When the US sneezes, everyone catches a cold. As the epicentre of the financial meltdown in 2008, recovery has been slow, and more firms have fallen by the wayside. But there are promising signs, with unemployment starting to fall and most of the banking sector showing growth.
When the US sneezes, everyone catches a cold. As the epicentre of the financial meltdown in 2008, recovery has been slow, and more firms have fallen by the wayside. But there are promising signs, with unemployment starting to fall and most of the banking sector showing growth.
It’s not all been good, however, The collapse of MF Global has led to severe losses. Missing client funds are now estimated at $1.2 billion, and might not be recovered if customer funds were not backed by collateral.
A lawyer briefed on the progress of the investigation into MF Global’s dealings being undertaken by various government regulators told CNBC that investigators now believe the bankrupt FCM used customer money to make trades, such as buying sovereign debt securities.
Earlier, there was hope the money would turn out to be held as collateral in an account with one of MF Global’s creditors, such as J.P. Morgan, but that does not now seem to be the case.
MF Global used customer funds in a variety of ways, the source told CNBC. In the futures business, MF Global was allowed to use “idle” cash in customer accounts to make investments on its own behalf. It would buy bonds and keep the coupon on them. The firm would also “borrow” from its clients accounts, posting collateral such as US Treasurys.
But as the New York Times has reported, the firm stopped backing the loans from customer accounts sometime in October. Basically, they just took the cash out. If this is right, it is probably impossible to recover the missing funds, writes CNBC.
The hole in MF Global’s customer accounts is now estimated at $1.2 billion by the bankruptcy trustee for the FCM’s US brokerage, according to the Financial Times. That is equivalent to almost a quarter of the $5.45 billion in client funds that the company was required to hold separately from its own funds.
The shortfall has blemished futures markets and left thousands of traders with insufficient margin deposits. Failure to separate customer and house funds is a violation under US law.
Concerns about the safety of the eurozone, the US downgrade and the possibility of a much longer than feared financial stagnation also led to stock markets around the world having a torrid summer. The values of financial firms in particular, were hard hit, and many investors suffered significant losses.
In August, global stocks suffered their worst nine-day drop since the 2008 financial crisis. For four days, The Dow Jones Industrial Average alternated between gains and losses of more than 400 points, the longest streak ever, and its intraday swings have averaged twice the level seen during the first seven months of the year.
Hedge funds are on track to post their second-worst year on record, with managers such as John Paulson seeing bets undermined by Europe’s two-year sovereign-debt crisis and concerns over the US economic recovery. US mutual funds are headed for their second-weakest year of deposits in two decades, and the top Wall Street banks posted their worst quarter in trading and investment banking since the depths of the 2008 financial crisis.
Investors withdrew a net $16.1 billion from US stock funds last month, extending a string that began in May, according to industry consultant Strategic Insight.
Stock funds attracted new cash during the first four months of this year, on the heels of strong market gains in late 2010. But the market was dominated this summer and fall by fears that Europe’s debt crisis was getting impossible to contain.
As the continent’s leaders struggled to come up with a debt-control plan, US stocks again followed a volatile path last month. The Standard & Poor’s 500 index slid about 9 percent in mid-November before recovering most of its gain to finish down less than 1 percent for the month.
“With the market still gyrating, investors still lack enthusiasm” for U.S. stock funds, says Avi Nachmany, research director with New York-based Strategic Insight.
JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley posted $13.5 billion in trading revenue minus accounting gains for the third quarter, down 35 percent from a year earlier. Investment-banking revenue plunged 41 percent from the second quarter to $4.47 billion.
Through November, investors withdrew a net $65 billion from stock funds. That exceeds the full-year total of 2010, when they pulled a net $49 billion from stock funds. Investing has taken a more conservative turn since the financial crisis of 2008, with money consistently flowing out of stock funds, and bond funds continuing to attract new cash.
Other details of how investors moved their money in November:
Foreign stock funds: Investors withdrew a net $2.6 billion from these funds, as debt troubles in Europe and slowing economic growth in China continued to depress stock prices in many foreign markets. Through November, investors have deposited a net $45 billion into foreign funds, reflecting expectations that China and other emerging markets such as India and Brazil continue to have good long-term prospects.
Bond funds: Investors deposited a net $11.9 billion in November. About $9 billion in new cash was added to taxable bond funds, a category that includes corporate bonds. About $2.9 billion was deposited last month into municipal bond funds, which buy the debt of state and local governments. Year-to-date, bond funds have attracted nearly $104 billion in new cash.
Money-market funds: A net $42 billion was deposited into these funds last month, marking a reversal from the $21 billion in net withdrawals in October. Strategic Insight said investors appeared to increasingly view money-market funds as a safety net from stock market volatility. They’re designed to be safe harbors where investors can temporarily park cash and quickly access it when needed. Net withdrawals from money fundstotal $173 billion year-to-date. Their appeal has dimmed because returns have been barely above zero since early 2009.
Exchange-traded funds: Investors deposited a net $5 billion into ETFs, which bundle together investments in a particular market index. Unlike mutual funds, they can be traded during daily sessions just like stocks. ETFs continue to grow much faster than mutual funds, with year-to-date net deposits of nearly $94 billion. At that rate, ETFs could end 2011 with more than $100 billion in new cash for the fifth year in row.
The continuing credit squeeze also means many of the big players in the industry are scaling back their trading, in an effort to avoid any potential problems if funding dries up.
With memories of sudden margin calls at the height of the 2008 crisis still fresh, many managers are scrutinising banking relationships and preparing for the likelihood of tighter, more expensive access to credit as several major banks face up to their own funding troubles.
“This is a dynamic we’re all very familiar with because it happened a great deal in 2008 and 2009,” Benjamin Keefe, investment advisory director at Gamma Finance, says.
“That will have a knock-on effect either in terms of forcing hedge funds to exercise a gate to stop investors redeeming or to sell their more liquid assets to meet recalled leverage lines.”
Europe’s spreading sovereign debt crisis has virtually frozen lending markets for banks in recent weeks, prompting the world’s major central banks to take joint action to provide cheap dollar funding for starved European banks.
Many hedge fund managers will struggle to deliver anything like the strong returns they have become famous for without an ability to amplify the size of their bets, especially in strategies, which try to exploit tiny asset price dislocations.
Borrowing was falling before the recent crisis. For every dollar of equity, funds were deploying $1.10 in leverage, down from $1.27 a year earlier, a Hedge Fund Research report published in May showed.
During the 2008 crisis, managers with big borrowings were forced to sell assets into tumbling markets after banks beset with their own leverage woes retrenched.
“We have seen no moves by prime brokers regarding cost of leveraging or access to leveraging (but) as the wholesale markets seize up and the banks’ ratings continue to decline, you have to say it must at some point start becoming an issue for the hedge fund community,” one hedge fund manager said.
The average fund is down 8.48 percent this year to November 30, the HFRX Global Hedge Fund Index shows, and with leverage falling many will find it even harder to end 2011 in the black.
The proportion of funds not typically using leverage has grown to around a third, data from Hedge Fund Research showed.
“I think they are very aware that in this environment the last thing you want to do is take significant leverage with so much uncertainty out there,” said one London-based prime broker.
Those managers who are still adding leverage say banks are demanding much more collateral - making it more expensive for them to borrow - as liquidity for some assets dries up.
