Marty Klinker is the 2000 Top Producer of The Year and a successful cattle and grain producer from Fairfield, Mont. Klinker submitted this letter to AgWeb on how the MF Global Bankruptcy is impacting his business and how he believes it may impact the entire agriculture industry.
Does Anyone See the Monster in the Closet?
What is the fall out of MF Global's Bankruptcy and CME's lack of fulfilling their responsibility to Safe Guard The System as the DSRO for MF Global?
By now most everyone is aware of the MF Global melt down. This, it seems, is just another in a long line of failed big businesses. Beginning with Enron and World Com, then AIG, Lehman Bros, Fannie & Freddie, GM, etc. etc. etc; we have heard of the mismanagement of these large companies by a few that cause a crumble and instant evaporation of equity for stock holders, lenders and creditors.
We have watched massive bail outs and then watched the market contemplate the morals of those receiving large bonuses as executives for companies that failed miserably. Then, as in Fannie and Freddie's case, it appears they have the nerve to come back for more bail out.
I believe this has desensitized us all to the point of not paying attention when the next big one falls. After all, with the prior mentioned failures, the equity markets had a pull back, the economy had a significant slow down, jobs were lost and unemployment reached highs not seen in 25 years. But, somehow we all continued on.
What is another big failure on Wall Street? We have seen it before. It hasn't effected us with too much discomfort, other then the general distaste we have in our mouth for those who are in positions of great financial power and choose not to uphold their moral or fiduciary responsibility, or, worse yet out right lie and steal.
The difference is we are within a few strong $,25 to $.50 point up moves days in the grain markets from possibly collapsing the markets on all exchanges.
Why? Because the markets are under margined somewhere in the neighborhood of $2.4 to $3 Billion dollars.
How did this happen?
On Friday 10-29-11 all positions in customer accounts were liquidated in advance of the weekend to plan for an exchange to a new FCM by way of sale.
Thru the weekend, it was found by a potential suitor that MF Global had "lost" $636,000,000 in segregated money from customer accounts. Thus, this book of business could not be sold to a new FCM.
Monday, 11-7-11, all customer accounts with positions that were liquidated on Friday were transferred to new FCMs and the new FCMs initiated new positions on the customers behalf. Also early Monday MF Global filed for Bankruptcy, and trustee was appointed and the trustee froze all the accounts of MF Global, including the customers segregated accounts.
Thus, no margin money was transferred to the new customer account causing these new accounts to be in margin deficiency.
Sometime late Monday or early Tuesday there was word that 50% to 70% of the customer margin money was being transferred from MF Global to the new customer accounts with the new FCM's. Wednesday, it was found out that this was only for positions held on the CME and that margin money was not yet transferred for positions held on KCBT or MGE.
Thus, as of Wednesday, the market was under-margined an estimated $2.5 to $4 billion dollars. I have read that, of the total $5.5 billion of customers segregated account monies, $1.5 billion transferred to the new FCM's. This leaves a total of $4 BILLION still held in the Bankruptcy proceedings. If we assume that 25% to 40% of that amount is excess equity, that would mean that the deficiency of the new accounts is $2.4 to $3 billion dollars.
I personally had 175,000 bu hedged and had an initial margin call on the new account for $110,000 for hedge positions sold on the KCBT.
Imagine a large elevator in Montana, Kansas, South Dakota, etc. with 10,000,000 bushels bought on HTA for the crop years 2011, 2012 and 2103. They would have an initial margin deficit of $6,250,000.
I would say it is a very good possibility that there will be a lack of funds to hold positions if there is a strong upward movement in the grains.
If this is the case, hedgers, including large elevators, may need to liquidate part or all of their positions.
If this happens, it is highly likely that there will be significant down pressure on the markets, and thus a fear or lack of confidence in the markets or the exchanges themselves... and we could see the markets free fall. This could cause the complete collapse of the grain markets in a worse case scenario.
The question the marketplace would have to ask is; "Do I feel confident in buying that depressed position (thus stopping the free fall) when the free fall has been caused by the lack of security on segregated accounts, causing hedgers to liquidate positions due to lack of funds? OR, should I simply get all of my money out of the market before there is a melt down and I also loose all of my money held at my FCM?"
I have heard that RJ Obrien early last week asked the Department of Agriculture not to release last weeks crop report because of their fear of the scenario I have described above. The USDA did release the report and the markets have been sideways down. If they turn strong up, the markets are going to be at risk until the margin money is released.
How to fix this problem?
Segregated Customer funds are suppose to be that... SEGREGATED.
All FCMs are required by SEC rules to have a Designated Self Regulating Organization (DSRO). The DSRO #1) charges a fee to the FCMs for their services #2) monitors FCM activity monthly, weekly, daily, hourly and on the minute to safeguard the system #3) gathers, thru fees to the FCMs, and holds a fund (i.e. CME Trust) to provide for any short falls by FCMs. By all representations, this fund is the FCM's money and not an asset of the DSRO, or in the least a required set asside similar to that of an insurance companies required set asides for the policies they write and receive premium.
- The CME was the DSRO for MF Global. They were the oversight and the safeguard of the system in regard to MF Globals activities. They have represented a $7 billion dollar contingency fund to make whole the market in such instances.
- CME's system failed to detect and safe guard the system of segregation of customer accounts.
- CME has a $7 Billion fund (CME TRUST) to "repay customers money lost in the failure of a clearinghouse member." as quoted from CME's press release in the Wall Street Journal Saturday November 12th.
CME needs to protect the system and make whole the customer segregated accounts so the market is not at risk of collapse.
On Saturday, the Wall Street Journal reported on a CME press release to pledge $250 million of it's own money, plus $50 million from "CME Trust, a fund set up to repay customers money lost in the failure of a clearing house member." By CME's posturing, one can assume that CME is trying to avoid their fiduciary responsibilities by packaging this gesture as a good will.
Meanwhile the markets sit on the edge of disaster.