The Bond King's Bad Bet

When a half-billion-dollar investment goes sideways, sometimes the cure is worse than the disease. Meet JC Flowers and John Corzine—two Goldman Sachs alumni whose friendship survived boardroom betrayals, political scandals, and a spectacular fall from grace, but couldn't survive their own hubris.

After Refco's spectacular 6-day collapse wiped out $3 billion in shareholder value, private equity kingpin JC Flowers saw opportunity in the wreckage. Years later, he'd recruit his old Goldman buddy John Corzine—fresh off losing the New Jersey governor's race—to transform the sleepy commodity broker MF Global into an investment banking powerhouse.

What could go wrong when you hand a firm 1/75th the size of Goldman Sachs to a man who once threw up in a garbage can after being ousted from Wall Street's most prestigious bank? Everything, as it turns out.

From Flowers' billion-dollar government-subsidized wins to Corzine's catastrophic European debt gamble, this is the story of two men who confused a rowboat for a cruise ship and tried to ride out a financial storm. Featuring illegal customer fund transfers, a Global Treasurer nicknamed "the grave digger," and the fastest way to lose other people's money while collecting your own bonuses.

Because some people never learn the first time—and some Wall Street networks run deeper than friendship.

This episode was researched and written by Cherise Lloyd. Some music was created by using UDO. You can find show notes, transcripts, and sources at www.overleveragedoverconfident.com. Follow us on Instagram at Overleveraged Overconfident. Support the show on Patreon and help us keep deep-diving into those spectacular financial fails.. Overleveraged Overconfident is part of Seven Seven Spider, which specializes in deep dive research and financial storytelling. All research uses publicly available sources, so no confidential or regulatory information, just my keen sense of spotting nonsense.

Transcript

Cherise 2 0:01

Imagine you invest half a billion dollars in a firm with a wrap sheet longer than a CVS receipt, and now you bring in Goldman Sachs to help take it public. Get some return on that investment. But what you don't know is your British CEO is stuffing bad debt in a broom closet like it's a body, and the vultures will begin to circle. JC flowers are former Goldman partner. Billionaire investor and a fixer for hire shows up. And while he is outbid and outmaneuvered this time in a few years, he'll be welcome back bringing his old friend John Kine. One thing I know, some people don't learn the first time and some networks run deeper than friendship on Wall Street. The Goldman connection isn't just a line on a resume. It's the invisible thread, stitching the suits together. This is how Flowers and Corzine's plans came undone, fast, loud, and global, and how the Goldman Gospel of Risk and rewards splintered into lost millions congressional subpoenas and outrage. I wonder how William Cohen, author of Money and Power, how Goldman Sachs came to rule the world. I wonder what his take was on this. I wonder if anyone asked him.

Bill Cohan 1:28

Now

Bloomberg Anchor 1:28

Cozy just joined the firm last year. Who else is running the show? Who's on the board there and what's their involvement?

Bill Cohan 1:34

Well, I mean, this is of course, a the biggest investor, a single investor is Chris Flowers. So you go back to, I mean, this, this, this story has all the great characters because Chris Flowers. Uh, who's supposed to be like the master of the universe when it comes to financial institutions investing? He and John Corzine have been thick as, as thieves for years. I mean, one of the reasons John Corzine lost his job at Goldman was because of his involvement with Chris Flowers and Hank Paulson, hated that combination and what they were doing and, and blew it up. So it is, I mean, it's really shocking, I have to say. It is just really shocking that these two guys. Could blow up this firm when they frankly, were supposed to turn around and make everybody you know, wealthy. Come on. Isn't

Bloomberg Anchor 2:14

that shocking, bill?

Cherise 2 2:15

Welcome to Over Leveraged Overconfident, the podcast where spectacular risk meets even more spectacular ego. The hedge fund tightens, FinTech darlings and CDO Cowboys who swagger into risk like they own the term sheet only to end up with subpoenas, sell offs, and sob stories. Hi, I'm Cherise and I've spent 15 years with a front row seat to financial meltdowns from the Federal Reserve to optimistic leverage finance. I've seen smart people do very dumb things with large sums of money.

AP Anchor 2:53

philip Bennett, the former Chief Executive of Refco Incorporated, has been sentenced to 16 years in prison for a financial coverup that brought down one of the world's largest commodities brokerages. Refco went public in August, 2005 and for bankruptcy just weeks later after disclosing that a$430 million debt owed to Refco by a firm controlled by Bennett had been concealed.

