As it turns out, MF Global's decision to bet the farm—and its client's money—on European sovereign debt was encouraged by regulations and the policies of the Federal Reserve.
MF Global was barred from investing funds held for clients in most US corporate bonds. It could only invest in CDs, commercial paper, corporate notes, and money market funds. In our age of zero-interest rates, none of those choices if very profitable.
But, as it turns out, there was one alternative investment permitted by the regulations that could pull a decent return—especially in 2011.
The investment? Sovereign debt.
Here's William Cohan explaining the relevant regulation:
In December 2000, the CFTC agreed to amend Regulation 1.25 “to permit investments in general obligations issued by any enterprise sponsored by the United States, bank certificates of deposit, commercial paper, corporate notes, general obligations of a sovereign nation, and interests in money market mutual funds”—in other words, riskier investments that could make more money for Wall Street.
Then, in February 2004 and May 2005, Regulation 1.25 was further amended and refined... In the end, the door was opened for firms such as MF Global to do internal repos of customers’ deposits and invest the funds in the “general obligations of a sovereign nation.”
So regulators basically loaded the dice in favor of MF Global's investment strategy
Did anyone else follow this regulatory view of risk into potential oblivion?
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