Wednesday, November 2, 2011

Corzine Forgot Lessons of Long-Term Capital - By Roger Lowenstein

Thirteen years ago, when the hedge fund Long-Term Capital Management was desperately negotiating with Wall Street banks for a bailout, Jon Corzine, the chief executive officer of Goldman Sachs Group Inc. (GS), called John Meriwether, LTCM’s founder, and read him the riot act. Wall Street would invest, Corzine said, but “JM” would have to accept more controls, including strict supervision over his firm’s trading limits.

Corzine, I wrote soon after, “understood the flaws” at LTCM better than anyone. The firm had no controls over risk limits, no accountability to anyone who wasn’t a trader.

Corzine was also tempted by the upside of high-risk trading -- and by Meriwether in particular. Perhaps his admiration for Meriwether didn’t begin when they were classmates at the University of Chicago Booth School of Business, in the early 1970s, but it blossomed soon after, when Corzine became a bond trader at Goldman and Meriwether one at Salomon Brothers.

Goldman, in that era, was still a firm guided by investment bankers, sometimes in tandem with traders but always with the motto “long-term greedy” rather than short-term. Its primary mission was doing deals for clients. Since Goldman was private, its partners avoided taking too much risk with the firm’s capital -- which, of course, was their own capital.

Salomon was brassier -- perhaps because it didn’t have a gold-plated roster of clients to fall back on. At Salomon, Meriwether built a trading powerhouse, one that Corzine envied. In the early 1980s, Salomon became a public company, and Meriwether’s famous bond arbitrageurs had more capital to trade with.


MF Global was leveraged 30 to 1, shades of LTCM. And of MF Global’s roughly $40 billion in assets, more than $6 billion were in volatile European sovereign debts. Corzine was the author of the firm’s strategy of risking its own capital. He wanted a firm like Meriwether’s, and he got one. Corzine also approved the strategy of loading up on European debt. According to the Wall Street Journal, he told a company executive that “Europe wouldn’t let these countries go down.” Just as, 13 years ago, traders believed that Russia wouldn’t default.

Corzine’s bet may still prove correct; “these countries” -- Italy and Spain, for instance -- may emerge from the current crisis solvent. But if they do, MF Global will not be around to reap the gains. Because the firm was so highly leveraged, and because it was dependent on short-term financing, its liquidity dried up and it failed. This seems to be the lesson that Wall Street never learns.