Malaysian households are vulnerable to market volatility with one-third of household financial assets in the form of equity,

Private risk in market volatility

Written by Syarina Hyzah Zakaria
Monday, 21 November 2011 12:45


KUALA LUMPUR: Effective this Jan 1, those looking to borrow from banks to buy houses and cars will be subject to Bank Negara Malaysia’s (BNM) new guidelines aimed at promoting prudent, responsible and transparent retail financing practices.

While much has been documented about the high borrowings of Malaysian households, little has been said about the 33% of households’ financial assets that are in the form of equities and unit trusts, which makes them also vulnerable to market volatility.

Malaysia’s high proportion of household debt to GDP of 76% is already a well-known fact. Having targeted the credit card segment earlier by imposing fees and stricter credit limits, the central bank is now tightening the income criteria for mortgages, requiring eligibility to be based on net income rather than gross income as it was previously.

Not only that, effective last Friday the tenure for car loans is now capped at nine years.

Although much has been said about the high level of household borrowings, what do their balance sheets look like?

Earlier this year, BNM published its 2010 Financial Stability and Payment Systems report, highlighting that some 33% of households’ financial assets are in the form of equities and unit trusts, and are susceptible to the performance of the stock market.

Equity holdings and unit trust funds accounted for 17% and 16% respectively of household assets at the end of 2010, with endowment policies accounting for 6%.

Bank deposits form the biggest chunk of household financial assets at 31%, followed by retirement savings with the Employees Provident Fund (EPF) with 30%, and equities 17%.

In fact, equity holdings were at their highest levels since the financial crisis in 2008, recording a 20% change on an annual basis according to the report. This was partly due to the stock market recovery that saw the FBM KLCI gaining 19.34% in 2010. It also contributed to the bulk of the 14.9% expansion in household financial assets last year.

If the high volatility in equity markets persists, it may impinge on a household’s ability to service its debt and mortgages, and inadvertently slow economic growth.


Malaysian households are vulnerable to market volatility as about 33% of their financial assets are in the form of equities and unit trusts.

Equity markets around the world have been on a downhill slide since August, hit by the European debt crisis and a slew of other external concerns. Starting with Standard & Poor’s downgrade of US sovereign debt, worries spread to a possible default by Greece and several other European countries, as well as slowing growth in China and a sluggish recovery in the US.

In August itself, 7.9% or RM97.4 billion was wiped off the KLCI’s market capitalisation, with a further RM69.6 billion erased in September.

Year-to-date, the KLCI has declined 5.15% to 1,454.4 last Friday, and is off an intra-day high of 1,597.08. From the year’s high to the year’s low of 1,310.53 on Sept 26, the index fell 17.9%. The market has since rebounded from the low rising 10.9% to last week’s close.

BNM shared its concern over the stock market’s impact in the report.

“With one-third of household financial assets in the form of equity, households are susceptible to volatile swings in equity prices as observed in 2008, when a 39.3% fall in the KLCI precipitated a decline in household financial assets. This in turn, may subject the household financial position to the vagaries of the equity market.”

In 2008, the value of equity holdings and endowment policies held by households fell by over 35% when the stock market slumped. The value of unit trusts fell over 15% while bank and EPF deposits chalked up modest growth.

However, BNM also said this risk is mitigated by “a substantial and almost equal proportion of household financial assets represented by deposits with financial institutions, which continue to provide a comfortable buffer to support households’ debt servicing ability”.

The central bank added that at the end of 2010, the ratio of financial assets-to-debt remained relatively unchanged at 238.4%, with more than 60% of the financial assets held in the form of highly liquid assets.

Economists contacted by The Edge Financial Daily were not too worried about the impact of the stock market volatility on household assets.

“Investors would have already taken that into consideration when investing,” said Dr Yeah Kim Leng, group chief economist at RAM Holdings.

The current market decline would produce negative wealth effects, but this would be offset by rising income and the rally in commodities prices this year, he said.

“The question now is what is the threshold that would trigger bankruptcy and defaults,” he elaborated. Yeah said the current correction in the markets is not sizable enough to trigger such a situation.

There are other indicators to observe, including employment levels, wage rates and bank credit flows, he said.

