MFGlobal’s Collapse: Is the System Working?

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Former New Jersey Governor Jon Corzine’s beleaguered trading shop, MFGlobal, filed for Chapter 11 bankruptcy protection Monday, six days after it reported a third quarter loss of $191.6 million, sending its stock into a 67% tail-spin.

The cause of the collapse? A $6.3 billion bet on European sovereign debt by Corzine, which amounted to about 10% of the firms overall assets. Two ratings agencies, Moody’s and Fitch, concluded the bet was too risky and showed lax oversight at the firm, and downgraded its ratings.

So, is this an example of the system working through a combination of regulation and self-policing by Wall Street to reduce risk that could set off a chain reaction? Or does it show Wall Street is still dangerously willing to take big risks with the system in pursuit of profit?

Initial reports suggest it’s more the former than the latter. Back in August, regulators from FINRA ordered MFGlobal to boost its capital because they were worried about its exposure to debt. That oversight was part of a quiet government-wide stress test of the U.S. financial system by the Fed, Treasury and other regulators over the summer, designed to assess and protect against the European sovereign debt crisis.

That oversight may not have saved MFGlobal, but it seems to have been enough for the big bank creditors exposed to MFGlobal to get out of their risk positions. Sources at J.P. Morgan, which is listed as holding over a $1 billion in MFGlobal paper, are telling CNBC the bank sold off all but $100 million of that debt over the last few months. Likewise, Deutsche Bank is telling reporters it parceled out its $300 million in MFGlobal exposure.

MFGlobal is a only medium-sized broker, but its bankruptcy will likely rank as the 8th largest ever. And traders are reflexively worried about the possible contagion from MFGlobal’s failure. But for now, it appears that regulatory oversight played a role in ensuring MFGlobal’s damage won’t spread beyond its, and Jon Corzine’s, offices.

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