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LORD COPPER: Have you taken Jon Corzine's position?

Dec 09, 2011 | 09:22 AM |


Hold the front page! Jon Corzine is sorry several times over he presided over the bankruptcy of MF Global.

That’s good to know, I guess, for the people who lost their jobs and livelihoods.

But it’s OK, because if you read his self-serving statement to the US house of representatives, it wasn’t really his fault anyway, and he’s doing the decent thing by not pleading the fifth amendment to the US constitution (the one that means you don’t have to testify, if by doing so you may incriminate yourself).

He raises some interesting issues though, not least concerning the decision taken to modify the company’s strategy from being a broker to becoming an “investment bank”.

Now, to me, a true investment bank is one concentrating on advisory work, on fund-raising, on investment management – things, largely, that do not involve major speculation with the bank’s own funds.

If we were looking for an example, it would be somebody like Rothschild, regularly near the top of the lists of corporate advisors, and yet minimally involved in own-account trading of financial instruments.

But that doesn’t seem to be the way of it for our friends at MF Global.

Corzine tells us that the company was not making enough (or possibly any) money on its customer brokerage/execution business, and that therefore as part of the new strategy, it should evolve the broker business into a broker/dealer business.

What that means, in simple terms, is that commission income was not proving sufficient, under pressure as it was from increasing electronic trading and low interest rates, and therefore the answer was going to be to increase the prop-trading books.

This is not anything new, I’ve seen it lots of times. (Indeed, if I’m honest, I’ve been responsible for making that change myself on occasion.)

But it’s very rarely a smart move.

If you can’t make your customer business cover your costs, then plunging into an orgy of speculative trading is very unlikely to rescue you.

You may get lucky for a while, but it doesn’t last.

There are far more people who think they are cleverer than the market than there are who actually are cleverer.

One of the few things I would say is axiomatic is that trying to get a brokerage out of a hole by turning it into a dealer is foolish.

And yet, there is an underlying truth in Corzine’s description of the business.

It is very clearly the case that commissions in commodity trading have been driven way down by the advent of the greater access to markets and exchanges brought about by the advent of electronic trading and direct customer access.

Order-routing hasn’t necessarily been the great panacea some were expecting, though brokers have traditionally been able to earn a good income from interest on the cash they hold.

With record low interest rates here for the foreseeable future, that source of income is also closed off.

One major effect of the current structure of the business, coupled with the current phase of the economic cycle, is to create an enormous pressure on market participants to become prop speculators, and this isn’t healthy, not only because of the risk failures and bankruptcies, but also because it creates what I would suggest is excessive volatility in the markets.

Cutting overheads to fit the cloth of the income from the customer business is obviously a sensible starting point to resolving this (though that means paying people less, which they won’t like).

But there is also a lesson here for all those managements who are comfortable that they have a sustainable customer business.

Have a closer look, because I don’t think Mr Corzine was unique in his analysis and strategy.





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