“If credit lending for retail and households were impinged, then spending would definitely be cut,” he warned.

Those who invested in the stock market would be the ones with excess savings, he said, adding that households can still depend on fixed income sources such as unit trusts like Amanah Saham Bumiputera and savings deposits which can provide stable returns.

Yeah estimated that the KLCI would have to drop between 30% and 50% from its peak this year to cause any real effects to households.

“This time around, the market is more dominated by institutional investors than retail compared with the 1997 Asian financial crisis. So investors won’t be directly burned by this correction,” said Suhaimi Ilias, an economist at Maybank IB Research.

Suhaimi said: “Unlike back in the 1990s, leveraged equity investments via share margin financing (SMF) were a big thing so individuals were far more vulnerable to market swings due to margin calls and forced selling. As mentioned, this time around household assets related to equity investments are mainly placed under professional fund managers who are better equipped to monitor the investment portfolio and manage risks. Banks are also far more careful in extending SMF these days.

“For that matter, banks are also exercising a great deal of prudence in lending as part of credit risk management, under the close watchful eyes of Bank Negara, which has also been implementing macro prudential measures since late 2010 on mortgages and credit card loan.

“To me, 33% of households invested in equities and unit trusts is not that high a ratio. Moreover, the household financial assets to household debt ratio obviously excludes real assets [such as property holdings] but includes mortgages on the debt side ... so the household assets to debt cover could be higher,” he said.

Nontheless, Suhaimi said a weakening sentiment can affect the real economy as households and consumers turn more cautious in their spending as they react to market news and movements.

“The household assets to debt cover figure is an aggregate statistic, with no breakdown by household income groups, that is high income, middle income, low income,” he added.

“Chances are the lower income households and those working in export-based industries, for example, may be vulnerable due to a lower household assets to debt cover, and from the impact of the global downturn, as what we saw in 2008/09 when many people in the manufacturing sector were retrenched outright or had reduced income due to redundancies or working on shorter shifts,” he said.

“This can lead to difficulties in repaying loans and rising non-performing loans. Back in 2008/09, Bank Negara stepped in to provide temporary relief for the retrenched workers by allowing banks to grant a six-month moratorium on housing loan repayments,” he said.

With high debts and a rising propensity to invest in riskier assets, maintaining near full employment and raising income levels are keys to maintaining households’ financial sustainability.


This article appeared in The Edge Financial Daily, November 21, 2011.

The Four Filters Invention of Warren Buffett and Charlie Munger

Charlie Munger, the Vice Chairman of Berkshire Hathaway mentions their "4 Investing Filters".

1. Understand the Business
2. Sustainable Competitive Advantages
3. Able and Trustworthy Managers
4. Bargain Price = Margin of Safety


"It is a very simple set of ideas and the reason that our idea has not spread faster is that they are too simple."


The QMV or QVM approach:

Q = Quality
M = Management
V = Valuation

Margin of Safety Concept as explained by Warren Buffett

The margin of safety has little to do with price but more to do with the quality of the business (durable competitive advantage and economic moat) and its management.

Buffett:   "In investing in securities, you can change your mind tomorrow and sell it if you feel you have made a mistake. When you buy a business, we buy businesses to keep. So .. our margin of safety is not in the price we pay .. it's in crossing the threshold of being virtually certain of buying into a business with durable competitive advantage, that is, one with good economics ... and we are buying in into people with a passion for the business and who are going to run it in the same way the year after they sold it to us the year that they run it the year before. So our margin of safety gets more into the qualitative characteristics than the quantitative aspects that you probably refer to in terms of the Ben Graham's standard of buying a business for .... he would say buy a stock .. if you think a stock is worth $10 .. don't pay $9.90 for it but $8.00 or something like that. When you are buying businesses, it's a different criteria, you are buying to keep and you better make sure that you are buying both the businesses that you like 10 or 20 years from now and the management that you are going to love 10 or 20 years from now.

