MF Global's Summer Scramble for Capital

NEW YORK (TheStreet) -- Securities firm MF Global(MF) knew it was in trouble even as it issued debt during the summer.

The company sold $325 million in senior convertible notes in July and then offered $325 million of senior notes in August.

Part of the money was used to replace 9% notes with much cheaper 6% and 3.275% debt. But part of it was intended to shore up the company's capital levels.

Revenue was dropping, as it was for most financial firms in the third quarter, but MF Global saw its net losses almost double, to $191.6 million from $94.3 million a year before.

CEO Jon Corzine, the former New Jersey governor, said the company was "focused on preserving capital and liquidity." Preserving capital is basically saying, "Grab the life jackets."

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The company has a market cap of $197 million but took on a risky $6 billion position in European debt. Not German sovereign debt, but the debt of troubled countries like Italy, Spain, Portugal and Ireland.

This exposure caused FINRA (the Financial Industry Regulatory Authority) to require MF Global to raise more capital, and JPMorgan Chase(JPM) extended the company $300 million in credit in September.

So in three months, MF Global sold more than $600 million worth of debt and took out another $300 million line of credit. Almost $1 billion in three months.

Lionel Mellul, Co-founder and Partner of Momentum Trading Partners says, "They took too big of a position of risk, $6 billion vs. their capital. That's the problem with poor risk management. They did not stop a losing position."

One employee that recently left the firm says that even though he was removed from the trading, everyone at the firm knew that the risk was rising.

"It felt like every day we went to work, we wondered did they put the chips on black or red that day," he said. "It was very disconcerting."

So just as MF Global is dealing with the dropping value of debt it purchased, so are the holders of MF Global debt.

The bonds trade in fairly small quantities, but as word began to spread that MF Global was in trouble, the bonds began trading in the millions.

The value dropped almost 60% at one point as bondholders scrambled to get something for their trouble.

Word had gotten out that some houses were told to quit trading with MF Global. That set off a chain reaction because no one wants to be the last guy out the door.

Everything MF Global said to try to reassure the market sounded ominously like what Bear Stearns and Lehman Brothers were saying before they went down.