Cherise 2 3:19

If you blinked in the fall of 2005, you might've missed the most seven expensive days in history. Let me set the stage. The financial firm sector was hot in the mid two thousands. In fact, all trading was hot. Wall Street revenue in the first three quarters of 2005, grew of 44.5%, seemed like the.com crash. Death toll had finally ended. Profits soared for banks and funds, not just by handling client trades, but by trading their own money. This is a practice called proprietary trading or prop trading. If you wanna sound cool at parties. Also on fire were initial public offerings or IPOs for financial firms. Take the chicago mercantile exchange It went public in 2002 at$3 a share, and within 18 months it was trading over 30. Everyone wanted in, including private equity Giant Thomas H. Lee Partners, also known as THL. THL was one of the original leveraged buyout shops. Famous for flipping companies like Snapple, GNC vitamins and Playtex. In 1992, they bought Snapple and held it for two years, and then flipped it for 1.5 billion in profit. For context, that is 3.4 billion today. In 2004, they saw a sleepy New York based commodities broker named Ray e Friedman and Company Refco for short. They saw potential despite the fact that the founder required a presidential pardon after being convicted of selling inferior food to the United States military. Refco wasn't an exchange like CME, but it was a major player, a broker for commodities and futures contracts. The middleman buying oil, wheat, gold, or locking prices in for future delivery. They connected buyers and sellers, executed trades, handled paperwork, collected fees, nothing glamorous, but volume was the name of the game, and Refco operated in 14 countries with massive trading volumes. THL invested$507 million. For a 47% stake, probably dreaming of another 10 times return. The next year in 2005, REFCO went public. Goldman Sachs, credit Suisse and Bank of America were named Joint Book Runners and the IPO was a smash. Hit refco, jumped to 3.5 billion in valuation by the end of the day, trading Refco, CEO. Philip Bennett, a 47-year-old Brit and former Cambridge rugby player entered the commodities world through banking, not trading. He first became familiar with the firm. He would one day lead while working at Chase Manhattan Bank in the seventies, handling deals across London, Brussels, Toronto, and New York. By 1991, he joined rco. He gained a reputation for a relentless work ethic, often arriving before 6:00 AM to the glass walled office overlooking KO's trading floor in the World Financial Center, as he drove the company to meet his global ambitions through international mergers and acquisitions. Employees recall him always being the first one in and the last one out. All thinking. He slept less than four hours a night. He was known as a meticulous dresser, spinning 12 to 13 hours at work, and his shirts didn't wrinkle. Colleagues would say, maybe that's because he never sat down with the successful IPO. The British educated math whiz with a soft accent became a newly minted billionaire. Investors seem totally unbothered by KO's 140 regulatory sanctions since 1983. I didn't misspeak 140, helping money managers, cheat municipalities, manipulating client accounts, front running, sloppy books. You named it. They've been fined for it. But Bennett had been in charge for six years and investors, it looked like he had righted the ship. But then just 61 days after the IPO, it all fell apart. October 10th, 2005, REFCO made a stunning announcement. Their newly hired controller had discovered$430 million in debt, hiding on the books. The debt was owed by a shadow entity secretly controlled by none other than Philip Bennett himself. The name of that shall. It's called Refco Group Holdings, Inc. Or RGHI. Here's the kicker. It wasn't new and despite the name, it wasn't part of Refco, it was connected to a Shell game that had been played since the late 1990s when Big Refco clients started losing money. Money they couldn't repay. Instead of reporting the losses immediately, Bennett shuffled them off the books into Shell companies, which he controlled. And every quarter as deadlines loomed, he would scramble using a company called Liberty Corner as a middleman. Who would buy the bad debts temporarily, flip them into the shell company, making the balance sheet look clean. Then later they would miraculously reappear on KO's balance sheet. He was playing with smoke and mirrors accounting. In regulatory speak, we call it window dressing. And he did it more than once. He did it 10 times between 2002 and 2004, allowing the money to grow to 430 million. And No one not the IPO underwriters, not the firm's auditors. Not the regulators caught it. When KO's board confronted Bennett, he made one final move. He borrowed 420 million from Balog, an Austrian bank with deep ties to Refco, and used this to pay the hidden debt. It didn't work. Once the news broke, clients fled, business collapsed and so did the stock. it plummeted from$29 a share to 65 cents a share, which was the collateral for the$420 million loan. Bennett resigned a CEO and was arrested days later. Refco filed for bankruptcy on October 17th, 2005. Just seven days after the initial announcement, over 3 billion in shareholder value was wiped out, and this is where we meet JC Flowers, Chris Flowers, the former Goldman Sachs banker who started his own private equity fund. He may have left the Goldman Temple to start his own religion, but he continued to preach from the same gilded hymnal. Jay Christopher Flowers was once the wonder kin of Goldman Sachs with a head, some might call fish like wire rim glasses, and a serious chess habit. He looked like an accountant straight from a 1930s film, raised in Massachusetts and graduating from Harvard. Magna cum loud flowers. Joined Goldman Sachs and focused on mergers for financial institutions. At 31, he became the youngest Goldman partner in the firm's history. He advised banks, brokers, and insurance companies on mergers, restructuring, and capital deals. He talked fast and swore often, and colleagues appreciated his pragmatic matter of fact approach to all his transactions after losing out on the top job at Goldman, I. Flowers walked launching his own firm, JC Flowers and Company. His first move with a consortium was a sweetheart deal in the rescue of the long-term credit bank. Which relied heavily on Japanese government guarantees, which eventually cost the Japanese government an estimated$508 billion. However, for flowers and his friends, it was a home run. After the bank was renamed and relaunched in an IPO flowers pocketed a reported billion dollars from the deal. The Wall Street Journal reported the deal was jokingly known as the second best private equity deal of all time trailing only the purchase of Manhattan by the Dutch from the Native Americans for$24 in trinkets. Called a math genius. He was brilliant. He was bold. He was borderline evangelical about his strategy, which seemed to be part of someone else's money and part government subsidy granted, not all of his plays worked out by late 2005, he was considered one of the wealthiest men in the United States, and somehow flowers saw a different kind of opportunity in KO's regulated business. Its cleanest, most valuable piece was available. Flowers struck a tentative deal to buy it though some were bothered by the timing. Only hours after the firm had declared bankruptcy. The problem was he wasn't the only one that saw value there. The word was out, RIS Interactive Brokers, the man group, even a Dubai consortium, showed up all smelling blood in the water, still flowers had a trick up his sleeve and had negotiated a clever breakup fee, meaning that if someone else bought KO's business, he'd still get a little cash. But let's be real. The optics of a former Goldman Sachs partner circling the corpse after Goldman's own IPO due diligence missed a$430 million black hole. Well, that was seemingly pretty bad by even Wall Street standards. Goldman already had a colorful history when it came to self-dealing. Now this was just another bad look. The bankruptcy judge wasn't buying it either. He called the breakup fee, quote, unjustifiable. So flowers bailed. The man group swooped in and won the bid taking over KO's futures business and selling off the European pieces. But flowers wasn't done with refco or trying to resurrect what was left. A few years later, he would return checkbook in hand.