We don't look for specific sectors, but we do look at businesses that I can understand. That means where I feel I have a high degree of confidence in my ability to see what they are going to look like 5, 10 and 20 years from now. It isn't that I don't understand, say the software product in general of the Microsoft but I don't know how that industry is going to develop 10 or 20 years. I didn't know that Google was going to come along in terms of search .. and all kind. So, anything that is rapidly developing, has lots of change embodied in it, by my definition, I won't understand. It may do wonders for society. It may have what appears to have a bright future, but I don't bring anything to that game that I know. Not only I don't know more that the other fellow, I do not know as much as the other fellow in evaluating what the industry will look like in 10 years. So, besides the things I look at businesses are reasonably easy to evaluate where the products .. how they will fit in with the economic picture .. how their economics will look in the 5, 10 or 20 years period. (2.40 minute)...Take an extreme example, I can understand Nestle ............................."

The corrosive effect of inflation explained.

"Inflation has turned £100 into less than £20"
One stockbroker explains the corrosive effect of inflation.

The dangers of inflation Photo: Larry Lilac / Alamy

By Paul Killik, senior partner at stockbroker Killik & Co

6:00AM GMT 19 Nov 2011

How would you feel if you bought a security for £100 back in 1971, and it was worth less than £20 today? Unfortunately, if you are over 60 years old, as I am, you will probably have done exactly this, as this is how much the purchasing power of sterling has fallen over this period.

To put it the other way around, had I gone into a supermarket 40 years ago and bought a trolley of goods for £20 and then returned to the supermarket today to buy the same trolley of goods, it would cost me £240.

Inflation is the most insidious investment risk, but its destructive power is frequently ignored by investors and financial regulators alike. There is a tendency to believe that if you save a pound, then, providing you get your pound back, plus a return while you were not using the money, all is well.

Wrong! Money is simply a form of exchange and its true value is determined by what it can purchase, not by its face value.

For the value of your money on deposit to hold its purchasing power, you would have to generate an interest income, after tax, equal to the rate of inflation. Even to a standard-rate taxpayer, that demands a return of 6.25pc with inflation at 5pc. What is more, you can't spend it – you have to save it.

Even over the past five years, from October 2006, the purchasing power of £1 has fallen to 84p.

Where is inflation going from here? The truth is that while short-term inflation can be predicted with some accuracy, and in the short term it is likely to decline as certain known increases of a year ago fall out, no one knows where it is going in the longer term.

There hangs the rub. Many commentators, and I would count myself among them, believe that the level of quantitative easing being undertaken by the Bank of England will result, in the longer term, in further serious – if not hyper – inflation.

In such an environment, monetary assets will decline in purchasing power, while, on the basis of historical precedent, physical assets such as property and shares will maintain their value in real terms.

The conventional wisdom, as one gets older, is to reduce exposure to equities and increase the money on deposit or in fixed income. The risk in this is that we have no idea how long we will live for, but with increasing life expectancy one is potentially exposing oneself to inflation risk for an indeterminate period of time.

Historically, this made sense – as shares generated less than fixed-income securities, so it was logical to go for the higher income and greater certainty. However, today, with the London equity market yielding 4pc after tax, equivalent to 5pc before tax, it is difficult to get an improvement from long-dated fixed-income securities and impossible from gilts or money on deposit.

I would therefore advise a higher equity content for portfolios today and, while I recognise that it is difficult to do so, I would also urge an investor to try to ignore the volatility in capital values, both good and bad, and focus on the dividends.

History tells us that over the years dividends have more or less maintained their purchasing power relative to inflation throughout most of the chaos that the world has thrown at us, and they have done so by steady growth and none of the volatility shown by the equity capital values.

http://www.telegraph.co.uk/finance/personalfinance/investing/8900038/Inflation-has-turned-100-into-less-than-20.html

Chinese rich are keen to emigrate

Chinese rich are keen to emigrate
Updated: 2011-11-03 11:35

By Shi Jing and Yu Ran (China Daily)

SHANGHAI - About 60 percent of the rich Chinese people, each of whom has a net asset of at least 60 million yuan ($9.44 million), said they intended to migrate from China, a report has found.

About 14 percent of them have either already migrated from China or have applied for migration.

The three most favored destinations by the Chinese rich are the United States, Canada and Singapore. The US is the first choice of some 40 percent of the people interviewed, according to a white paper jointly released by Hurun Report and the Bank of China (BOC) on Saturday.

