MF Global, NY Fed, Chutzpah?

MF Global, NY Fed, Chutzpah?
November 5, 2011
David R. Kotok


“The Federal Reserve Bank of New York has terminated MF Global, Inc’s status as a primary dealer.”  –October 31, 2011, NY Fed press release

For the details involving primary dealers and a list of those firms that are currently members of this select club, see the New York Fed website.  This link: and a few minutes of reading will tell the story.

Among the rules and policies of the New York Fed primary dealers you will find the following sentence.  “The Bank (NY Fed) expects primary dealers to submit accurate data, but the Bank itself does not audit the data”  (boldface is mine).  Readers may note that regulatory oversight of primary dealers is not conducted by the NY Fed.  This is so even AFTER Dodd-Frank.

The policies regarding primary dealers were updated on January 11, 2010.  Here is the link:  January 2010 is AFTER a primary dealer named Countrywide failed and was merged with a primary dealer named Bank of America, which was enticed to do the deal with a rule change promulgated by the Fed.  January 2010 is AFTER a primary dealer named Bear Stearns was merged with another primary dealer named JP Morgan Chase, whom the Fed assisted by taking assets under “Maiden Lane LLC.”  January 2010 is AFTER a primary dealer named Merrill Lynch was merged with the primary dealer named Bank of America.  And January 2010 is AFTER a primary dealer named Lehman Brothers failed and triggered the financial meltdown we know as the Great Recession, for which we are still paying a price.

Readers may note that the NY Fed also published the criteria for admission to this select club of primary dealers.  Take a look at them.  Then ask yourself if the policy of selection, transaction, and reporting of primary dealers is consistent with the Fed disclaimer you will read below and in the rules.  Is this a sound policy?  Or is it chutzpah?

The citation is from the NY Fed website.  The boldface portion is my doing, for emphasis.

“The New York Fed continues to emphasize that the nature of its relationship with primary dealers is a counterparty relationship, not a regulatory one. This policy establishes the framework by which the New York Fed will prudently manage its counterparty risk consistent with its mandates to implement monetary policy and promote financial stability. The New York Fed also recognizes the value of maintaining transparency in its administration of its relationships with the primary dealers. In light of the foregoing, third parties are reminded that the designation of an entity as a primary dealer by the New York Fed in no way constitutes a public endorsement of that entity by the New York Fed, nor should such designation be viewed as a replacement for prudent counterparty risk management and due diligence.”

Is this not chutzpah?

Let me engage in a quick digression so I am not accused of being anti-semantic.  New York City is a wonderful place to visit.  It is also the global bastion of innovative financial chutzpah.  For those unfamiliar with the word chutzpah, please note it is a Yiddish term meaning boldness and self-confidence, temerity, or lack of respect.  Example of financial chutzpah: a lawyer takes a taxi to the MF Global bankruptcy hearing.  The cabby says “That will be $37.50.  The lawyer says “Come inside and join the unsecured creditors.”  That’s chutzpah.

The MF Global affair is doubly muddied up by alleged fraud and misuse of client funds.  We cannot blame the NY Fed for an alleged fraud.  But we can ask if the sanction for a primary dealer that fails the “transparency” and the “accuracy” tests should be limited to getting kicked out of the club.  Maybe the $150 million minimum regulatory net capital requirement should be expanded, and maybe the shareholders and debt holders of a primary dealer should be told they are subordinated to claims that will include financial penalties for failure to comply with NY  Fed rules.  Maybe the NY Fed should take on an escrow safety-cushioning function in the same way a landlord holds a security deposit for a tenant.  Maybe this whole system of New York Fed actions and primary dealer status needs reexamination.  Maybe the system needs a chutzpah scan to remove the viruses.

Was the MF Global risk taking apparent?  Many say no.  But there are some very smart and skilled folks who say otherwise.  One of them is Janet Tavakoli.  Janet nailed it.  For readers who are not familiar with Janet, see her website:

Here is an excerpt from a note that Janet wrote on November 3.  We are fortunate enough to see her superb and timely work.  We talked with Janet on Friday.  She walked us through the evidence that was missed by many.  Janet, you are awesome!

Janet wrote: “The fact that MF Global was exposed to default risk and liquidity risk because of these trades and that they were linked to European sovereign debt was disclosed in MF Global’s 10K for the year ending March 31, 2011, a required financial statement filed with the SEC.  The CFTC and other regulators had the information right under their noses, but it appears they didn’t understand that they were looking at a leveraged credit-derivative transaction that could lead to margin calls that MF Global would be unable to meet.”

Thank you, Janet.

Let’s segue to some questions.  More will be revealed on the fraud allegations; nothing for us to add there.  But one question haunts us.  Will the opacity of the New York Fed and the accountability for its oversight or lack of oversight be made transparent?  Has anything really changed since the six-month period between the Bear Stearns merger (March 2008) and the Lehman failure (September 2008)?  If the New York Fed was “watching the store,” did they miss the clues for lack of skill, or were they deceived by MF Global?  Is the disclaimer of the NY Fed financial chutzpah to the Nth degree?

Inquiring minds want to know.  So should all the others who have to live with the results of the failure of the primary dealer named Lehman Brothers, whose CEO sat on the board of directors of the NY Fed until his firm failed.  And so do the creditors of MF Global.

One corrective note.  In my interview with Bloomberg’s Tom Keene (October 31,, I misspoke.  I said that MF Global was not a primary dealer.  Live television is unforgiving, and so let me clarify.  What I was trying to do is distinguish between two primary dealer failures.  The first was Lehman’s failure and the aftermath that followed.  The second is the present MF Global failure.  I argued that the latter is a one-off event and is not a systemic threat like Lehman turned out to be.  That was during the Monday interview and discussion with Tom Keene and Stephanie Ruhle.  On Friday, I had some quality phone time with Janet Tavakoli.  She alerted me to some details that were new information for me.  I’m less sanguine about systemic risk now than I was on Monday.

Thank you, Janet.  And also a sincere thank you to Rick Lang, a friend, fellow GIC member, and retired Fed official who noted my comments on Tom Keene’s show.  Rick inspired me to clarify them; hence, today’s missive strays from our usual market-outlook commentary.


David R. Kotok, Chairman and Chief Investment Officer

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