14:09

What we know now is Wall Street can bring down Main Street and uh, frankly, I'm gonna tell you, it's a little scary. Your company is now bankrupt. Our economy is in a state of crisis. Did you mislead your invest? And I remind you, sir, you're under oath in your testimony today. Right here, right now, you continue to deflect personal responsibility. And I'm gonna be blunt here. People wanna know if you defrauded investors, that should be a yes or no, sir. You don't seem to acknowledge that you did anything wrong, the American financial system is rocked to its foundation as top Wall street institutions topple under a mountain of debt. When you step back for just a moment, consider the events, uh, of the last few days, it is truly unbelievable.

Cherise 2 14:52

Let's set the scene between ref coast collapse and where we picked the story up. There was this great financial crisis or GFC. This started in 2007, which was triggered by the collapse of the United States Housing bubble. And widespread failure of mortgage backed securities. As banks, insurers and investment firms racked up massive losses. Credit markets froze, unemployment surged and the global economy plunged into the worst downturn since the Great Depression in 2008, Chris Flowers got a second chance at Refco, or at least what Refco had become after the man group won the auction. Back in 2005, the brokerage business was spun out and relaunched as a public company in 2007. They called it MF Global, but it quickly hit turbulence. It appears a rogue broker circumvented trading limits and lost$141 million. Betting a wheat with its stock still underperforming and weighed down by debt MF Global, accepted what could best be characterized as a rescue investment from the Flowers private equity firm. In return for a commitment of$30 million, flowers secured the right to appoint two board members and received discounted convertible shares at a hefty 10.725% yield. A JP Morgan analyst labeled the terms onerous giving flowers, considerable influence, but the deal ultimately worked. Flowers, investment help restore market confidence and MF Global when 8 billion in overnight funding could dry up with just 24 hours of notice. MF Global needed to know and cared what people thought about it. It needed investors to believe it was good for the money and the flowers. Investment secured a little sunshine. Flowers looked unstoppable. Hiring ramped up fast. There was a new CEO, general Counsel, head of European government bond trading, head of repo sales. And even a chief economist global head of fixed Income and A COO for North America, but the business margins were thin, and the glamor was even thinner by then the great financial crisis had not turned out to be exactly what flowers had called the Super Bowl of investment. he couldn't find a way to monetize it. It Was reported that he had done valuation work for Bank of America to buy Merrill Lynch in 2008 and was paid 20 million for his time. But while Bank of America's CEO Ken Lewis praised flowers for his very, very extensive due diligence on Meryl's Holdings. Ken was still so shocked at projected losses that he had to be strong armed by the Treasury Department to complete the transaction. Flowers had failed to find anything meaningful or financially rewarding from Lehman Brothers or Bear Stearns troubles. However, he was able to be part of the purchase of a failed Southern California lender called iMac after it was shuttered by the FDIC even if that turned ugly, when the owners seemed to be accelerating residential foreclosures in order to take the fullest advantage of the loan loss sharing agreement with the FDIC. So he turned his attention back to MF Global and made some decisions. Either from loyalty or desperation. Flowers turned to his old friend, his former boss at Goldman Sachs, John Kine, the ex CEO, former New Jersey governor and US Senator. If anyone can drag MF Global, out of the sleepy backwaters of the future's brokerage and into the real money flowers, thought it was corion. John Corzine's exit from Goldman Sachs in 1999 was like a take down worthy of Shakespeare, complete with betrayal, ambition, and a really awkward management committee meeting. So let's hold on. Let's rewind and discuss flowers and Corzine's. Shared history. 