The last days of MF Global

Goldfield, 52, was a former trading superstar who had spent 15 years at Goldman Sachs—brilliant and impeccably connected (Bob Rubin and Larry Summers loved him), but equally quirky and unassuming. Raised in the South Bronx, he’d majored in physics at Harvard before dropping out of law school there to start at Goldman, where he made partner in record time.

After leaving the partnership with a fortune in 2000, Goldfield helped manage U.S. Senator Jon Corzine’s blind trust and spent a year and a half as chief investment officer for George Soros’ $11-billion hedge fund. Now on his own, he periodically journeyed west to Stanford, where he conducted economics research at a university think tank.

Goldfield was a crisis junkie. He exuded a childlike fascination with economic events, especially disasters. He found himself summoned to the scene of each new meltdown—AIG, Bear Stearns, Lehman Brothers—by desperate men seeking his aid in the often-hopeless struggle to save a balance sheet under siege. Sometimes he stood to make some money, if a private rescue actually went through. Sometimes it was just volunteer work. Goldfield did it for his friends, or simply because he found it interesting.

Goldfield held a singular notion of how to think about a financial crisis. He viewed it as a predator, intelligent and merciless, hunting you. If you didn’t move fast enough, you’d meet a swift and certain end.

Now MF Global needed his advice.

The collapse of MF Global in October 2011 was a remarkably powerful event: It destroyed the reputation of a famous man; it elevated a firm that no one had ever heard of to infamy; and it shattered public trust in the belief that brokerage customers’ money is always safe.

In the months that followed, America’s eighth-largest bankruptcy has become a spectacle and public scandal. Jon Corzine, the former U.S. senator, governor, and chief of Goldman Sachs who rode MF Global into the abyss, finds his legacy in tatters. And the hunt for the money continues, with investigators chasing $1.6 billion in customer cash that went  missing—something that’s never happened before on Wall Street.

A six-month Fortune investigation into the failure of MF Global reveals a mismatch of tragic proportions: how a too-small company came together with a too-big CEO. Combining their mutual shortcomings—in ambition, controls, and discipline—simply proved toxic.

This story is based on more than seventy interviews with regulators, industry executives, legislators, lawyers, friends and family of Corzine, and people at all levels of MF Global. Fortune also gained access to hundreds of pages of confidential board minutes, internal reports, company emails, and other documents.

A 275-page report just released by James Giddens, the bankruptcy  trustee pursuing the missing money, confirms and amplifies many of the findings in Fortune’s investigation. It concludes that there is a basis for civil claims against Corzine and two of his deputies for “breach of fiduciary duty and negligence.” (Update: In a statement, a Corzine spokesman responded: “We simply do not agree with the Trustee’s suggestion that Mr. Corzine was negligent or there is any other basis to sue him.”) But while the aftermath of MF Global’s failure is the dusty stuff of courts, lawyers and accountants, Fortune’s exploration of its fall reveals a distinctly human drama.

The MF Global saga unfolds like a Hollywood disaster movie. It begins with a larger-than-life protagonist, accompanied by the classic elements of hubris, the pursuit of redemption, and the pressure to please Wall Street; it picks up speed as warning signs are foolishly ignored; and it ends with a frantic, nightmarish week of desperation and chaos—the week of the call to Jacob Goldfield—that climaxes on Halloween.

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What was MF Global anyway?

Of all the places on Wall Street for Jon Corzine to land—at 63, after one career at Goldman Sachs (GS) and a second act in high-octane politics—it’s hard to imagine a less likely spot.

MF Global was a publicly traded futures broker. Its primary business was handling trades that allowed hedging and speculation in such things as pork bellies, metals, and foreign currencies. Its customers and trading partners included small farmers and day traders, as well as giant hedge funds and big companies, such as Koch Supply and Trading, BP (BP), and Pepsico (PEP).

But the firm itself was a pipsqueak. Measured by market cap, Goldman Sachs was a hundred times its size. And by any standard, it was a mess. Since emerging as a public company in 2007 from the Man Group, the giant British hedge fund, it had already been through two CEOs and a couple of near-death experiences.