According to US Citizenship and Immigration Services (USCIS), the number of Chinese applicants for investment immigration has exceeded applications from any other country or region.

Last year, the USCIS issued 772 EB-5 visas, meant for investor immigrants, to Chinese people. They account for 41 percent of the total EB-5 visas issued by the agency.

"Among all the destinations in terms of investment immigration, the US always outstand all other options as the country does not impose any quota," said Jiao Lingyan, a client executive of the investment immigration department of the Beijing-based GlobeImmi International Education Consultation Co.

"The minimum amount required for investment immigration to the US is $500,000. But it should be noted that this applies to investments in projects recommended by authorities in the US. People considering these projects should take into account that they may not make profits," Jiao said.

"It is worth noting that the minimum amount for investment immigration will be raised in the coming years, because the number of rich people in China is rapidly growing," she said.

Among the 980 people interviewed by Hurun Report and the BOC, one-third said they have assets overseas, which on an average account for 19 percent of their total assets.

While 32 percent of the interviewees said they have invested overseas with a view to immigrate, half of them said they did so mainly for the sake of their children's education.

Zhang Yuehui, a Beijing-based immigration expert, said children's education is also the top concern among those who want to immigrate.

"A growing number of parents in China have realized that children growing up in the examination-oriented education system in China will find it hard to compete in an increasingly globalized world," Zhang said.

Wang Lilan, 38, a mother of two who immigrated to Australia from her home province of Fujian two years ago, was one of those parents.

"My 12-year-old elder daughter used to do her homework very late into the night. But here in Australia, she does quite a lot practical assignment, in a playful way. And she has more spare time to do the things she likes," Wang said.

"I feel very delighted to see my children having fun while studying," Wang said.

Chinese immigrants are also getting younger, with the largest group aged between 25 and 30, compared to the 40-45 age group in the past, Zhang said

http://www.chinadaily.com.cn/business/2011-11/03/content_14028075.htm

MIS-SELLING STOCKS: "Buying the Dip", "Averaging In" and "Buy and Hold"

Das argues that many expressions used by financial advisers are an attempt to defend bad advice. Cheekily, he puts ''buying the dip'', ''averaging in'' and ''buy and hold'' into this category.

"If you believe that shares only go one way, which is up, then every time they go down, it's a buying opportunity,'' he says. ''If a stock was good value at $10 then it must be cheap at $9 and a bargain at $8. People forget that the lowest it can go is zero."

Averaging-in, or dollar-cost-averaging, is a strategy designed to avoid trying to time the market and investing all your money at the wrong time.

The idea is that by investing small amounts regularly you buy more when prices are low and less when prices are high. Left to their own devices, most people do the opposite.

This works well in a rising market but when prices are falling you simply throw good money after bad and keep fund managers in business.

"The only way out of a hole is to stop digging," Das says.

The buy-and-hold strategy is based on the premise that if you hold a stock long enough it will make money.

This may be true for good quality stocks some of the time but it is not an excuse to nod off at the wheel. Some stocks are lemons and there are times when it pays to reduce your overall exposure to shares and invest in something that provides a better return.

"People forget that after the 1929 crash it took 25 years to recover,'' Das says. ''The Japanese market has never regained its high of 1989."

The ABCs of GFC jargon

Are you scared of Dutch disease? And would a haircut help? Barbara Drury wonders if even self-described experts know what they're talking about.

Financial markets are home to some of the worst abuses of the English language and some of the greatest creativity. The language of the street, from Wall Street to Bond and Collins Street, also tells us a lot about the world we live in.

When financial markets are falling and the outlook is uncertain, the temptation is to gild the lily, obfuscate or engage in self-denial.

Financial adviser and Money contributor Noel Whittaker is fed up with industry insiders who refuse to call a spade a spade.

Advertisement: Story continues below

Off the hook ... a bailout means Greece has no incentives to change its ways. Photo: Reuters

He says a loss is no longer called a loss but a ''negative return''.

Similarly, ''negative growth'' is a recession by another name, says Satyajit Das, author of Extreme Money: The Masters of the Universe and the Cult of Risk. Das likes to quote US cowboy and commentator Will Rogers, who once said you can't say civilisation doesn't advance when in every war they kill you in a new way.