10 years older than flowers. Corzine is six two. Bear of a man who grew up in Illinois and was a college football quarterback. He was a Marine in the reserves during college, making his way to the University of Chicago for his MBA. As a young married father, he moved between several Midwest banks in the bond department. Until he landed a job as a bond trader at Goldman Sachs in 1975, working his way up steadily. He made partner by 1980 and then became the CFO and then eventually stepped into CEO In Corzine's own words, I was either very lucky or reasonably, consistently good as a trader. I had my good days and bad days, but I was reasonably effective in the world. I was responsible for fixed income trading. He also acknowledged that he'd been very lucky to join Goldman during a time of extreme growth in terms of people and scope of business. When he joined the firm, it was approximately 1700 people and grew to 16,000 in 1994. Entering global markets and having technology innovation that capitalize the firm's capabilities ahead of the competition. Kine Sporting a beard and fuzzy sweaters combined. A folky name remembering charm. With direct eye contact while exhibiting an authoritarian leadership style that brook almost no dissent as one colleague put it. It's not that he always thinks he's right, it's that he knows he's right. So either luck or skill sent him into the role of CEOA a bold risk taker with a nose for profit had long push for Goldman to go public. Sold on reaping the equity built up for years by previous Goldman partners. This ruffled feathers, especially his Goldman CO-CEO and future Treasury Secretary Hank Paulson, But he couldn't just stop at IPO Dreams. He wanted Goldman to explore mega mergers like JP Morgan, Solomon Brothers, and any one of the big Wall Street partners that would play ball, all of which he confided to close Associate Jay Christopher Flowers. Paulson, became aware of secret meetings with Mellon Bank, and was enraged with Corzine for negotiating behind the back of the board. He trapped Corzine in a meeting in which Corzine had denied even talking to Mellon, but only listening, only to have Chris flowers contradict him in front of the whole board. Corzine did the only thing you do as an adult. When caught in a lie, he ran from the room. Flowers considered an ally, had inadvertently triggered his downfall. Paulson had always thought flowers an arrogant manipulator. After tense conversations with Hank Paulson, it was clear that Flowers' career at Goldman was over. He hated Paulson anyway, referring frequently to him as an idiot. When Flowers resigned from Goldman, he cashed out his partnership shares only to ask for them back when the IPO was on track a few months later, which led to a screaming match with Paulson. Corzine stayed until after the successful IPO, which made him a multi-millionaire and then left and promptly ran for a Senate seat for New Jersey and then on to Governor. Then in 2009.

john corzine 22:24

I called Mr. Christie and congratulated him on becoming New Jersey's Next governor. Uh, I want you to know that Chris was gracious in his response, and we will work hard together to make sure that the transition is smooth. That we are able to do everything that serves the people of this great state. That's my responsibility. That's our responsibility. It's my administration's responsibility.

Cherise 2 22:52

when Flowers proposed the CEO and Chairman role of MF Global to Cozy, he was coming off losing a bid for a second term as a governor of New Jersey. Losing out to Chris Christie, Corzine's wife, had advised him to wait not to do anything for a while. But he emphatically followed another path from flowers'. First conversation to John accepting the role was only seven days. Cozy was handed 1.5 million. Signing bonus, the same in salary. A double is a target bonus, but the real prize was a portion of the carried interest in the Flower's private equity fund. A man with the resume of a future Treasury secretary had just taken over MF Global, a move that ensured he would never be a Cabinet member. A sleepy commodity broker with the market cap one 75th of the size of Goldman Wall Street. People asked. What's this guy doing here? Is this a midlife crisis? Poor judgment, second chance. I mean, to them it was like Bill Ackman had become a day trader, and as they say, don't dress for the job you have, dress for the job you want. Or in this case, make the job. You have the job you want. And John Kine, who once threw up in a garbage can in the Goldman Sachs office after being ousted, wanted a second chance. A chance to run the firm his way, and it was his decision to transform MF Global from a simple brokerage into an investment bank. Corzine appeared on CNBC where he laid out his grand vision.