With $1.4 billion in annual revenue, MF Global had far-flung operations in a dozen countries, as distant as Australia and Dubai, loosely strung together from 17 acquisitions. Although much of its revenue was generated overseas, MF Global’s headquarters was in New York, while most of its U.S. employees—and all its back-office operations—were in Chicago. The firm had grown so fast that it had never assembled a centralized identity, corporate culture, or infrastructure. Its businesses operated like independent states, with different compensation systems, more than a dozen brand names, and 262 websites. It had never employed a global risk officer.

MF Global had promoted itself to IPO investors as a growth story, citing soaring revenues and profits. But those numbers masked a gaping weakness in its business model. Because of shrinking commissions—and unusually generous payment arrangements with its brokers—MF Global’s core trading business was actually a money-loser; its chief purpose was to attract billions in customer deposits. For the many years when interest rates were high, the firm made a healthy overall profit thanks to “net interest income”—the spread between the meager rate it paid customers on their balances and what it earned from investing all that cash. After rates dropped to zero beginning in 2008, it regularly lost money.

MF Global had barely survived a rogue-trading disaster just seven months after going public. Brent Dooley, a 40-year-old registered broker affiliated with MF Global’s Memphis office, had spent the night of February 26, 2008, trading wheat futures at home on his laptop computer after finishing dinner with his family. Dooley, who placed his trades through the firm’s OrderExpress system, had declared bankruptcy six years earlier and had a negative balance of $3,004 in his personal firm account. Yet for some reason, no one—and nothing—at MF Global stopped him.

By 6:10 a.m. the next day, according to government filings, Dooley had executed 16,428 short contracts for May delivery of wheat futures; he was betting that the price would fall. But as Dooley, in a thin overnight market, tried to buy futures to close out this massive position—three times the regulatory limit—the price soared instead. By the time the firm finally stepped in, terminated Dooley’s account, and liquidated his positions, he had racked up a loss of $141,020,850—which MF Global would have to pay. (Federal prosecutors in Chicago charged Dooley with fraud. Dooley, who has pled not guilty, has yet to go to trial.)

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News of this fiasco had sent the firm’s stock into a tailspin, generated an exodus of panicked customers, exposed the weakness of its firmwide risk systems, and ultimately forced the departure of CEO Kevin Davis, a chain-smoking salesman who had run the business for nine years. Davis was replaced by Bernie Dan, a former CEO of the Chicago Board of Trade, who spent hundreds of millions on the necessary task of upgrading MF Global’s controls.

MF Global’s weakened state had also forced it into the opportunistic arms of J. Christopher Flowers, the former Goldman Sachs partner who would bring Corzine to the firm. Flowers had made a fortune in a huge Japanese bank deal that forged his reputation as a genius at turning crippled financial institutions into gold. He set up his own fund, J.C. Flowers & Co., attracting billions from investors. Droll and cerebral, Flowers had once boasted that in the aftermath of the financial crisis, “lowlife grave dancers like me will make a fortune,” and that “every single investment” in his new private equity fund would make money. (Several didn’t).

In May 2008, he had exploited MF Global’s desperation for capital by investing $109 million on unusually generous terms. Flowers got a 10% stake in the business, through convertible shares with a juicy annual dividend that amounted to about 15%. He also got a seat on the MF Global board, filled by 34-year-old David Schamis, his Yale-educated managing director. “We’d taken advantage of their unhappy situation to make a good deal for ourselves,” says Flowers. When all was said and done, he expected to double his money.

But Dan, the new CEO, wasn’t sticking around to see it happen. In March 2010, Schamis received an unhappy message from MF Global’s general counsel: “Bernie just quit again.” The board had already talked Dan (who cited personal reasons) out of quitting once before. This time, they weren’t about to try to change his mind.

