Worse yet, we keep on hearing frustrating tales about poor communication whether it be from the Commodity Futures Trading Commission (CFTC), CME Group or the Securities Investor Protection Corporation (SIPC) trustee from MFGI customers who for years were told by the leaders of the industry that what has been happening could not happen. Namely that their segregated funds where safe and would not be put in jeopardy even — or especially — in case of an FCM collapsing.

While there has been progress of late there still has not been a viable explanation why it has been so difficult to get customers their money back. We understand there is a shortfall in customer segregated funds and we understand an investigation takes time but there has been no logical explanation from the trustee why they can’t pinpoint the size of the shortfall or why what customer money is accounted for hasn’t been returned to them already.

And perhaps most disturbing is that what progress has been accomplished so far has been attributable to a grassroots movement of a handful of angry customers and ad hoc organizations formed on the fly as opposed to the so called leaders of the futures industry who have appeared to be asleep at the wheel and willing to let futures customers twist in the wind.

CME Group blamed MF Global shortly after the bankruptcy claiming that on the week they were in trouble (later determined to be Wednesday Oct. 26) they completed an audit that showed MF Global was in compliance with its segregation requirements. They then learned on Oct. 31 that MF Global had a shortfall in customer segregated funds (and by the way put out a pretty specific estimate of the shortfall of $633,027,696). According to numerous back office sources an FCM is required to report its customer segregated funds to its designated self regulatory organization (DSRO), in this case CME Group, on a daily basis. At the point their audit was completed, it was common knowledge that MF was in much distress so we find it difficult to understand how CME was not more on top of it. As former CME regulator Peter Moy wrote on a comment board, “in previous situations like MF Global, the Audit Department would be present at the firm everyday to insure that all segregated customer funds were properly accounted for. The excuse that they transferred the funds after the audit is lame.”

The CFTC has been MIA for most of this as Chairman Gary Gensler recused himself due to his relationship with former MF Global Chairman and CEO Jon Corzine from their days at Goldman Sachs. The SIPC liquidation trustee has come under a lot of criticism but most of it has to do with his lack of knowledge of the industry, which is why many in the industry were perplexed the CFTC and CME Group didn’t fight for more control of the process. One former MFGI customer who still has nearly $185,000 frozen wondered whether the trustee assumed customers with positions got 60% of their money back instead of just 60% of the margin held at CME Clearing.

It is an important question because the trustee pledged last week—after much external pressure from groups like the Commodity Customers Coalition (CCC)—to have an interim distribution to “cash only” customers. The Intercontinental Exchange (ICE) sent a letter to the trustee pointing out that customers who exited their positions before the bankruptcy did not receive any allocation as the trustee just completed a transfer of positions and a portion of the margin used to hold those positions. While the cash only transfer addresses certain customers, many other had only minimal positions and still have 80%, 90% or 95% of their accounts frozen. Today the trustee noted that there will be another interim distribution that would attempt to get all customers 60% of their assets returned.

Former MF Introducing broker Sean McGillivray just wrote, “The impact on investors have been well documented. Inconsistent and unequal treatment of differing accounts by regulators as well as the exchanges has eroded confidence in the system. It has also forced unnecessary client liquidation losses. Our firm now holds unsecured debits on the books at our new FCM, because of the CME’s (half hearted and really half thought out) transfer plan.” McGillivray went on, “The majority of our client accounts remain frozen with little hope of a speedy resolution. The industry must step up to restore confidence. The CME is one of the few entities capable of guaranteeing any shortfall, effectively allowing for the immediate release of client funds.” 

This is one of many notes we have received detailing the frustration with a broken process and a disconnect between customers and businesses under stress  and those responsible for resolving a problem that was not supposed to happen and has not been well managed.

So lets recap. Tomorrow will be three weeks since MFGI went under. The trustee completed it initial transfer that returned positions and $1.5 billion in customer margin money last week to 14,500 accounts. It has pledged a second distribution of 60%, about $520 million, of the capital in cash only accounts. The second distribution is said to have begun but is not complete. When that is complete it would mean that just over $2 billion of $5.4 billion would have been returned to customers in just under a month. That is a little more than 35% of customer money that was never supposed to be at risk, even in a bankruptcy.

That is not a give job. Not by the trustee and not by the folks who should be looking out for their customers or the folks who are charged with keeping an orderly marketplace.

