battle that took place in the late 90s between then CFTC Chairwoman Brooksley Born and then Goldman Sachs Chairman Jon Corzine, who is said to have directed lobbying efforts and the Washington D.C. â€śWorking Groupâ€ť to dispense with the â€śirascibleâ€ť Ms. Born.Â This is a story that has dramatically impacted society, leaving a scare of undisclosed leverage that can even be seen in todayâ€™s debt crisis.
What surprises me most about this story is the fact that it has generally remained untold.Â Hopefully at Mr. Corzineâ€™s congressional hearing tomorrow tough questions, listed at the end of this article, will bring forth additional details regarding the actions of Mr. Corzine and the Working Group.
Mr. Corzineâ€™s tale really should be told by considering a pattern of behavior where the Goldman superstar ignored advice of risk managers and arrogantly rolled over regulators, literally toppling those who dare question his methods of non-transparent leverage management.Â Contrast this to Ms. Bornâ€™s efforts to simply make the leverage transparent and traded on an open, regulated exchange and consider what was left in the wake: the explosion of Long Term Capital Management, the Enron debacle, the deceptively wrapped mortgage credit default swaps that imploded in 2008, and the fireworks display to end Mr. Corzineâ€™s career, MF Global.
To the determent of society, Mr. Corzine has utilized undisclosed leverage throughout his career in a way that is yet to be properly recorded.Â Ms. Bornâ€™s story is simply one her trying to enforce basic derivatives management practices vs Mr. Corzineâ€™s â€śnew schoolâ€ť attitude that bended or broke rules that the U.S. citizen simply didnâ€™t think applied to him or his colleagues at Goldman Sachs.Â If you think it was a fair fight between a principled regulator with old school derivatives management philosophy and a Wall Street oligarchy, I have a trading floor to sell you.
This article addresses how powerful private enterprise forces controlling the levers of financial engineering literally ran through regulators on their quest to impose their unsustainable methods of leverage management on society.
Mr. Corzineâ€™s Rolling of Brooksley Born
Brooksley Born was a demure lawyer, well known and highly respected in the derivatives industry during an era of time when derivatives industry experience mattered at the top of the Commodity Futures Trading Commission (CFTC).Â Upon taking over at the CFTC on August 26, 1996, life-long derivatives industry executive Ms. Born likely never though her career would abruptly end less than three years later, forced from office by the powerful financial services lobby.
Ms. Born discovered an issue that might similarly catch the attention of many in the derivatives industry if they were in her shoes.Â She discovered massive undisclosed leverage in mortgage derivatives over the counter trading and wanted such potentially toxic assets to transparently disclose their contents and be traded on a regulated exchange. Â Logical enough. Â The regulator then dispatched Michael Greenberg, head of the divisions of trading and markets, to simply prepare a list of questions to be answered about the over the counter market.Â The document asked questions and raised issues regarding previous industry fraud, potential default and market collapse and the growth of the OTC industry.Â This internal CFTC document was titled the â€śConcept Releaseâ€ť [link:http://www.cftc.gov/opa/press98/opamntn.htm] and was designed to be nothing more than a thought piece.Â Little did Ms. Born recognize that freedom of thought might get her in trouble with the financial oligarchy.
â€śI thought asking questions couldnâ€™t hurt,â€ť Ms. Born was later quoted as saying. â€śI was shocked at the strong negative reaction to merely asking questions about a market.â€ť
The Concept Release was said to be shock to the system in both New York and Washington D.C.Â It was at this point private citizen Corzine is said to have called the â€śWorking Groupâ€ť into action, an elite club of financial engineers who determined the future of the world economy.Â Operated at a high level by the likes of Â Robert Rubin with Alan GreenspanÂ and Larry Summers at his side, the group was said to have a second layer of devotees with tentacles that spread throughout all major economic levers of power in Washington D.C. Â In response to the Concept Release, Working Group leader Robert Rubin called an emergency meeting of group participants to muster support for silencing Ms. Born.
Concept Release now public, it was the summer of 1998 and Born started testifying before Congress.Â She simply told the truth about transparency and unregulated derivatives â€“ and the financial oligarchy really became uncomfortable.Â Ms. Born warned about how mortgage derivatives traded in unregulated over-the-counter markets lacked transparency and could explode upon the economic landscape. SuchÂ hereticalÂ talk enraged the working group.