Bloomberg Anchor 24:38

He's the former Goldman Sachs, CEO, who served five years as United States Senator and four years as governor of New Jersey. Now, John Kine is back on Wall Street with a new firm, MF Global. It may be small by comparison, but his ambitions are not. John Corzine joins us now on the inside track. John, what I want to know, welcome back by the way. Good to be here, is just how grand are your ambitions for this little firm?

john corzine 25:00

Well, my ambitions for it to perform. For our shareholders, but most importantly for our clients are our grand. We have a pretty simple business. Program today we're a broker. We're evolving into a broker dealer that's someone who makes markets in the same things that we're connecting people to exchanges on across the globe. And frankly, I do want us to be an investment bank, giving advice, managing, assets for clients. We deal with a wide, wide set of clients. We ought to offer them deeper services in the areas where I think we can bring expert. Help, advice and execution.

Bloomberg Anchor 25:38

So why dismiss the notion that you're building a mini Glo, Goldman Sachs? There's nothing wrong with Goldman Sachs. You ran the firm for a while. It's certainly something that we're,

john corzine 25:45

we're not dismissing. Any particular view, I would like to build it in our own character. So we'll have our own character as we build it. Very much a commodity oriented, uh, organization in that brokerage space, we'll build in our, uh, broker dealer, our contacts with our clients, and we'll build out an asset management and advisory work that are very much germane to the things that we do.

Cherise 2 26:08

For years, MF Global had simply matched buyers and sellers for futures contracts. Taking a small commission, nothing fancy, but by the time cozy arrived, commissions were razor thin. Near zero interest rates had crushed profitability, and the firm had posted five straight quarter losses. Corzine's, relentless work ethic, gambler's instinct began to shape MF Global into a one man show taking the job. He had fired over 1400 employees. About one a third of the staff replacing some of them with high paid Wall Street hires, including Brad elo, a businessman who had worked with Cozy at Goldman and then had been chief of Staff when he was governor of New Jersey. Was then hired to be the COO of MF Global, and here is Corzine's Fatal flaw. He refused to listen. I mean, this is a man who once almost died in a car crash because he refused to wear a seatbelt surrounding himself with yes men and threatening to resign when challenged. Harboring what colleagues called an element of Machiavellian behavior. Beneath those fuzzy sweaters, kine leaned into his instincts and focused on the issue of earnings. He decided the firm needed a new strategy and took the unique approach of not only leading the firm, but becoming one of the most profitable traders with the firm's own capital without stronger revenues. The rating agencies were warning of downgrades. And for a firm that needed daily external financing, a downgrade would be a death sentence. Junk ratings mean higher borrowing costs and more collateral demands and rattle customers. Corzine settled on a strategy, European sovereign debt at the time. 2010 and 2011. The European debt crisis was raging. Countries like Italy, Spain, Belgium, Ireland, and Portugal were getting hammered. Bond yields were skyrocketing. Corion and others saw an opportunity. MF Global would buy European country debt with debt through what was called a repurchase to maturity or RTM transaction. This was Corzine's secret sauce from his days at Goldman, and here's how it worked. The firm would borrow From, say, JP Morgan at a rate of about 1%. With the idea to use the money to buy a European bond, say Italy's, which was paying 8.5%, and then you would book the spread, say the 7.5 difference as profit immediately without showing the liability of the JP Morgan loan or the asset of the European bond on your balance sheet. It's like claiming victory in a race you haven't finished. Completely legal. Completely correct from an accounting standpoint. Now, here's the problem. Everything stays the same. You have big profits. But if they don't, and say the den defaults, then you end up owning billions to the people you borrowed the money from without a matched way to pay for it. This leverage makes the default hurt worse, and let me be clear. Corzine hadn't traded a bomb since the late 1990s. In fact, FINRA had to give him a waiver, both for recurring education and his series seven and series 24 exams. Since his licenses had expired during his time in government, I mean other traders felt his strategy was almost quaint, like watching a family member churn butter. It was an odd choice given how skittish the street was around European debt and the real possibility to fault MF Global's reputation for reliability merited almost more than its actual sustainability. It was like waving a red flag to its lenders. It needed to borrow from them. Say whatever you want about Goldman Sachs. It really had superior risk management systems. MF Global did not, and Corzine had refused to upgrade them due to cost. However, it probably didn't matter. The CEO and the chairman of the board is one of the firm's largest proprietary traders. It creates a serious conflict of interest and undermines any risk system. This dual role blurs the line between oversight and execution. Allowing the CEO to potentially override internal controls and risk limits for personal and short-term gain. It concentrates risk in a single individual, even with a friendly board and a flowers representative. There was some pushback occasionally, which Corzine met with vague threats to quit, which immediately dampened any pushback and weakened the board's ability to provide oversight. It also set a dangerous cultural tone within the firm, a place where the Global Treasurer was labeled the Grave Digger for warning management about the unsustainability of the firm's liquidity position. Corzine still insisted he could deliver double digit returns to the shareholders and lead the way as the firm's largest trader. Capturing his own separate line item on the p and l with his initials. Maybe he just thought he needed a big win to regain some of those wins he had in the nineties. Maybe he thought he could recreate Goldman in miniature. What he forgot was is that MF Global was not Goldman Sachs, and you may wanna ride out a global economic storm on a cruise ship, but don't do it on a rowboat. You'll drown before the first wave hits. The size of MF Global's. European Trade exploded from 1.5 billion to 6.3 billion in just a few months. Which eventually caught the attention of MF Global's regulators, which noticed the wide monthly swings in profits from trading finra. The financial industry regulatory authority grew, concerned, and notified the SEC, which had the power to enforce the firm to make a capital cushion to protect from losses. Coza himself flew to DC to present his case. However, losing out on a lower number ended up. With 200 million as a capital cushion. It was a burden MF Global and Corion had not planned on, and it would have to stretch to meet in July. The company raised 650 million to shore up capital. Eventually the European trade became too large, even for the board and the risk committee. By the summer of 2011, Corzine was forced to stop buying. MF Global's trades its own trades. Those prop trades were getting more expensive counterparties were demanding more collateral, The firm was beginning to run out of cash and Cozy did not want to tap their credit line because it would be a signal of weakness. On Tuesday, October 25th, the firm released its earnings at 7:30 AM It made it clear the company had a net loss. Which was explained as a difference in accounting. The firm stated that it was fine in terms of liquidity with 3.7 billion in cash, which included a$1.3 billion revolver, two things really did shock the market One was the firm's 6.3 billion off balance sheet Holdings of sovereign debt and second, Moody's had downgraded the firm the previous evening. Perhaps Coon was expecting some positive news that morning outta Europe, but the summit scheduled for the following day, the 26th, you know, a sure sign of his belief that no country would default. How did the market feel about European sovereign debt that morning? Well, let's hear from some MF global traders.