"Financial markets find more ways of losing money every time," Das says.

One way to keep your head, and your savings, while everyone around you is losing theirs is to cut through the jargon, hype and obfuscation to reveal what lies beneath. The following is just a small sample of the current argot.

QUANTITATIVE EASING (QE)

QEI and QEII are not stately ocean liners but successive attempts at economic shock therapy administered by America's central bank, the US Federal Reserve (the Fed).

The only thing quantitative easing has in common with a royal barge is that they are both very big and difficult to manoeuvre in a tight spot.

The chief economist at AMP Capital Investors, Shane Oliver, explains: "In traditional economics you try and change the price of money [by raising or lowering interest rates], but when interest rates are already zero you try and change the quantity of money to boost growth."

This is how it works.

Quantitative easing is a policy that aims to increase the supply of money circulating in the economy to boost economic activity and avoid a recession.

Central banks do this by printing money and buying bonds from high-street banks such as Bank of America.

If all goes well, the banks lend this money to businesses and individuals to spend on goods and services. That's the theory. Unfortunately, it hasn't worked.

Oliver says American consumers are so concerned about job security and their future economic prospects that they are reluctant to borrow, even when interest rates are close to zero, for fear they won't be able to repay their loans.

So all that freshly minted money is trapped in bank accounts with the Federal Reserve while the US economy limps on without the shot of financial adrenalin it needs.

Oliver calls this a classic ''liquidity trap'' - but that's another story.

DUTCH DISEASE

Not to be confused with Dutch-elm disease, a fungus that is deadly to elm trees, although Dutch disease is potentially as lethal to branches of the economy. The term Dutch disease was first used to describe the situation in the Netherlands in the 1960s when the discovery of North Sea natural gas deposits resulted in a resources boom and rising currency at the expense of manufacturing exports. Sound familiar?

In Australia's case, a rise in the price of commodities has fuelled a mining boom, pushing up the value of the Australian dollar as well as wages.

Not only do local manufacturers face rising wage costs in the competition for workers but the rising dollar makes it difficult to compete with cheaper overseas goods and services.

Despite the similarities, Oliver argues that Australia faces structural problems that were not around in the '60s. "In Australia, it is not just Dutch disease we are facing but an increase in competition from emerging economies,'' Oliver says. ''Chinese workers get paid a fraction of what our workers get paid."

MIS-SELLING STOCKS

Das argues that many expressions used by financial advisers are an attempt to defend bad advice. Cheekily, he puts ''buying the dip'', ''averaging in'' and ''buy and hold'' into this category.

"If you believe that shares only go one way, which is up, then every time they go down, it's a buying opportunity,'' he says. ''If a stock was good value at $10 then it must be cheap at $9 and a bargain at $8. People forget that the lowest it can go is zero."

Averaging-in, or dollar-cost-averaging, is a strategy designed to avoid trying to time the market and investing all your money at the wrong time.

The idea is that by investing small amounts regularly you buy more when prices are low and less when prices are high. Left to their own devices, most people do the opposite.

This works well in a rising market but when prices are falling you simply throw good money after bad and keep fund managers in business.

"The only way out of a hole is to stop digging," Das says.

The buy-and-hold strategy is based on the premise that if you hold a stock long enough it will make money.

This may be true for good quality stocks some of the time but it is not an excuse to nod off at the wheel. Some stocks are lemons and there are times when it pays to reduce your overall exposure to shares and invest in something that provides a better return.

"People forget that after the 1929 crash it took 25 years to recover,'' Das says. ''The Japanese market has never regained its high of 1989."

THE 2/20 RULE

To an outsider, the world of hedge funds makes as much sense as the lyrics of a Beatles song from their acid-tripping days. They use strategies with names that shed little light on their activities, such as market neutral, short bias, quantitative directional and discretionary thematic.

The main reason for these patently silly names is to convince investors that hedge fund managers are very clever chaps who can miraculously make money in both rising and falling markets.

Some hedge fund managers are undoubtedly skilled but many others used the long-market boom to cash in on humanity's relentless and fruitless quest to turn lead into gold.

"My view is that they will lose money in all seasons," Das says. Many have done just that.