Silencing the Principled Regulator Because She Requested Transparency
The orders to the working group were clear: silence the regulator who is requesting transparency and OTC derivatives trading on open markets.Â The Working Groupâ€™s first tactic was arm twisting.Â Ms. Born was first called before Goldman alumni Robert Rubin, who flatly told Ms. Born her agency lacked the authority to regulate derivatives, a move that had some in the derivatives circles shaking their heads in disbelief of Rubin’s remarks.Â This didnâ€™t stop Ms. Born, so the working group turned to the next man on the enforcer list, who happened to be then SEC chairman Arthur Levitt. Â Mr. Levitt’s attempts at persuasion wereÂ similarlyÂ unsuccessful. Â Thus, the third hitter up to bat was Alan Greenspan.Â In published reports, Mr. Greenspanâ€™s face was said to have turned red during the meeting as she told Ms. Born of dire consequences if mortgage derivatives were made transparent.Â Ms. Born held her ground, and the phone lines between D.C. and New York were ablaze with talk of â€śteaching Ms. Born a lesson.â€ť
With the Working Groupâ€™s favored behind the scenes leverage tactics experiencing surprise rare defeat, they turned to overt pressure through Congress.Â Later that year Born received her rebut from Congress, the censure of her powers.Â She later resigned from office effective June 1, 1999 and Mr. Corzine had drawn the blood of his first federal regulator.
One note about the financial oligarchy is that while members may be individually brilliant, the notion that thought on issues can be independent isnâ€™t always valued.Â The group mind think at the time was that non-transparent leverage was positive for the economy (or at least there was sufficient profitability in the deceptive mortgage derivative products to make it positive).Â Thus, any attempts to shine light on proper derivatives management were outed.
This shouldnâ€™t have been a big issue; â€śold schoolâ€ť derivatives management dictated that proper leverage management was transparent and traded on open exchanges.Â Unfortunately for society, this is when Born ran into the â€śnew schoolâ€ť of derivatives management, one that didnâ€™t feel any need for transparency, eschewed disclosure into the actual leveraged components and thought trading on regulated exchanges was a burdensome detail. In short, Ms. Born was introduced to Mr. Corzineâ€™s philosophy.Â It was this moment, newly minted CFTC chairwoman Brooksley Born fought an unexpected a battle between â€śold schoolâ€ť commodities management and a powerful new school that would soon silence the demure regulator â€“ and any future regulator that dared challenge the Wall Street power base.
With a history of rolling over regulation, Mr. Corzineâ€™s behavior with MF Global should come as no surprise, but the financial oligarchy he lead has not always come out on top.
Wall Street Doesnâ€™t Get Its Way All the Time â€“ Just Most of the Time
To be clear, there have been rare successes when the derivatives industry has faced off with equity interests.Â One highly visible example took place when German futures exchange, Eurex, looked to take control futures on the U.S. yield curve in the early 2000â€™s. This effort of off-shore control of futures trading on interest rates, backed by Goldman Sachs, was one of the rare points when the commodity industry successfully fought off Goldmanâ€™s powerful Wall Street force.
In this instance, the whispered story that emerged years after the event was one of the financial services industry and Washington D.C. saying NO to Goldman Sachs.Â At the time of this fight, Goldman wasnâ€™t the current omnipresent force it is now.
Significant preparation for the fight with Eurex was said to take place, but a generally calm approach was taken by those at the top of the CBOT.Â In stories that have emerged long since the event occurred, the real battlefield was said to take place at a dinner in Washington D.C. and private meetings in New York.Â In Washington D.C. a simple argument was said to be made: U.S. control of futures on the yield curve could one day prove to be strategically critical at some future point.Â Fast forward to 2011, with a debt crisis swirling around, this derivatives industry warning could be viewed as accurate.Â In this case, influential forces in Washington recognized the logical argument regarding national interest.Â This was also a time when the omni-potent force of Goldman Sachs did not prevail, to the surprise of some.Â After successful meetings in D.C., the New York meetings were said to have a different tone.
