Is House Agriculture the Best Committee for the MF Global Hearing?

by Kurt Schulzke

CFTC Comm SommersIn action before the House Agriculture Committee today, CFTC Commissioner Jill Sommers (pictured right) and James Kobak, lead counsel for the MF Global liquidation trustee, both acquitted themselves as well as can be expected under the circumstances.  Not so much Agriculture Committee members, those posing the questions. I get it that market players most hurt by MF Global’s collapse are farmers and ranchers from districts represented by Agriculture Committee members.  But if Committee members truly represent their constituents…

Let’s just say that Republicans and Democrats on the Committee (though not all of them) could spend more time reading the Wall Street Journal and less campaigning.  Sommers and Kobak — both highly articulate and evidently competent — visibly struggled to communicate banking, commodities and derivatives concepts to Committee members who seemed oblivious to basic market realities. More than one Committee member, including Rep. Jeff Fortenberry (R – Neb), appeared to be urging Ms. Sommers to push for criminal prosecution of someone, anyone despite the fact that various agency investigations into the affair have only recently begun.  Sentence first, verdict after?

Similarly, Rep. Timothy Walz (D – Minn) energetically pressed Ms. Sommers to say whether, among currently operating Futures Commission Merchant firms, any appear on a CFTC “watch list” of “potential bankruptcies.”  Walz — who pointedly asked, “Do you have a watch list?… Are other potential bankruptcies out there?… seemed unaware that the disclosure of such a CFTC “watch list” (the existence of which Sommers effectively denied) would send financial markets into a tail spin.

Rep. Joe Baca (D – CA) wanted to know whether “the money” (apparently the $1.2 billion currently missing from customer accounts) “was ever there”.  Rep. David Scott (D – GA) reads well from cue cards but has no clue about what it takes to run an FCM or any other trading concern — “why would you ever invest in European sovereign debt”.  Rep. Dennis Cardoza (D – CA) pontificated as to how, if he had lost “a billion or two billion dollars” (as if he has not during his decade in Congress!) he would have “gone to the restroom and thrown up.”  Definitely not high-brow conversation.

Refreshing contrast was provided by  Rep. Michael Conway (R – TX), who followed a cogent line of questioning regarding MF Global’s treatment of segregated funds.  Similarly, Rep. Terri Sewell (D – AL) explored Corzine’s appetite for risk but ended with an unfortunately snide “Hope springs eternal” in response to Corzine’s assertion that he believes (and hopes) that further investigation will recover the currently lost customer funds.

Jon CorzineAfter Sommers and Kobak left the hearing, Jon Corzine (pictured left) took the stand.  Trying to explain how MF Global could fail after 230 years in business, Corzine said it was largely a result of MF Global’s “inability to convey what [its] losses were about.”  In other words, MF Global lost the confidence of the market because market players wrongly concluded that MF Global’s losses resulted from bad investments in European sovereign debt when, in fact, those sovereign debt instruments are still intact.

Further into Corzine’s testimony, both Rep. Timothy Johnson (R – IL) and Rep. Steve King (R – IA) asked Corzine whether he would be willing to reimburse MF Global’s customers for their losses.  Along these lines, King asked Corzine whether he “anticipates a proportional loss” in net worth.  Corzine was understandably embarrassed by the question and mumbled something to the effect of “no”.

While it is easier to craft clever comebacks from the cheap seats, surely this is one question that Corzine should have anticipated.  He might fairly have answered something like, “No one yet knows for sure whether MF Global’s customers have permanently lost funds and, if so, how the funds were lost or who might be responsible for the loss.  Therefore, I am not in a position to speak to what role I should play in reimbursing losses that are still speculative.”  Due process, folks.  Even Jon Corzine is entitled to it.

The “communication gap” evidenced by some of the questioning points to a likely reason for MF Global’s failure.  The transactions in which such firms engage are just too complicated for most people — certainly most congressional representatives — to understand.  Lack of understanding breeds fear.  Fear triggers a run on the bank.

In this regard, one of the more interesting admissions came late in the day, when Corzine confessed that despite his history of advocating more regulation of financial markets (as in, ahem, co-authorship of the Sarbanes-Oxley Act), he now believes that multiplicity of regulators and regulations — he specifically mentioned the SEC, CFTC and British regulators — makes it more difficult for firms in crisis to survive.  Thus, he now favors a “less complex” or “integrated” approach to market regulation.

Corzine’s testimony ended at about 4:45 p.m. leaving unanswered key questions such as where are the “lost” customer funds, why were they lost and how did MF Global collapse.  No smoking guns.  Markets are often irrational.  People make mistakes and will continue to do so no matter what the regulatory environment, as Corzine admitted.  Clearly, no collection of congresspeople or regulators is capable of understanding and controlling markets.  Perhaps MF Global’s customer funds will be found.  We hope so.  Perhaps investigations will uncover some kind of wrongdoing.  Perhaps not.  Meanwhile, players in commodities and futures markets should carefully evaluate their counterparty risk and adjust their hedging practices accordingly.

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