Das points out that hedge fund managers have an expression for the premium they charge for their supposedly superior skills - the 2/20 rule.

That is, they charge a management fee of 2 per cent of the money you invest with them and take 20 per cent of your investment gains (it goes without saying that they don't refund 20 per cent of losses).

A traditional fund manager generally charges about 1 per cent of funds under management. The only difference between the two managers is often their name. The most important thing with hedge funds is not the label but the ingredients.

Hedge funds use a variety of strategies, the most important being:

❏ Short-selling: the practice of selling securities you do not own in the hope or expectation of buying them back at a lower price for a profit (see below).

❏ Leverage: the use of borrowing to increase potential profits but at the risk of increasing potential losses.

❏ Hedging: the use of short-selling as insurance against loss in another part of the portfolio, rather than as pure speculation.

In the past decade, these strategies have gone mainstream. Many traditional fund managers use them, as do the new investment products that were responsible for some of the worst losses of the global financial crisis such as the ones following.

CDOs IN THE GFC

''Structured product'' is code for risk, even though they claim to do the opposite and offer protection against market risk.

"You can't have a product that says 'I will rip you off and give you more risk', so product providers say 'we will give you a structured product'," Das says.

The term ''structured product'' has a ''safely engineered'' ring to it. Unfortunately, when faced with a product that is potentially hazardous to wealth, the temptation is to give it a name so mind-numbingly bland and meaningless that investors will be lulled into complacency. Like ''collateralised debt obligations'', or CDOs.

In 2007, veteran commentator Ian Kerr dubbed them ''Chernobyl death obligations'' after the Russian nuclear disaster. And toxic they were.

The CDOs offered to investors before the global financial crisis bundled together thousands of mortgages to spread the risk of any one mortgage-holder defaulting. The mortgage pool was divided into several ''tranches'', or slices, with varying degrees of risk so they could be sold to investors with different risk tolerances.

Das likens the structure to buying an apartment in a flood-prone area. Buying an apartment on the eighth floor might seem risk-free when the high water mark reaches only the second floor. But a severe flood weakens the foundations and makes the whole building unsafe. That's what happened to investors who thought they were protected by the ''safe'' CDO structure when the GFC tidal wave of mortgage defaults hit.

To make matters worse, CDOs were what is referred to in the trade as derivatives or synthetic instruments. In other words, they were designed to look and feel like a mortgage-backed investment but they weren't the real thing. Instead, they invested in things that mimicked the performance of mortgage-backed securities.

If you are still confused, take heart. Most of the guys who sold the things either didn't know, or didn't want to know, how they worked either.

The GFC has not cured financial markets of their taste for derivatives.

A new rash of financial products based on derivatives is entering the market, promising to inoculate investors against further market falls.

The only protection against investment losses is common sense, education and discrimination - and they are free of charge for anyone with the discipline and patience to develop them.

Shave and a haircut

There is a difference between obfuscation and verbal shorthand that is designed to put a smile on your dial. Like the fashion for haircuts.

Commentators are predicting European banks that have lent money to Greece will have to ''take a haircut''. That is, they may be forced to forgive part of their debt repayments or risk Greece defaulting on its loans.

Eureka Report's Alan Kohler describes a haircut as losing part of your money but not all of it.

''It can be just a bit off the top and sides,'' he says. ''If a Greek default is averted, you could call it a close shave.

''We have all had a close shave in the turmoil and aftermath of the financial crisis. By learning to decipher financial market code we might avoid being scalped in future.''

Put a price on morals

Forget Greeks bearing gifts, now we are warned to beware of Greeks acting immorally - in the fiscal, not biblical, sense.

The European Central Bank and the puritanical Germans are prevaricating about whether they should write off Greek government debt. A bailout would allow Greece to avoid bankruptcy and the rest of Europe to avoid an even bigger debt crisis. But the ECB worries that by letting Greece off the hook, it would not have any incentive to reduce spending and get its financial house in order.

In other words, Greece would be exposed to moral hazard.

Moral hazard first became a talking point after the failure of Lehman Brothers and the run on British bank Northern Rock.

Governments in Britain, Australia and elsewhere responded with guarantees for bank deposits to restore confidence in the banking system.