Throughout the process the language of the trustee appears to confuse the distinction between customer segregated money and general claims in a bankruptcy. Nothing has angered former MFGI customers more than the term “claims process.” They reply that they have segregated accounts. It is their money that by law is kept apart from the funds of the broker. They don’t want to make a claim, they want their money back. And they should have gotten it back by now, or at least what is left of it and they should be first in line for anything that is left.

The bank did put out a news release earlier in September describing “transformation” efforts by the bank that would reduce its exposure to sovereign debt, lower it s leverage and control costs. 

Societe Generale Chairman and CEO Frédéric Oudéa stated in the release, “Societe Generale’s foundations are solid. Its exposure to (Greece, Italy, Ireland, Portugal and Spain’s) sovereign debt is low and very manageable in any final scenario. The Group’s businesses are profitable, it liquidity situation is very much satisfactory and so are its shareholder equity and solvency levels.”

The release detailed how the bank has been reducing access to short-term liquidity.

What may have led to rumors about Soc Gen unloading assets  is an item in the release under the sub title “Resolute actions to accelerate the transformation.”

In addition to lowering leverage and cutting costs, it said, “The Group would free €4 billion of capital by 2013 through business assets disposals.”

Oudéa did not provide specifics regarding what assets would be sold at a press conference following the release but said they would mostly come from the global investment management and services division, which includes Newedge as well as several other of the bank’s assets including Amundi Asset Management,  TCW, Societe Generale Private Banking and Societe Generale Securities Services.

Since then there has been a lot of speculation regarding exactly what assets would be sold to raise that capital. Part of the speculation surrounded Newedge but what I didn’t see speculated on was who in the world would buy them.

Newedge is the number one futures commission merchant based on customer segregated funds. As of the Commodity Futures Trading Commission’s July report, Newedge had $24.7 billion in customer segregated funds, increasing their lead over second place Goldman Sachs considerably. And that does not include customer funds held outside of the United States.

I couldn’t guess what type of player would have the size and scope to purchase such an asset and for how much.

And from experience I know that that #1 ranking means something to the folks at Newedge, which was formed by the merger of Fimat and Calyon Financial in 2008 after a long courtship.

We will shortly be putting together our annual ranking of Top FCMs.  One item included is a survey question regarding non-U.S. customer equity. It was added a few years back after Fimat made the point that their size was underrepresented because their non-U.S. assets were not included. We thought they had a point and decided to include an item on non-U.S. assets in our survey but the item is not tremendously useful as not everyone includes it.

We often hear complaints that customer seg funds is not the best measure of a firm but it is the only one we can get that is complete and comes from a third party source. And despite complaints all the FCMs are eager to see how they measure up.

Since the merger Newedge has competed with Goldman Sachs for the top spot and now appears to be the clear #1.

I wonder if we will have a last minute change. I doubt it.

I started by Googling state corporate income tax rates to see how bad the rate in Illinois was compared to surrounding states, figuring if the CME Group wanted to remain close to its namesake, it would find a bordering state. Illinois has a flat rate of 9.5%, but that includes something called a replacement tax of 2.5%, which I’m not sure applies to all companies, but probably applies to the CME Group, which is a financial institution.

Wisconsin seems a logical choice with its new hard nosed Governor Scott Walker who loves giving businesses tax breaks while concurrently breaking public worker unions. Wisconsin, according to my source, has a flat rate of 7.9%. Many traders have summer homes in southern Wisconsin, so perhaps that 1.6% savings would be worth it, and hey, Friday nights are great for fish fries.

And Indiana is a short hop from Chicago. Who doesn’t love Gary, Indiana, afterall, a song was written about it. Indiana’s corporate rate was a flat 8.5%, which meant a 1% savings. Hardly enough to move everyone across the state line, unless they wanted to save on cigarette and gasoline taxes as well.

Iowa, which is a bit of a drive, came in at a sliding scale, as low as 6% and as high as 12%. No doubt the CME Group would be in the higher tax brackett, but maybe not. I’m not sure how good it would be for traders, however it might appeal to Iowa farmers who have long begrudged LaSalle Street traders, after all, they wouldn’t have to drive their tractors so far to protest.

Those are the closest states, although other Midwest states might be plausible: not Minnesota with a 9.8% tax rate, but Michigan with a 4.95% rate seems downright reasonable. And I’m told Detroit has alot of open buildings.

Then I thought: if they were going to move, why not go all the way and find a state that has no corporate tax rate? Surely there has to be some of those, and it turns out, there are.