That left the firm facing yet another crisis. MF Global had lost money for four straight quarters; the CFTC had just fined the company $10 million for Dooley and other regulatory failures; its shares were approaching penny-stock territory. Now it would need to announce the resignation of its CEO—a man hailed as a stabilizing force—just 16 months after he’d taken over.

Under SEC rules, the MF Global board had four business days to make this latest bad news public. But who would take over? Desperate for a plan to minimize the damage—one they could announce at the same time as Dan’s departure—Schamis called Flowers with a wild idea: approaching Jon Corzine.

Corzine had lost his bid for reelection as governor of New Jersey to Republican Chris Christie just four months earlier. Flowers, who had worked with Corzine at Goldman, had remained close to him through his nine years in politics, even serving as one of the managers of his blind trust. Indeed, Flowers had met with Corzine just days before Bernie Dan’s resignation, to finalize an agreement for Corzine’s new part-time role as an operating partner of J.C. Flowers. Corzine was also entertaining a second lucrative side job, with the hedge fund D.E. Shaw. After an expensive stretch away from business, here was an easy way to replenish his fortune.

But, at 63, Corzine wasn’t content with the sort of well-paid sinecure that former governors and retired Wall Street eminences usually embraced. He was already itching to get back to work fulltime. “I like working,” he told friends. “I plan on working until I’m 75 or 80 years old.”

Would Corzine consider serving as interim CEO at MF Global? The firm would need an answer immediately. Before his conversations about signing on with Flowers, Corzine hadn’t even heard of MF Global. But now, after three days of consideration, he shocked everyone by saying he would take the job—but only if it could be on a permanent basis.

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Corzine had never had anything to do with the futures business, had never run a public company, and hadn’t worked on Wall Street for a decade. His time there had ended badly. But by any reasonable standard, the former Goldman chief seemed almost embarrassingly overqualified. Says Flowers: “It seemed like we had more CEO than company.”

MF Global had a thrilling solution to at least one of its problems: Who would care about Bernie Dan’s departure now? In the board meeting where Corzine was revealed as the mysterious “Mr. X” discussing the job, one director emailed another: “Speechless.”

On March 23, 2010, when Jon Corzine was publicly announced as CEO, there was the immediate sense, inside and outside the firm, that MF Global’s savior had arrived. The stock jumped 10% the next day.

There seemed to be an expectation that Corzine could run MF Global with one hand behind his back. On the same day he took the job, it was also officially announced that he had agreed to become an operating partner at J.C. Flowers, as well as a visiting professor at Princeton.

But there was certainly reason, looking at Corzine’s record, to wonder about exactly what kind of CEO he’d make.

Even when he was running Goldman Sachs, Corzine placed a few of his own trades for the firm’s account. “He loves trading,” says his 41-year-old daughter, Jennifer Corzine-Pisani. “He said this to me: ‘There are some people who are carpenters, and they become very good at it.’ This is what he did. He feels skilled in trading. He has built that skill. It is his.”

Trading is where Corzine first made his mark on Wall Street, after arriving at Goldman’s tiny government bond desk in 1975. Behind his bearded, professorial exterior lurks an intensely competitive overachiever. Raised on a tiny Midwestern farm, he played quarterback in high school, made Phi Beta Kappa in college, and served in the Marine Reserves. As a trader, he embraced the exotic derivative instruments that were transforming the fixed-income world, creating exponentially greater opportunities to make—and lose—money. Boldly certain of his conviction, Corzine tended to bet big, and hang tough if his gamble started to go the wrong way.

At Goldman, it usually turned out well.  He worked at the firm for 23 years, rising rapidly and becoming senior partner in 1994. Says Bob Katz, then Goldman’s general counsel: “Everybody thought they were Corzine’s best friend.”

Everybody, perhaps, except Hank Paulson.

Corzine led a crusade to take Goldman public. Paulson, then his No. 2, had reservations about the idea, which the partnership had debated for decades. Corzine ultimately succeeded—the firm went public in May 1999—but before the IPO, he was ousted in a shocking palace coup led by Paulson.