The D.C. argument was said to be different than the equity industry argument.Â In stories that have emerged years after the events took place, CBOT officials were said to gather the major Wall Street players with the exception of Goldman Sachs, of course.Â The core argument was made that it simply wasnâ€™t appropriate for Goldman Sachs to have such omnipresent control over the U.S. futures markets and the financial industry at large.Â Such accurate and prophetic words, as the battle was won but the war was lost.
In short, the battle over the U.S. yield curve was won by the U.S. futures exchanges, racking up a rare loss for Goldman Sachs.Â But ironically the omni-present control by one financial services firm continues.Â With Goldman Sachs now the un-disputed heavyweight champion in financial circles in both New York and Washington D.C., it is ironic that their leader, the man who as a private citizen helped draw first blood from a regulator, was now in front of Congress after a reign of terror through the halls of MF Global.
Betting on a Bailout and Benefiting from â€śWorking Groupâ€ť Connections
Upon taking over at MF Global, Mr. Corzine was said to show little if any interest in the industry in which his firm operated.Â The derivatives markets and its old school methods of leverage management were of little concern, even less concern than were regulators.Â Perhaps it is for this reason when the CFTC gave MF Global a warning regarding toxic sovereign debt over a year before the firm declared bankruptcy, that warning could have been so easily ignored by Mr. Corzine along with warnings form MF Global internal risk managers.Â Instead, Mr. Corzine is said to have relied on inside whispers from contacts in Washington D.C.Â U.S. Treasury Secretary Timothy Geithner is said to have re-assured Mr. Corzine that European bonds would not be allowed to drift into default.Â In other words, Mr. Corzine could ignore the warnings of regulators so as to rely on another government bailout to support his adventures in sovereign debt.Â Â The rest, as they say, is history.
With this as a backdrop, perhaps it is time to get answers to important questions on the record.
Questions that Congress should Ask Mr. Corzine
Mr. Corzine, you were warned on the risk in your positions on several occasions. First, you violated an old school risk management principal to diversify risk away from one significant economic headwind.Â That diversification technique might not be as â€śsexyâ€ť as concentration of risk towards positive economic outcomes, but it tends to work well in a variety of market circumstances.Â Here is the big question: How many times were you warned the risk in your sovereign debt position was too much exposure in one direction?Â Who were the people that warned you regarding sovereign debt and when did those warnings take place?Â Did the CFTC provide MF Global a specific warning regarding sovereign debt?Â Why was that warning ignored?
When U.S. Treasury Secretary and former Working Group member Timothy Geithner visited Wall Street this year, what was the focus of conversations?Â Did Mr. Geithner assure you that governments in Europe wouldnâ€™t be â€śallowedâ€ť to collapse? How did reliance on a government bailout impact your decision relative to highly leveraged investments in sovereign debt?
Mr. Corzine, describe your relationship with regulators and regulation in general.Â Specifically, what discussions did you have with a â€śWorking Groupâ€ť in Washington D.C. regarding the deposition of Brooksley Born as CFTC Chairwoman?Â The first tier of Working Group participants has been placed in the public domain.Â Will you name the second tier of the Working Group and disclose their current positions in the U.S. Government?
Mr. Corzine, the American public finds itself in debt crisis that as early as this summer many in the public didnâ€™t really recognize.Â Â It seems to me that the level of leverage and methods to manage this leverage have pretty much been undisclosed.Â Â I would like your recollection of how undisclosed leverage was defended in 1998 during fights with CFTC Chairwoman Brooksley Born, and then more appropriately how undisclosed leverage led to the downfall of MF Global?Â Â Can you tie together your involvement in the following and specifically touch on how undisclosed leverage was a factor in the demise of Long Term Capital Management, the mortgage / credit crisis of 2008 and your current situation at MF Global?
Mr. Corzine, if you can reflect on the past 15 years of your career, a period of time when one Wall Street financial services firm with one groupthink mentality clearly dominates financial decision making in governments across the world, can you assess the impact undisclosed leverage might have on societyâ€™s future?
Mark H. Melin is author / editor of three books, including High Performance Managed Futures (Wiley, 2010) and was an adjunct instructor in managed futures at Northwestern University. Â Follow him on Twitter @MarkMelin.
Risk Disclosure: Managed futures can be a volatile investment and is not appropriate for all investors. Â Past performance is not indicative of future results.
The opinions expressed in this article are those of the author, may not have considered all risk factors and may not be appropriate for all investors.