Washington State surprised me. Wonder why Bill Gates doesn’t move. But a strange thing happened several years ago: Boeing Co. moved it’s corporate headquarters from Washington State to Chicago. I can see the building from my window…and I’m sure CME Group Chairman Terry Duffy can as well. So why move to Illinois? I seemed to recall that it was centrally located, business friendly and they were better able to recruit. And it didn’t rain so much.

Other states without corporate taxes: South Dakota (recruiting might be hard), Wyoming (good skiing but same problem as South Dakota), Florida (too many hurricanes, but home to many traders) and Nevada. And my own feeling is Nevada is a non-starter; can you imagine the public relations nightmare of the largest futures exchange in the world moving to a state built on gambling?

So if the CME Group is serious about moving, they need to review all the possibilities. A savings needs to cover the expense of moving, finding new people (who won’t move to Gary), and of course changing the name. Chicago (the ‘C’ in CME ) would have to go, and that would mean new branding expense. Boy, now that 1.6% savings Wisconsin would give doesn’t look like so much. Further, the Illinois rate is slated to drop back to 5.25% (not including replacement tax) in 2014.

 So what’s the point other than leaning on the state and city of Chicago for tax breaks, which no doubt will be coming. And that, as they say, is exactly the point.

Today’s employment situation report showed growth in nonfarm payrolls of 54,000, about 120,000 fewer than were expected and that expectation was dropped this week due to other weak economic news. Namely Wednesday’s Institute For Supply Management’s (ISM) manufacturing index.

 ISM  dropped to 53.5 in May from 60.4 in April, the largest month over month drop since 1984.  The new orders component slipped to a reading of 51. Readings below 50 indicate a contracting economy. ISM has become one of the most followed economic indicators and if you have any doubt follow the below ISM chart along with a chart of the Dow Jones Industrial Average Index. Dips in ISM have been followed closely by drops in the stock market.

Federal Reserve Board Chairman Ben Bernanke announced in April that the Fed would complete QE2 this month in the Fed’s first ever press conference, though it was not clear whether or not he ruled out a QE3. What was clear was that the Fed would continue reinvesting principal payments from its securities holdings.

That is significant as ending that practice would be the first step in an exit strategy. That exit strategy seems to be further away today than it was last week, but if you were paying close attention to the markets you would have seen that expectations of Fed tightening have been pushed back fairly dramatically since April 1.

Despite what was on the surface a strong employment report for March, which was released on April 1, that is when Fed Funds began rallying sharply. On April 1 the expectation based on fed funds futures was for a 25 basis point tightening by December, now it indicates no change. The June 2012 contract indicated on April 1, rates would have risen to between 0.75%-1% by June 2012,  now it is pricing in no change. The October 2012 contract indicated on April 1 that the rate would be between 1%-1.25% by that time, now it is indicating a rate of 0.50% on the eve of the 2012 election.

Given these numbers, talk of a double dip recession doesn’t seem so crazy.

Aubrae De Buse wrote a piece for us exploring the four stages of a bull market. In the article, De Buse warns that as a bull market gets close to its bursting point, all you will hear is people yelling to buy more of whatever it is. Eventually, he even says it gets to the point where “clowns are driving the bus.”

What do you think? Read De Buse’s piece and watch what Cramer has to say in the video below. Should investors start to worry that clowns are driving the bus, or does this market legitimately have some more room to run?

It is a particularly dangerous time as the Commodity Futures Trading Commission (CFTC)is contemplating final rules on commodity position limits.

While much of the focus has been on crude oil this could change as on  Monday, silver futures surpassed $41.50 and is currently trading above it (see chart below). That level is significant as it is the high set in January 1980 at the peak of the Hunt Brothers attempt to corner the silver market. The key to that attempt — and nearly all corner and squeeze attempts — as Henry Jarecki explains in our upcoming May metals issue, is their huge presence in the cash market.

This fact is being lost on many so called experts as silver is back  at elevated levels and for some that is proof enough of manipulation. There is a furor that somebody needs to do something about high prices. That is always a dangerous place to be because often that something creates more problems than existed in the first place.

In  previous articles and in testimony before the CFTC, Jarecki has argued that blaming Futures markets is akin to blaming a thermometer for spikes in the weather.

We will examine this in coming weeks as we expect the controversy to grow but we want to here from you.