But critics said this would encourage banks to continue to engage in risky lending practices and stop depositors punishing banks by withdrawing their funds.

It is interesting that moral hazard troubles the market only in times of crisis. When markets are booming, morality and the hazards of risky behaviour are the last things on people's minds.

Read more: http://www.smh.com.au/money/the-abcs-of-gfc-jargon-20111025-1mgsb.html#ixzz1cStP3N63

MF Global collapses under euro-zone bets

November 1, 2011 - 10:18AM

Jon Corzine's bid to revive his Wall Street career crashed and burned overnight when his futures brokerage MF Global Holdings Ltd filed for bankruptcy protection following bad bets on euro zone debt.

Corzine, 64, who once ran Goldman Sachs before becoming a U.S. senator and then governor of New Jersey, had been trying to turn the more than 200-year-old MF Global into a mini Goldman by taking on more risky trades.

But once regulators forced it to fully disclose the bets on debt issued by countries including Italy, Portugal and Spain, it rapidly unraveled with no buyers willing to step in.

MF Global's meltdown in less than a week made it the biggest U.S. casualty of Europe's debt crisis, and the seventh-largest bankruptcy by assets in U.S. history.

The company's shares plunged last week as its credit ratings were cut to junk. The Chapter 11 bankruptcy filing came after talks to sell a variety of assets to Interactive Brokers Group Inc broke down earlier on Monday, a person familiar with the matter said.

Regulators had expressed "grave concerns" about the viability of MF Global, which filed for bankruptcy only after "no viable alternative was available in the limited time leading up to the regulators' deadline," the company's chief operating officer, Bradley Abelow, said in a court filing.

One of the regulators that pressed MF Global, the U.S. Commodity Futures Trading Commission, was unhappy with the brokerage's failure to give it the required data and records. "(T)o date we don't have the information that we should have," a source close to the CFTC told Reuters.

In the end, regulators and markets reacted swiftly to MF Global's troubles, which may have been exacerbated by Corzine's affinity for risk-taking over the course of a career that took him to the top echelons of Wall Street and then into politics.

"They went for what would be a very profitable trade with European sovereign debt that obviously has blown up in their face, and brought the company down," said Dave Westhouse, vice president of Chicago retail broker PTI Securities and Futures.

RIPPLE EFFECTS

The bankruptcy is reminiscent of the collapse of Lehman Brothers in 2008 at the height of the financial crisis. But market participants said the impact from this collapse, far smaller, would likely be contained.

Still, MF Global's 2,870 employees, as well as trading counterparties, were left scrambling and confused on Monday, as MF Global halted its shares but did not file for bankruptcy until well after U.S. markets had opened.

Trading activity in U.S. gold, crude oil and grain futures slowed to a crawl as the bankruptcy forced a chaotic scramble to untangle trading positions.

"Ultimately it will have lost all confidence of its investor base," Michael Epstein, a restructuring adviser with CRG Partners, said of MF Global. "I'm not sure what restructuring it actually does. In some respects, it's a baby Lehman, in effect."

There was also uncertainty over Wall Street's exposure.

JPMorgan Chase & Co's exposure for a $1.2 billion syndicated loan to MF Global is less than $100 million, a source at the bank said. Deutsche Bank is listed in the court filing as a trustee for bondholders with $1 billion of claims. The banks declined to comment.

The impact on the markets should be smaller and nothing like when Lehman failed and hedge funds had money locked up with the firm for months, said Jeff Carter, an independent futures trader in Chicago.

At the Chicago Board of Trade, three traders wearing MF Global jackets were seen leaving prior to the opening of pit trading, and floor sources told Reuters they had been turned away after their security access cards were denied.

Back outside the Manhattan office, one MF Global employee said all he knew about the bankruptcy was what has been on TV. The company's HR department, meanwhile, was busy making calls withdrawing job offers it made in the past few weeks, according to a person familiar with the situation.

"A sale here is potentially the best outcome for employees because the company will continue to operate as opposed to slowly winding down," said Dan McElhinney, the managing director of corporate restructuring for Epiq Systems.

"I think there will be a lot of effort to tee up the sale pretty quickly here."

