Tuesday, November 1, 2011

What Was Jon Corzine Thinking? (Updated)

Careers don’t crater any more ignominiously than Jon Corzine’s.  Consider the trajectory:  from the fabulously rich and accomplished head of Goldman Sachs, to a star of the Democratic senatorial caucus, to a Governor of New Jersey with national political ambitions, to the guy who managed to lose to a belligerent Republican in a dark-blue state which he left with an $8 billion deficit, to the guy hired to turn MF Global into the next Goldman Sachs who managed to turn it into the next Lehman Bros. instead.

Apparently, Corzine bet his company on the proposition that the still-solvent EU member states and the European Central Bank would never let the PIGS default on their sovereign debt.  And MF shareholders went along for ride, presumably on the theory that someone with Corzine’s experience was the right guy to bet on when it came to managing risk that arose at the intersection of finance and politics.  In light of the events of the last three years, it’s hard to say what looks worse in hindsight, Corzine’s faith in his own capacity to foretell the financial/political future, or the shareholder’s faith in Corzine.

The shareholders’ faith in Corzine is more excusable, however, because sophisticated individual shareholders presumably weren’t putting all of their financial eggs in Corzine’s basket.  He was a fiduciary betting his whole company on his capacity to manage risk.  Corzine knew what happened to companies like Bear Stearns and Lehman Bros. when that laid down similarly unhedged bets, but he laid down his on sovereign debt anyway.  What could he have been thinking?

Henry Blodgett does a good job of sharpening the question:
“For the past three years, Europe has been a slow-motion train-wreck. And although it may have seemed a certainty to Corzine and his traders that the idiots who lent money to Spain, Portugal, et al, would get the same 100-cents-on-the-dollar bailout that the idiots who lent money to US banks got, there was always a chance that they wouldn't. And Corzine and his traders obviously knew that.”

Blodgett argues, convincingly enough, that Corzine underestimated the risk that the PIGs would default because a still-demented Wall Street incentive structure magnifies the upside and mitigates the downside for the people positioned to place such improvident bets.  But it’s important to note it was mostly political risk that Corzine was underestimating.  He thought that the bond market was undervaluing PIGS debt less out of a mistaken view of their solvency than out of his overestimation of the capacity of the EU and the European Central Bank to manage the balance sheets of member states and the determination of still-solvent EU member states to bail the PIGS (and their national banks holding lots of PIGS debt) out before they defaulted.  Apparently, it didn't occur to Corzine that there'd be limits to the German taxpayers' tolerance for the profligacy of the Italian and Spanish and governments.    

When you come to think of it, Corzine had pretty much the same misplaced confidence in the people running the EU that he had in himself when he was running up a deficit in New Jersey.

Update:  Charles Gasparino reminds me that Corzine got in trouble for similarly inept risk management when he was running Goldman Sachs.


Anonymous said...

A stunning failure. There will be books and articles and case studies about this one, to be sure.

Corzine was taking a bet with OPM and could have either hit the jackpot or crashed and burned. The fires are just being stoked and now, with the latest news of co-mingling of firm money with customer accounts and missing money, there are a few shoes left to drop.

Expect a perp walk before too long.

Mean Voter said...

Corzine was thinking he was a Master of the Universe. I'm sure he still does.