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MF Global 'disaster' worsens

What started out as a bad situation is getting worse.

MF Global's announcement that it was filing for bankruptcy a couple weeks ago has set into motion a string of events that led to the revelation this week that now as much as $1.2 billion of client funds could be lost after the brokerage firm allegedly commingled client funds with its own investment money to meet margin calls. Tavakoli Structured Finance, Inc., president Janet Tavakoli puts it this way.

"You may buy a Rolls Royce with customers’ excess cash, sell it at a profit, and pocket part of the profits. You may buy a Rolls Royce and try to resell it at a profit with your firm’s cash. But you aren’t allowed to take customers’ money to make the car payments on your firm’s Rolls Royce," she says. "If one engages in this impermissible activity, it becomes almost impossible to cover up if you have an accident driving your Rolls Royce."

MF Global's actions, according CME Group leaders, haven't been in compliance with rules on the segregation of customer and corporate money. And now as former MF Global customers work to transfer accounts to other brokers, it's likely that they'll incur losses. How much is still a big question mark, says ICAP Energy LLC Derivatives Manager and options trader and specialist Scott Shellady.

"MF Global was a very aggressive clearing firm insofar as prices clearing elsewhere will most certainly be more expensive. A more nervous and more expensive trading environment does not bode well for business," Shellady says. "How long 'til the trade puts all this behind us? What will all the final segregated losses be? Only time will tell."

Those losses -- though huge in the context of today's marketplace -- could pale in comparison to the damage the markets could incur in the future if regulatory changes don't do enough to restore trader and investor fears about the security of their investments in the commodity trade, Shellady says.

"I am not sure what the exchange can do to give its customers some confidence in the system but if they don't they risk losing their franchise. While the 'system' worked and we didn't melt down on a shadow bank failure, there will be higher costs for everyone going forward," he says. "The regulations that will ultimately be enacted will make it more expensive for us to trade. We have an opportunity to either bolster good sentiment or set the industry back decades.

"It is a disaster. A 'Tylenol type' moment. How the exchange and regulators handle this will be studied in business school for a long time," Shellady adds.

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