Corzine soon came to realize the challenge was bigger than he’d expected. After a fast tour of MF Global’s offices around the globe, he spoke to Dan Neidich, an old Goldman friend. “I remember him saying the firm was a lot worse than he thought it would be,” Neidich says. Notes MF Global director Schamis, “He figured out pretty quickly what we all knew: MF Global was one big bet on interest rates.”

On the day he took over, Corzine met privately with each of the credit-rating agencies, who told him they needed to see a quick turnaround or they’d downgrade the firm’s debt, already just two notches above junk. Corzine promised to deliver.

One obvious option was slashing costs and hunkering down in the hope that interest rates would soon rise. Corzine accelerated payroll cuts that were underway. And he aggressively restructured compensation, phasing out eat-what-you-kill monthly cash bonuses for brokers, instead giving everyone a big chunk of their pay in stock.

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This was an extraordinarily ambitious strategy, given the depressed economy, the firm’s shaky condition, the scale of the undertaking, and the compressed time frame. It was as though Corzine were building a race car to run on bicycle tires. And he’d have to start making serious money along the way. Moody’s soon set a target of $200-300 million in annual pretax profits.

To Corzine, there was only one way to do that: trading.

In media interviews he conducted on his first day as CEO, Corzine spoke about the need for the firm to put its own money at risk, something MF Global had never done. He explained to his new lieutenants, “By doing nothing, you’re making one of the biggest bets ever. You’re betting on interest rates.” By year’s end he had established a special trading team, called the Principal Strategies Group (PSG), to gamble the firm’s own capital. But he didn’t wait that long to start trading—or rely on anyone else.

In the early stages of the European debt crisis, short-term government bonds were paying unusually high returns. This resulted from fears that one or more of the troubled nations might actually default. Greece had already required a bailout. But Corzine firmly believed a default wouldn’t happen; the Euro Zone countries had just established a special fund to rescue any nation on the brink.

MF Global had already been dabbling in European sovereign debt when he arrived. Once Corzine understood the trade, he decided to massively increase the bet in a way that would get profits in the door fast.

MF Global wouldn’t simply buy the foreign bonds and hold them until they matured (no later than the end of 2012). If it did that, it would have to “mark to market” any gyrations in their value before then, and report them each quarter. Growing pessimism about the overseas debt would actually lower MF Global’s profits.

Because MF Global wouldn’t technically own the bonds during their term—they’d be given to the lender as collateral until they matured, when MF Global would repurchase them—it wouldn’t have to publicly report swings in the bonds’ value.

While Corzine loved this bet, the nightmarish prospect of a default or debt restructuring wasn’t the only risk. MF Global would have to post margin—in the form of cash or securities—with the London Clearing House (LCH), where it would make almost all of these trades. This collateral would cover any shortfall if the bonds dropped below their face value. Initially, the required margin would be small, no more than 3%. But if default fears grew—and the bonds’ prices dropped—the clearinghouse could boost its “haircut” at will, requiring MF Global to cough up huge sums in a matter of hours. LCH could also demand extra margin simply if it had reason to doubt that MF Global would pay its bills.

This made Michael Roseman nervous. A onetime aerospace engineer, Roseman had come aboard as MF Global’s chief risk officer after the Dooley episode, and presided over a wholesale upgrade of the firm’s risk systems. In a public hearing, congressmen would later cast Roseman as a Cassandra, fired by Corzine and replaced by a ‘yes’ man for standing in the way of his risky gamble. The truth was more complex.

Well before Corzine arrived, Roseman had developed a reputation as a poor communicator and a bit of an alarmist—a man who rarely met a risk he didn’t dislike. “If we did what Mike wanted to do,” says one former senior trading executive, “we’d have zero revenues.” Former CEO Dan had targeted Roseman for replacement, with the directors’ blessing. Wanting to reach his own judgment, Corzine put that move on hold after he arrived, offering Roseman a reprieve. “After Jon got to know him better,” says one board member, “he agreed.”

