Permanent Portfolio

MF Global lays out the perfect case for Rule #10 in the 16 Golden Rules of Financial Safety:

Are customer accounts at brokerage firms safe?

Until the collapse of MF Global, that’s a question I thought I’d never have to ask.

Brokerage firms are required by law to maintain segregated accounts holding all client assets, including stocks, bonds, mutual funds, money market funds and cash. The law was passed after the 1929 crash, in the depths of the Depression, to make sure that customer assets were there at all times, ready to be disbursed even if everyone asked for their money at once.

This obligation to protect customer assets “is considered sacrosanct,” Robert Cook, director of the division of trading and markets at the Securities and Exchange Commission, told me this week. “It’s considered a sacred obligation.”

Lehman Brothers may have engaged in many foolhardy practices, but even in the firm’s last days, when officials were desperate for cash, no one dared touch customer assets, which remained safely segregated despite the firm’s collapse.

And then came the revelation that an estimated $1.2 billion in customer assets had vanished at MF Global, the large brokerage and futures trading firm headed by Jon S. Corzine, the former Goldman Sachs executive and Democratic politician, that collapsed in late October after a catastrophic bet on European sovereign debt.

How could such a thing happen? I had always assumed it was impossible and that strict internal controls existed at all brokerage firms so that firm officials couldn’t tap segregated customer funds even if they were willing to break the law. Thanks to MF Global, it’s now apparent that isn’t necessarily true. “If people are determined to misuse customer funds, they will misuse them,” said Ananda Radhakrishnan, the director of the division of clearing and risk at the Commodities Futures Trading Commission. – A Risk Once Unthinkable by James B. Stewart – New York Times December 9, 2011

(Emphasis added)

Rule #10 States:

Rule #10: Don’t depend on any one investment, institution, or person for your safety.

Every investment has its time in the sun — and its moment of shame. Precious metals ruled the roost in the 1970s while stocks and bonds were in disgrace. But then gold and silver became the losers of the 1980s and 1990s, while stocks and bonds multiplied their value. No one investment is good for all times. Even Treasury bills can lose real value during times of inflation.

And you can’t rely on any single institution to protect your wealth for you. Old-line banks have failed and pension funds have folded. The company you think will keep your wealth safe might not be there when you’re ready to withdraw your life savings. 

We live in an uncertain world, and surprises are the norm. You shouldn’t risk the chance that a single surprise will wipe out a large part of your holdings.

(Emphasis added)

I always recommend keeping your savings at more than one institution and not using the same fund company for all your investment money (for instance not using all Vanguard funds or all iShares or all Fidelity, etc.). It’s best to split up the assets in case something very bad were to happen with your brokerage or the company running the funds.

I know it’s more convenient to keep everything at one broker or fund provider because of unified statements, etc, but it’s really not a good idea for diversification. You’ll even notice on this blog when I recommend using ETFs, I tend to not provide tickers from all the same company (like iShares). Rather I think it a better idea to use some Vanguard, iShares, SPDRs and of course physical gold storage somewhere secure. MF Global is the poster-child why this kind of thinking is a good idea.

H/T to Ad Orientem for his link on the forum reminding me to make a comment about this latest financial industry debacle.