MF Trader 33:59

Jeffrey Friedman, senior market strategist with MF Global Tuesday, the 25th of October, stock Morning comments, futures what do we have on the docket? We know tomorrow is the big announcement from Europe. A lot of people say that we're gonna be disappointed and we might. To have your technicals in place, have your stops in place if you're in futures positions, because all the news is waiting on next, or tomorrow's decision out of Europe. It looks as though they're gonna try to continue to what, uh, traders are calling an economists are calling, kicking the can just do anything that they can to plug the, plug the leaks here or potential, uh, disasters in, in the Euro zone by, meeting expectations at least. France and Germany need to come to some form of an agreement of, uh. You know where we go from here, but we'll have more news on that tomorrow. The trade date today is for both the dollar and for the treasuries to advance throughout the day today. Underlying the markets here, will be concerns, for the European Summit. Actually in the last, few minutes, we did have news here that summit is now going to be canceled, no longer gonna have the European summit. Other than that, we will be looking for, corporate earnings to be released throughout the day today within the us, which will underlie the market.

Cherise 2 35:10

Moody's downgraded the company not once but twice in one week, moving it to junk status, citing the European debt concern over the 200 million required capital call by the SEC, which was funded by a credit from JP Morgan and that triggered margin calls big ones. While Kon was angered by the change, insisting that Moody's was aware of the European trade, he felt somewhat to blame since he neglected to walk the newly assigned Moody's analyst through the scheme to understand how devastating this was. Follow me for a moment on how cash and assets become liquidity and collateral, and how an exchange relies on their credit rating. Picture this, every morning you have to convince a bank to borrow$8 billion. Not refinance it, Literally prove you're credit worthy enough to have enough cash to stay in business every single day. That is essentially what a commodities exchange faces with its credit rating. A commodities exchange is essentially a constant daily high stakes trust fall. Traders make promises to sell and buy futures backed by the exchanges guarantee of payment. Your credit rating acts as your I'm good for it. Reputation like in high school dictates everything. A slide can be swift and merciless.