None of that, of course, changes the fact that Roseman was the earliest, loudest voice questioning MF Global’s growing gamble on European bonds. Roseman later told Congress his concern peaked in November, when Corzine, citing “the profitability of the transactions and the importance of generating earnings,” wanted to hike the ceiling for the RTM investment to $4.75 billion. The two men brought the issue to the board, where Roseman detailed his fears.

By then, Roseman’s reprieve was over. In September, MF Global retained a search firm to find a new chief risk officer. In late January, Roseman was informed that he would be replaced by Michael Stockman, who had once worked in the risk department at UBS.

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If Roseman was too risk-averse for some at MF Global, Stockman was the contrary. After taking over in January, Stockman expressed no discomfort with the growing RTM position for six months. Corzine later told Congress that the skills of his new risk officer better matched the direction he was taking the firm.

Confidential minutes and interviews leave no doubt about the board’s acquiescence in Corzine’s trades. The CEO’s growing bet was detailed, debated, analyzed—and approved—every step of the way. Not until August 2011 did the board finally tap the brakes, insisting that Corzine stop adding to his position, while allowing the existing trades to gradually expire.

Schamis, for his part, viscerally disliked the accounting-driven structure of the trade. There were less arcane ways to make the same bet that would generate far more income—and if MF Global ever got into a bind, they’d be far easier to unwind and sell.

Absolutely not, Corzine replied. The firm couldn’t risk having to report the big price swings—and it needed the up-front profits.

“The thing I always disliked about the RTM trade was not Europe—I got that,” says Schamis, “but the structure of doing it in an RTM. It was less liquid and less profitable than it would have been only because he wanted the accounting outcome. It was to placate the rating agencies and produce profits.”

As the directors voiced varying levels of agita, Corzine pushed back during a board performance review, suggesting he felt unloved. “I just think this is the right thing for this company to be doing right now,” he told lead director Ed Goldberg. “If you all don’t agree with this, maybe you need someone else to be running it.” But no one wanted to see that happen. Instead, on at least three occasions, the board granted Corzine’s request to raise the sovereign limit—and watched the gamble closely.

Schamis asked MF Global’s CFO to track what the earnings impact would be if the firm did have to report swings in the bonds’ value. The board also received detailed reports on credit-default-swap spreads for the debt—reflecting the market’s level of anxiety with the risk—complete with a table estimating “probability of default” and “expected loss” should that result.

Through March 31, MF Global already had booked a total of $86 million in net revenues on the sovereign trades. That month, the board renewed Corzine’s contract through 2014, with a $1.5-million retention bonus, amid rumors that President Obama might name him Treasury Secretary to replace Tim Geithner. Corzine was considered so invaluable that when MF Global unveiled a $325 million debt offering, it included a provision to pay bondholders an extra 1% interest if he left for a government job.

By that point, Corzine had publicly detailed his game plan for reinventing the firm, making clear that risk-taking was a big part of it. He expected principal trades, for the firm and its customers, to ultimately represent 20 to 40 percent of MF Global’s net revenue. He’d already begun hiring teams of hotshot producers from blue-chip firms, aimed at “talent upgrading” and moving the futures broker into new lines of business, such as trading mortgage-backed securities. He’d also persuaded the Federal Reserve to name MF Global as one of 20 primary dealers, responsible for making a market in U.S. Treasury bills. It was a prestigious designation, one MF Global trumpeted proudly.

Corzine’s new direction represented a wrenching change at MF Global, which had always marketed itself as a pure broker that—in contrast to, say, Goldman—never took proprietary positions that presented risk or might conflict with its customers’ interests. His new recruits accentuated a deep cultural divide, between the old MF Global, focused on futures brokerage and based in Chicago, and the new MF Global, focused on principal risk-taking and based in New York.

Even as it became clear to insiders that MF Global couldn’t be transformed overnight, the pressure to produce profits was growing. After its tiny profit in mid-2010, the firm had racked up three more losing quarters. In May 2011, Corzine promised he’d be making money by year-end.

