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Dodd Frank Victory as MF Global Avoids Contagion

Stocks in this article: MFBACJPMICEGSCME

It is MF's major shareholders like RS Investment Management , Fine Capital, Pyramis, TIAA Cref and even Vanguard who have taken it on the chin.

The difference between MF and Lehman bolsters the case for the reform of derivatives sought in the 2010 Dodd Frank Act. Chiefly, it's a signal of why regulators like the Commodities Futures Trading Commission want to make trades written between two parties like credit default swaps and interest rate swaps standardized, cleared and traded through exchanges - instead of email, faxes and phones.

In fact, MF gained its present day market leadership when its parent Man Group bought bankrupt brokerage Refco in 2005 after a fraud scandal. Man then spun MF as its commodity trading arm in a 2007 IPO. Recently, MF's even made a push to become a full-fledged investment bank, which accelerated with the hiring of former Goldman Sachs (GS) co-head and New Jersey Governor Jon S. Corzine. Still, markets are saying the firm's not too big to fail.

In MF's business of executing trades like buying next year's jet fuel for an airline or making a bet on interest rates in 2012 for a home builder, the company acts as a 'futures commission merchant' executing trades on futures and options markets. In those customer trades, MF holds nearly $7.3 billion of money in the U.S. alone as of an Oct. 2nd filing, roughly 4.3% of all client money brokered under the jurisdiction of the CFTC. The amount's significant and would be a cause for alarm except that the money is held in segregated accounts at clearinghouses that are protected even if MF were to go bankrupt.

Dodd Frank rewires over-the-counter derivatives markets using the model of exchange based markets where MF is a major but unsystematically important player - building safeguards that will hopefully allow a major trader to go out of business without jeopardizing the global financial system and economy, as Lehman did.

It also allows financial players to fairly reap both gains and their potential demise in trading risks, without harmful consequences for others.

The markets muted reaction to MF's plight doesn't mean it isn't in a crisis stemming from poor risk taking. When announcing its downgrade of MF to junk, Fitch explained its rating by saying "the firm's increase in principal and, to a lesser extent, proprietary trading activities has elevated the firm's traditional risk profile. These increased risk taking activities have resulted in sizeable concentrated positions relative to the firm's capital base, leaving MF vulnerable to potential credit deterioration and/or significant margin calls." The company's shares and viability have suffered since cut.

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