WASHINGTON (DTN) -- Senators looked for answers Thursday regarding whether the MF Global collapse was a one-time market failure, part of a bigger systemic problem, a loophole in regulations, or a breakdown of basic oversight.

Initially, the Senate Agriculture Committee hearing was supposed to highlight how the Commodity Futures Trading Commission and Securities and Exchange Commission were implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act. But from the opening salvos, the focus was on how regulators allowed the MF Global bankruptcy to entangle customer accounts to the tune of an estimated $1.2 billion.

Almost every senator had tales of farmers and grain elevators caught in the bankruptcy with frozen assets and lack of answers about what happened to their accounts.

"This is not an academic exercise for a lot of people," said Sen. Max Baucus, D-Mont. "I'm speaking of farmers and ranchers who routinely hedge to lock in a price. It's a very common transaction."

As has been documented over the past month, the MF Global bankruptcy has hurt the confidence of farmers, grain elevators and others who invest in commodity futures.

A letter to Congress sent jointly on Wednesday by the National Grain and Feed Association and 18 other associations representing commodity producers, ag lenders and end users, stated, "Producers and agribusiness firms that rely on exchange trading to facilitate risk management, as well as lending institutions that support them, have had their confidence shaken ... We always have believed that the risk to customer funds when trading on exchanges was virtually zero. Now we see that is not the case."

"We need these markets to function properly and we need consumers to have faith in them," said Sen. Debbie Stabenow, D-Mich., chairwoman of the Senate Agriculture Committee. "Now, their confidence is shaken and MF Global's customers are understandably very angry."

The Senate Agriculture Committee hearing is the first of several on the subject to be held in the coming weeks. The House Agriculture Committee has a hearing Dec. 8, and senators will hold another on Dec. 13. The House Financial Services Committee has one set for two days later.

In describing the impacts on people, Baucus said he knew one Montana farmer who had $336,000 in assets at MF Global and another $108,000 in open trades with the company. He has recouped 60% but thus far appears to be out 40% of his funds. Baucus said such situations exacerbate the lack of faith in Washington to protect people in financial markets.

"How can ordinary folks trust Washington with their money? How can they?" Baucus said.

CFTC Chairman Gary Gensler, who has recused himself from the MF Global investigation, agreed with Baucus' assertion.

"You are absolutely right. The system needs to work for the farmers and ranchers and energy companies and all of the people who rely on segregation of funds as the absolute core of this system," Gensler said.

Customer funds are to be kept separated from company funds. Gensler said the rules on segregated accounts are clear. "Customer funds are to be segregated at all times of the day, not just at the end of the day."

Gensler also stressed that CFTC's obligations are growing, but funding provided by Congress is not keeping pace. Gensler pointed to a new computer system that will cost much more than allotted funds allow. Cuts may come from elsewhere in the agency, he said.

Mary Schapiro, chairwoman of the SEC, said there were no good answers for what happened with MF Global, but the bankruptcy and use of segregated customer accounts is not a systemic problem. Further, market oversight is based on a reliance that companies and clearing houses maintain market checks and balances. "We have to rely on people to follow the rules," Schapiro said. "That said, there has to be oversight of their activities."

A big part of MF Global's overall collapse was due to the company's heavy investment in European bonds. Sen. Kent Conrad, D-N.D., noted that under the law a company could invest customer funds in sovereign debt. But Gensler noted that the law says that could only occur if the customer was using that country's specific currency in transactions. Further, the rule requires the foreign debt to have a high rating by a rating agency. Oddly enough, the Dodd-Frank Wall Street Reform law actually requires the CFTC to remove the rating agency requirement from all rules.

Another problem raised by Conrad and others is that the Securities and Exchange Commission runs an insurance program, the Securities Investor Protection Corp., that covers losses up to $500,000. But it has never been deemed necessary to create a similar insurance program in commodities.

ACCOUNTING LOOPHOLE

Conrad also questioned how MF Global could use a hidden accounting technique to buy European bonds. The bonds actually appeared to account for several times more than appeared in the company's entire market accounts. MF Global used a "repossession and maturity technique" that made the bond trades appear to be sold for accounting purposes. Conrad said this would appear to be a bigger overall problem and would allow other major financial firms to be leveraged even more than they might otherwise appear.

"How is it possible someone is able to bet the farm multiple times here, multiple times the market cap and it disappears from the balance sheet because this repo and maturity technique considers them sold?" Conrad asked.

Schapiro acknowledged there are questions over whether repo and maturity transactions should appear on the balance sheet of a company.

"That is a loophole so big you could drive a Mack truck through it," Conrad said. "If we don't close that down I don't know what we're doing."

Outside the hearing, Conrad expressed more concern. "What they are saying is under generally accepted accounting principles you don't have to disclose debt obligations that you actually have," Conrad said.

Sen. Mike Johanns, R-Neb., said the rules are clear, but it appeared to him that the situation stemmed from a failure of regulators to pay attention to people who played with money and made bad bets. CFTC Commissioner Jill Sommers, who is overseeing the MF Global investigation, said it was too soon to determine whether the regulators failed.

"You can have the strongest, most effective oversight and it will not prevent people from violating the law," Sommers said.

The association letter asked Congress -- and the CFTC, which received a nearly identical letter -- to consider:

- Whether it is more appropriate for another entity, such as the futures exchange, to hold segregated funds rather than the clearing firm;

- Whether the auditing process is sufficient in terms of who is responsible for the oversight, who does the audit, what should be included in the audit and frequency of audits;

- How segregated customer funds are allowed to be invested;

- Whether exchanges should have some legal responsibility for customer funds in cases of bankruptcy or malfeasance on the part of clearing members;

- Whether the Securities Investor Protection Corp., which insures securities, should be expanded to cover commodities.

STATUS

The bankruptcy trustee has moved to fund customer accounts up to 60% of their value before MF Global's collapse. The trustee also has a motion now in the bankruptcy court to bump up that fund reimbursement to 66%. It's unclear whether regulators and investigators will find more funds to repay customers above that level, but Sommers said the goal is to fund the entirety of the customer accounts.

"We are hopeful we will be able to return all of the money that is in the accounts -- to make them whole," Sommers said. "That is our goal."

One of the reasons the bankruptcy trustee has been able to incrementally fund accounts to higher levels is that CME Group has set up a $550 million account. That account would kick in if the trustee finds that the MF Global shortfall for customer funds is actually higher than the current 34% gap that customers now face.

Stabenow noted in her opening statement that MF Global demonstrated "how dangerously exposed our economy is to what is happening in Europe."

Gensler worked at Goldman Sachs in the 1990s with former MF Global CEO Jon Corzine. Gensler found himself answering repeated questions about why he felt he needed to recuse himself from the MF Global investigation and the timing of his recusal. Committee Ranking Member Pat Roberts, R-Kan., questioned Gensler on that point, as did Johanns. Yet, Sen. Charles Grassley, R-Iowa, commended Gensler for the decision, having specifically asked Gensler to step aside on the investigation just shortly before Gensler did so.

Chris Clayton can be reached at chris.clayton@telventdtn.com

(LS/SK/AG)

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