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David at Deus ex Machiatto turns his discerning and well-trained eye to the MF mess. He basically concurs with my initial diagnosis that what brought down MF was increased haircuts on its repo trades. He concludes:

It seems much more likely to me that Corzine et al. didn’t understand the repo haircut risk – a modern phenomenon – than that they were rogues. Or, to use my own slang, this is a cockup not a conspiracy.

This would indeed be a cockup of massive proportions, and an ironic one to boot. Adjustment of repo haircuts is analogous to marking-to-market and variation margining in the futures world–which one of the world’s largest futures brokerages deals with on a daily basis. Did they think that this wasn’t an issue in repo? The very newness of the phenomenon should have put them on warning.

As David explains in his excellent and very readable book Unravelling the Credit Crunch, mark-to-market gives rise to risks throughout the life of the trade. Included in these risks are risks to fundamentals–in this case, changes in the likelihood of default on Italian, Portuguese, etc. bonds. But they also include changes in risk tolerance/risk aversion–the market price of default risk. They also include liquidity risks: Market prices change with liquidity conditions as well as fundamental conditions. In a mark-to-market mechanism, these risks combine to give rise to funding risk: You have to be able to access liquidity in order to make the cash payments obligations caused by changes in market prices driven by any or all of these factors.

These considerations are second nature–hell, fifth nature–to anyone who trades futures with their rigorous mark-to-market and variation margining mechanism. That is MF’s bread-and-butter, so it should have been particularly conscious of this issue. Any trading strategy has to be made, and funding for it provided, based on an assessment and understanding of these risks. Did Corzine really, truly not understand this was relevant for the repo trades in question? That would be negligent beyond belief. At the very least, he should have asked the question: What are the funding risks over the life of this trade? You should ask that about any and every trade you make.

In other words, Corzine’s trading strategy was either grossly negligent in its failure to take into account important risks (which seems to be David’s interpretation), or extremely reckless in its disregard thereof.

Cockup would be an understated description if Corzine did not ask this question, and take these risks into account. Or perhaps he did, but thought they were worth running. No, not a conspiracy, but an indication of a substantial willingness to take risk and/or a colossal deprecation of those risks.