AP Anchor 36:39

Much of the beginning of tonight's program, talking about things unraveling in Europe with, uh, perhaps a Greek referendum turning back the deal. But did it in fact turn out to be a bad bet? Have those MF global purchases, those bonds actually lost their value. I. Well,

Joe Nocera 36:54

not, not ultimately Ray, but, but that actually doesn't matter. That is not what the question is. The question is what does the market value it at a particular moment? And most of these, uh, bond purchases usually have, uh, collateral calls attached to them. So if the value. Decreases in the marketplace if the market value decreases, you know, counterparties can call for more collateral and, and this sort of thing feeds on itself. As the collateral calls comes, they have less money. Investors get jittery, their customers get jittery, and then they can't, get the loans they need to run the business on an overnight basis. And once they lose that, they're dead. And in fact, that's, it's a kind of, it's a, it's a modern version of the run on the bank,

Cherise 2 37:29

mf Global stock price. Plunged signaling the market's fear that the exchange would fail. Co zine began sleeping on the floor of his office while telling the staff the sun would come out tomorrow. He began to search for a buyer for the firm. The global treasurer warned that meeting the calls for more cash was not sustainable and that the firm was skating on thin ice. Core Zine had a reluctance to tap into the revolver for the signal it would send to the market about the condition of MF Global. But it soon became obvious. The firm had no choice and the finance news channels we're covering every move.

Bloomberg Anchor 38:08

What's going on at MF Global, uh, Matthew reporting today that they drew down their bank lines. What do they mean? What do you mean by that? Bank lines and how important is this? Well, it's very important because, uh, firms like this depend on liquidity, and they usually are able to fund themselves through the market. And the fact that they're not able to do that means that they have to draw down on credit lines from their banks. So it's, there's sort of an emergency backstop. They're, it's like they're pulling the fire alarm. So Matthew, who are their lenders? For these credit lines we're talking about Bank of America, Citigroup and JP Morgan. And they've disclosed this week that they had about$1.3 billion in these two, credit revolvers. And as we were, as we've reported those are, they, they've tapped those so they can't go back for more.

Cherise 2 38:46

MF Global's desperation was now broadcast to every investor, and the billion plus from the revolvers was not enough. It was like filling in a swimming pool with a teacup. Finally on the 28th, cozy told the back office to cover an overnight overdraft at JP Morgan, and it was the most important thing, or the bank was going to cease handling MF Global's business, essentially killing the firm. The response came back. The only place they had, it was in Seg The Firm began to move money from its segregated customer accounts, the seg. The funds they were legally required to keep safe and not use to cover their own losses and brokerage obligations. It was like a conman cashing stolen checks from your grandmother's account to support a river boat gambling habit. Now, here's where it really goes sideways. On the 28th, the global Treasury team saw that, the segregated report, and they knew it looked ugly. And somebody manually added another adjustment, about 540 million. No document, no backup, nothing. Just poof a credit to make the firm look compliant. So let's walk through Friday. Only four days since the quarter results were released and the regulators were circling. JP Morgan who had processed some of the cash moves got really spooked. They demanded written assurance that MF Global had not misused customer money mF Global, never signed the document. Attempts to sell the firm over the weekend. Would end by the due diligence of the buyers finding a huge hole in the balance sheet, cash was missing and then the inevitable happened on Halloween 2011.

Anchor 40:36

On Monday, the commodities and derivatives brokerage house, MF Global Holdings filed one of the largest bankruptcies in American corporate history. I. With almost$40 billion in liabilities. It's the largest failure on Wall Street since the collapse of Lehman Brothers in 2008. The Chair and Chief Executive Officer of MF Global Holdings is John Corzine, the former New Jersey governor, US Senator Corzine's. Also the former CEO of Goldman Sachs, MF Global is also the biggest. US casualty so far of the European debt crisis, MF Global filed for bankruptcy in part because of risky bets on debt issued by Italy, Portugal, and Spain. Mf global shocked markets. Last week after disclosing$191 million quarterly loss, this saw shares fall by two thirds and its credit rating caught exponentially. The firm had made big bets on sovereign bonds issued by European countries, but the unsteady future of the Eurozone meant investors downgraded the firm's prospects.

Cherise 2 41:24

They'd only have to wait a few days before figuring out how big the hole was.

Bloomberg Anchor 41:30

Out of the now bankrupt MF Global, uh, the shortfall in customer accounts, maybe as much as$1.2 billion. Remember, we've been reporting to you that there is missing money at MF Global. We were reporting as for many news organizations, that that amount was in the hundreds of millions. Well, today, uh, we are learning from the trustee who's in charge of liquidating MF Global, that in fact, the shortfall is multiple of that. Uh, it may be. Between 1.3 to$1.6 billion.

Cherise 2 42:01

While the receiver could calculate the amount of the missing funds, it was difficult to see why it would take so long.

