For those unfamiliar, you can read here about Janet. To say she is the world’s foremost expert on structured finance would be an understatement.
- Shortfall estimated at $1.2 billion or more (up from $600 million)
- “Repo-to-Maturity” is a “Total Return Swap-to-Maturity,” a Type of Credit Derivative
- Probable Shortfalls Throughout 2011
- Regulators Waive Required Tests for Jon Corzine
- Jon Corzine to Credit Derivatives Head: Next Time “Double Up
JT Note: Subsequent to this report Jim Parascandola told me that he was never told to increase the size of any position, albeit his trades were profitable.
- Questions About How MF Global Became a Primary Dealer
- MF Global Wrote Rubber Checks for some Electronic Checks for Others
- Tip-Offs for Some Customers?
- CFTC’s Gary Gensler Didn’t Act
- MF Global Debacle Damages a Key Global Market
Here’s the punchline folks, as I’ve outlined as well:
MF Global’s problematic trades were different from AIG’s, but they were also derivatives, in fact, they were a form of credit derivative. The “repo-to-maturity” transaction was just a form over substance gimmick to disguise this fact. Specifically the transactions are total return swaps, a type of credit derivative, and the chief purpose of these transactions is leverage.
A total return swap-to-maturity includes a type of credit derivative. It allows you to sell a bond you own and get off-balance sheet financing in the form of a total return swap. Alternatively, you can get off-balance sheet financing on a bond with risk you want (but do not currently own so there is no need to sell anything) and take the risk of the default and price risk. (Price risk can be due both to credit risk and/or interest rate risk.) This is an off-balance sheet transaction in which the total return receiver (MF Global) has both the price risk and the default risk of the reference bonds. In this case, MF Global had the price risk and the default risk of $6.3 billion of the sovereign debt of Belgium, Italy, Spain, Portugal, and Ireland. As it happened, the price fluctuations of this debt in 2011 weren’t due to a general rise in interest rates, they were due to a general increase in the perceived credit risk of this debt.
In short the risk doesn’t go away but it’s not on your balance sheet so it is effectively hidden.
Read the entire report folks. It’s not pretty and, in my opinion, it is required reading from a very credible source.