But the real competition has to do with the battle over margin efficiencies in the massive Treasury complex. CME Group and prior to the creation of if it (through the Chicago Mercantile Exchange’s acquisition of the Chicago Board of Trade) CBOT has battled to keep its supremacy in interest rate futures. The CBOT pushed aside most rivals with ease but when DB subsidiary Eurex made a serious challenge to list Treasuries while also negotiating with the Board of trade Clearing Corporation (BOTCC) to clear its soon to be listed U.S. Treasury futures contracts, the challenge became more viable.

The two Chicago futures giants answered by creating the Common Clearing Link, which delivered efficiencies to end users that they had been clamoring over for many years. They would later merge.

Contrary to popular opinion at the time, the CBOT had moved into the future and had a viable electronic market so they were not as vulnerable as some had suspected. By moving all CBOT positions to the CME clearinghouse they created additional efficiencies for end users.

NYSE Liffe U.S. offered a glimpse of the real competition it is embarked on with CME after the New York Portfolio Clearing was approved last week. NYSE Liffe U.S., like so many others before it, is attempting to take on the huge Chicago interest rate complex. Can they succeed? Many people like to say that it is impossible for one exchange to move a liquid viable contract from another exchange. That is not quite true. It happened with the bund and was about to happen with the Comex gold and silver contracts when the CME bailed out Comex and the New York Mercantile Exchange by forcing the CBOT to stand down (through its buyout offer along with existing non-competes with Nymex) right when the CBOT was close to gaining the upper hand.

The lesson is that in order gain traction when taking on an entrenched contract you need to offer an additional efficiency.

NYSE LIffe U.S. believes they have it with NYPC, a joint venture between the Depository Trust Clearing Corporation and NYSE Euronext, which will clear both cash Treasuries and futures in a ‘One Pot” clearinghouse. The CME already answered—a day earlier—with a new clearing entity they purport will offer the same efficiencies.

We will not handicap the battle at this point but it is clear that the creation of NYPC ups the ante a bit. Like other attempts to wrestle control of the Treasury complex many of the end users have a financial stake in the competing entity, but as history has proven this is insufficient in itself to create change. But given the expense of the operation it is clear this is not simply an attempt to put a check on CME Group for fear of its pricing power but a serious attempt to provide something new. It will be an interesting battle—NYSE Liffe will launch Eurodollars on March 21 and the entire Treasury suite a week later—and one more interesting than all this merge talk.

 Pause here, please, to hear the guffows of family farmers who have complied with the exchange/clearing margin regime for about 150 years.

 So, what does margining really do? Tom Cruise knows: “Show me the money!” Want to trade? Deposit some funds as collateral first.  If your trade posts paper losses, add more. Neither the original deposit nor any additional deposits will truly be “lost” unless, in the end, you really DO owe money. Otherwise, you will get all of it back. Meanwhile, you can deposit interest-bearing securities that yield income to you. That is a better outcome than pursuing a failed merger, or a dry drilling exploration, or a new product that tanks.

 According to news reports, corporate America is sitting atop a $2 trillion cash heap. One major corporation, exempt under Dodd-Frank, just reported a NET PROFIT of $9+billion for its 4th quarter alone, after all of the spending it could muster.

It is too late to change the law but this does not justify changing the facts.

Philip McBride Johnson is a former CFTC chairman. He writes regular blogs for Buytherumorsellthefact.com. You can reach him at philipmcbridejohnson@gmail.com

Below is a video we found that attempts to explain the bank bailouts in a straightforward way. While it is definately done tongue-in-cheek throughout most of it, it raises some good questions. While we are not vouching for the validity of everything it claims, much of it sounds familiar to the massage we heard from former FDIC Chairman Bill Isaac when we interviewed him in July 2010, be sure to check out his comments as well.

After you watch the video and read what Isaac says, we would love to hear your thoughts on the subject. Were the bailouts necessary? Should TARP be considered a success?

While it is easy to claim HFT is just the next evolution of trading, it is hard to ignore some of the concerns some people have about HFT’s impact on the markets. Although it is decidely negative, the below video does a good job bringing up some of the concerns that are out there about HFT.

To be fair, the video is a little over the top and many HFTs claim their actual trading is different from their market maker responsibilities and the video does not differentiate between the two. There are plenty of other things that can be said to the defense of HFT, but if nothing else, the video gives a good idea of how many people view HFT.

Note: We are not vouching for the varacity of the video, we merely found it interesting. We would love to hear what you have to say on the subject. Please leave your comments below.