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With Javeri’s rapid departure, Corzine unabashedly embraced the role of head trader for the firm. He wasn’t just trading RTMs (which didn’t require much attention after the positions were put in place). He was also trading oil futures and T-bills and foreign currencies. While MF Global’s executive offices were on the 40^th floor of its Park Avenue headquarters, Corzine had located his on 39, steps away the trading floor, and became deeply absorbed in the day-to-day action.

Corzine tracked his positions to the point of distraction, on his Bloomberg terminal, on his Blackberry, on his iPad. “Day to day, you couldn’t have a meeting with Jon where he wasn’t staring at a screen the whole time, because he was running his own [trading] book,” says a former senior executive of the firm. “You’d be in a meeting. He’d call the PSG group twice and stare at a screen five times.”

Trading, after all, wasn’t the only way to keep MF Global afloat. An assortment of strategic moves were also on the table: selling off the retail futures business, known as Lind-Waldock; a joint venture with a big custodial institution, such as Bank of New York, to boost clearing revenue and bolster the balance sheet; a merger with Interactive Brokers Group, a firm that lacked MF Global’s customer base and sales network but had cutting-edge trading and backoffice systems. Each of these transformative ideas languished.

Thomas Peterffy, the Hungarian-born billionaire who founded Interactive, had been drooling for years over the prospect of combining MF Global’s customer relationships with Interactive’s systems. “I wanted to put together all their messy broker business under Interactive technology,” Peterffy, an engineer by training, told Fortune. “We’d integrate it all and simplify it all, and it would become a terrific business.” In June 2011, Peterffy had even met secretly with Corzine in a room at the St. Regis Hotel during an investor conference, to spell out his vision. According to Peterffy, Corzine listened, but then nothing happened.

Corzine was making progress on some fronts. He was consolidating the firm’s brands and websites under the MF Global name, had sold off several stray businesses, and reduced borrowing costs through debt and stock offerings. In May 2011, a report to the board by Promontory Financial Group, a Washington consultant hired as part of the CFTC Dooley settlement, concluded that the firm had “vastly improved” its systems and risk controls, and praised management for setting “a tone at the top” supporting “best practices.”

These findings reflected a broader, growing concern among financial and back office staff. While Corzine was “adding sales guys and traders in leaps and bounds,” says one such senior manager, the company was “short-staffed in operations and didn’t have the right people or processes or systems to support the new businesses.”

On June 6, Corzine persuaded the MF Global board to raise the sovereign limits again. According to the board minutes, “Mr. Corzine advised the Board of the potential return on investment in the event the limits were in fact increased as requested by Mr. Corzine and how the request fits within the firm’s strategy which includes taking thoughtful, measured risk.”

For months the board embraced Corzine’s view that default was the remotest of possibilities. But as the European situation worsened, margin demands on the firm’s positions soared. “While default is unlikely,” board minutes explained, “the market demands a premium due to uncertainty.”

As sovereign exposure reached a peak of $7.4 billion, Stockman had grown concerned. In a July 30 email cited by the bankruptcy trustee’s report, the chief risk officer told Corzine: “I am not currently supportive of buying more sovereigns.” He urged the CEO to stop adding new positions, and hedge those in place. In early August, Stockman advised the board that margin requirements had multiplied since the beginning of the year from $100 million to $550 million.

After a discussion of the growing threat the sovereign debt posed to the firm’s liquidity, the directors finally barred any new European RTMs. But the existing positions wouldn’t be unwound and sold, just allowed to melt away as the bonds matured at different dates through the end of 2012.

In its summary passage, the 23-page document concluded that MF Global would survive.  “Key message: We remain solvent – are able to manage liquidity through stress period as we reposition our business and stabilize our financing lines.” The plan spelled out day-by-day steps that the firm would need to take, including drawing down a $1.2 billion line of credit; preserving cash by responding slowly to a rush of customer redemptions; and finding a way to meet massive margin calls, especially on the sovereign RTMs. The foreign bonds, the report noted, were “the biggest draw on cash today.” Treasury and operations staff would be in the eye of the storm, requiring “all hands on deck.” A critical issue, it noted, was to safeguard customer money.