Anchor 42:08

Somehow in that final week when things were so crazy, lots of chaos in the back office, people were swamped. They weren't using, if you can imagine, Paul, they weren't actually using digital processing for this. They were doing it by hand. They were keeping track of all their loans by hand, and just a combination of human error as well as just. Ignorance of what was going on led to this accumulation of 1.6 billion. It's pretty remarkable that the, you know, in the day and age of technology where you're supposed to have instantaneous knowledge of what's happening, right? You're still relying on Microsoft.

Cherise 2 42:38

John Corzine testified in front of some of the very people he used to serve in Congress with He testified insisting he never meant to tell anyone or convey that the firm should use customer funds. Oh, and also that he was probably right. The bond trade would've performed just as he said they would if he had only had time. But then again, let's return to William Cohen. How did he respond to those claims?

Bloomberg Anchor 43:05

now is Bill Cohen Bloomberg, contributing editor and author. And of course you have personally interviewed John Corzine many times. We have three Le C-level executives now today basically all reiterating the same thing. They had no idea what was going on. Are you astounded,

Bill Cohan 43:18

dumbfounded? I mean, I, I can't understand it. What have they been getting paid for? What do they do all day if they're not understanding where this money is or what happened in those final hours? What were they doing? I, it's, it just, it just strains any believability. What whatsoever. And, and frankly, Lisa, one of the arguments that Corzine made last week when he testified is he'd resigned on November 3rd. He hadn't had a chance to look at his emails or his documents. He couldn't possibly reconstruct what had happened in those final hours.'cause he couldn't recollect what had happened without going back to his nose. Well, Brad Avalo is still there. So why doesn't he refresh his recollection since he's got access to all those documents and all those emails, and he goes in there and says, I don't know where it is either, and I have no idea what happened. It's just, uh, very, very hard to believe. In 2017. Corzine Settled with the CFTC for 5 million. Eventually reentering the financial industry by founding a fund focused on global macro strategies. However, by September, 2023, he was winding it down, returning capital to investors, eventually ending his attempt to reestablish himself in the investment world. However, he continues to speak with reporters and always insists the European trade had been a good one and he also insists he would've been right.

Michael Okeefe 44:34

Make sure fault's not keeping any bad news outta the mix. It's open kimono to quote Dick, there's a revolting image

Cherise 2 44:41

That was Michael O'Keefe playing Chris Flowers in the HBO movie. Too Big to Fail, which dramatizes the action the Treasury and the Federal Reserve took during the financial crisis in 2008. Flowers is identified as a bank takeover expert. Some of the movie focuses on his work to save Lehman Brothers from failing. However, he asked for extensive concessions from the government to even start raising financing for any deal he agreed to. The movie was completed before MF Global Failed His home run investment in Shinsei Bank eventually turned sour as well. He continued to hold the bank stock even as the share price collapsed. after the financial crisis flowers refocused in England on small banks only to suffer heavy losses again, after Brexit. In 2015, he returned 3 billion to China's sovereign fund after failing to find suitable distressed banks for investment. And in case you are curious why?

Chris Flowers 45:40

Well, I think it is a little bit different. And of course you asked me do I think private equity has a role of financial institutions. That's all we do all day long for 14 years. So of course I think the answer to that is yes, as you would expect me to think. Um, and in a strange kind of way, I wish fewer people agreed with me.'cause then we would've less competition, which would make me very happy. Um, we do have competition however, and there, there is really I think, a useful role for private equity and financial. And financial institutions investing.

Cherise 2 46:08

He's still a billionaire. And yes, despite all of this, coine and flowers are reportedly still friends. On a good note, the firm's trustee did recover all of the missing money. I guess one thought here is that if you don't win the first time, maybe it's best to stay away the second time and JC Flowers. Don't hire a cruise ship captain for a booze cruise. You may end up in open water two blitz to make it back to port. Thank you for listening to Over Leveraged Overconfident. If you enjoyed this episode, please subscribe and leave us a rating on Apple Podcasts, Spotify, Google, Amazon Music, or wherever you get your podcasts. This episode was researched and written by Cherise Lloyd. Music was created by using UDO. The William Cohan book Money and Power: How Goldman Sachs Came to Rule the World was valuable for my research. You can find show notes, transcripts and sources@overleveragedoverconfident.com. Follow us on Instagram at over leveraged overconfident. Support the show on Patreon and help us keep deep diving into those spectacular financial fails. Speaking, which if you have a favorite corporate disaster you'd like to hear about, reach out and connect with us@sevensevenspider.com. Over leveraged overconfident is part of Seven seven Spider specializing in deep dive research and financial storytelling. All research uses publicly available sources, so no confidential or regulatory information, just my keen sense of spotting nonsense. Until next time as we continue tracking the inevitable journey from hubris to bankruptcy.