MF Global (MF): Already Ugly. Getting Uglier.

The latest estimates of the shortfall in MF Global (MF) customer accounts have doubled, to $1.2 billion:

The trustee overseeing the wind-down of MF Global Holdings Ltd.’s brokerage said more than $1.2 billion in customer funds could be missing from the failed firm, more than double the original estimate of missing cash.That estimate of missing funds represents funds that should have been segregated in stand-alone customer accounts by MF Global in accordance with regulations, the trustee said.

Apparently the issue is that MF held about $600 million of its own capital in customer seg accounts to cover potential customer defaults (which as a clearing broker it is on the hook for). Add that $600 million to the $600 million original shortfall estimate (which apparently was made without taking into account the MF Global capital held in the accounts), and you get to the $1.2 billion figure.

Already ugly. Getting uglier.

When financial/trading firms implode, they do so with incredible speed. A lot of money sloshes in and out of them every day, and in the desperation and chaos of the implosion controls break down–and are sometimes deliberately broken down. In the scramble for cash to meet incompatible demands from importuning creditors and clients, a lot of money can go out the door. This isn’t like the collapse of a manufacturing firm with assets like machines and buildings that are hard to turn into cash quickly, and which keeps little cash on hand. Firms like MF have mainly liquid assets, and handle large quantities of cash and liquid assets for others. Thus, there is a much greater risk of illicit transfers in collapse of this type of firm than in others.

Interestingly, this is one reason why financial firms have fragile capital structures. If they didn’t, it would be quite easy for managers to misappropriate assets. Capital structure fragility and the associated potential for runs are a disciplinary device: customers and funders who suspect misappropriation can run, and destroy the firm in a trice.

But this disciplinary device is imperfect, as are all such devices. Sometimes managers misbehave, and these firms implode quickly as customers and funders flee. We are witnessing exactly that with MF Global.