The New York Federal Reserve terminated MF Global as one of its primary dealers. CME Group Inc, IntercontinentalExchange Inc, Singapore Exchange Ltd and Singapore's central bank, among others, halted the broker's operations in some form except for liquidations.

European clearinghouse LCH.Clearnet declared MF Global in default.

THE ROAD TO BANKRUPTCY

Corzine was trying to transform MF Global from a brokerage that mainly places customers' trades on exchanges into an investment bank that bets with its own capital.

In the past week, the company posted a quarterly loss and its shares fell by two-thirds as investors focused on the euro zone bets and the effect of low interest rates, which hurt profits from its core brokerage operations.

MF Global scrambled through the weekend and into Monday to find buyers for all or parts of the company, while at the same time hiring restructuring and bankruptcy advisers in case nothing could be done.

In the court filing explaining what went wrong, MF Global pointed a finger at regulators. The bankruptcy was hastened by pressure from the CFTC, the Securities and Exchange Commission and the Financial Industry Regulatory Authority, wrote Abelow, the COO.

FINRA ordered that its U.S. broker-dealer unit, called MFGI, boost net capital, and then reveal a $6.3 billion stake in short-term debt from European sovereigns with "troubled economies," he wrote.

Market concerns over such exposures led to MF Global being downgraded to "junk" status by various credit rating agencies, sparking margin calls that threatened liquidity, he added.

"Concerned about the events of the past week, some of MFGI's principal regulators -- the CFTC and the SEC -- expressed their grave concerns about MFGI's viability."

MF Global in the filing did not elaborate on the regulators' concerns or the reasons behind them. The SEC, CFTC and FINRA each declined to comment.

According to a July proxy filing, Corzine would be entitled to $12.1 million in severance, prorated bonus and other benefits upon being terminated without cause. Two other executives would be entitled to more: retail operations chief Randy MacDonald could get $17.9 million, and Abelow could get $13.7 million.

However, federal bankruptcy law may limit any possible severance payouts.

First-day hearings in the case were scheduled for Tuesday at 3 p.m. in U.S. Bankruptcy Court in Manhattan. Among other things, MF Global is expected to seek permission from Judge Martin Glenn to use cash collateral to keep operating its business, court papers show.

CLOCK TICKING

By filing for bankruptcy, MF Global freezes the value of its free-falling notes and gives potential suitors a clearer picture of the losses they would be taking on, said Bill Brandt, CEO of Chicago-based turnaround firm Development Specialists Inc.

If a sale is in the offing, he added, the buyer may be a European bank or sovereign government, as such entities would be particularly keen on stopping the slide and maximizing the value of the notes.

"The real question is how many assets will be left to transfer," said Niamh Alexander, an analyst at Keefe, Bruyette & Woods. "Customers might move very quickly and it may be that every hour that passes shrinks the portfolio of assets that could be transferred" to a buyer, she said.

The bankruptcy is the latest flop for finance-focused private equity fund J.C. Flowers, whose other recent investments include nationalized German bank Hypo Real Estate.

After dividends the private equity firm has received for its preferred shares, J.C. Flowers' net exposure to MF Global is $47.8 million, according to a source familiar with the matter. The firm declined to comment.

MF Global hired boutique investment bank Evercore Partners to help find a buyer, separate sources said last week.

The broker's deeply distressed 6.25 percent notes maturing in 2016 fell 4 cents to 46 on the dollar, according to the Trace, which reports bond trades. The price had earlier fallen as low as 15 cents.

MF Global shares remained halted in New York

Reuters

Read more: http://www.smh.com.au/business/world-business/mf-global-collapses-under-eurozone-bets-20111101-1msqp.html#ixzz1cPA8MyYV

Comments:
How can things go so wrong for the professionals managing Other People's Money?

Consequences must dominate Probabilities

In making decisions under conditions of uncertainty, the consequences must dominate the probabilities. We never know the future.

The intelligent investor must focus not just on getting the analysis right. You must also ensure against loss if your analysis turns out to be wrong - as even the best analyses will be at least some of the time. 

The probability of making at least one mistake at some point in your investing lifetime is virtually 100%, and those odds are entirely out of your control. However, you do have control over the consequences of being wrong.

http://myinvestingnotes.blogspot.com/2008/10/consequences-must-dominate.html