Much of this was insightful and prescient—with the conspicuous exception, of course, of the prediction that MF Global would survive. But the circumstances that set the disaster in motion—and the fatal blow—were something the firm never anticipated.

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Oversight in the $648-trillion derivatives industry is ineffectual, balkanized and byzantine. That was especially true at MF Global, where at least six different entities shared responsibility. Because the firm serviced both 36,000 futures customers and 318 securities accounts, it had two government regulators: the Commodity Futures Trading Commission and the Securities and Exchange Commission. But both agencies delegated day-to-day oversight to industry-funded “self-regulators”: on the futures side, the Chicago Mercantile Exchange (CME) and the National Futures Association; for the broker-dealer, the Financial Industry Regulatory Authority (FINRA) and the Chicago Board Options Exchange.

Until the spring of 2011, MF Global also revealed virtually nothing about the bet in its public disclosures. The first explicit mention came in a May 2011 annual SEC filing, which described the holding.

MF Global protested mightily, insisting that the positions required no extra capital because they posed zero risk.

How much, the regulators asked, was the London Clearing House requiring in margin for these “riskless” RTMs?

$500 million, MF Global officials replied.

Despite Corzine’s personal protest of this ruling to SEC regulators in Washington, MF Global in August was ordered to set aside an extra $255 million. Even worse, it would have to file a public “hindsight notice” of a regulatory capital deficiency for July.  It did so on August 25.

By then, MF Global’s European gamble was no secret. The firm had disclosed the sovereign bet in several public filings, even listing it as a “risk factor.” Corzine and his recently appointed CFO, 35-year-old Henri Steenkamp, had discussed the RTMs during investor calls. Analyst reports had also mentioned the positions, as evidence of MF Global’s initiative to boost income from principal transactions.

And, strangely enough, no one seemed to care.

Interest rates hadn’t budged; Corzine’s expensive new hires weren’t yet making money; and the board had put the kibosh on more RTMs, which had generated $124 million in upfront gains. To make matters worse, MF Global would also need to take a $119-million accounting charge, a writeoff of tax credits accumulated from years of operating losses. The reason itself was worrisome: MF Global’s outside accountants had concluded there was little probability that it would make real money anytime soon. The charge would boost the quarterly loss to a record $191.6 million. And that wasn’t all. The worsening Euro zone crisis might give investors fresh reason to panic over Corzine’s $6 billion sovereign gamble.

The worried band of executives—which included CFO Steenkamp and global treasurer Vinay Mahajan—agreed: MF Global needed to do something dramatic. Dump the RTMs. Sell a big division. A joint venture. Perhaps even find a buyer for the entire firm. They’d been talking about some of these ideas with Corzine for months, but little had happened. Now inaction simply wasn’t an option.

In meetings with Corzine, the group spelled out their fears. They could blunt the impact of the bad news, they told their boss. It would be painful, to be sure: an admission that their game plan—Corzine’s game plan—hadn’t worked. But there was still time to act.

But Corzine didn’t think the firm needed to make a quick blockbuster move. “We don’t want to do those types of things,” the CEO told his deputies. He’d bring in JP Morgan for advice in dealing with the rating agencies. Then he’d personally explain to the credit firms—and to investors—why everything would be all right. They just needed a little more time. “It was a belief,” says one of the dismayed executives, “in an ability to get through any situation.”

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On Monday, October 17, seven weeks after MF Global had first disclosed it in a public filing, the Wall Street Journal broke the news that regulators had forced the firm to set aside extra capital because of its investment in risky European debt. MF Global shares, already below $4, fell 6%.

Three days later, Corzine and his top executives began a series of private meetings with the three big credit-rating agencies about the forthcoming quarterly results. MF Global wasn’t actually scheduled to report its earnings for a week, but the agencies typically got an advance briefing on the understanding they wouldn’t act on this information until after it became public.

The session with Moody’s, which had been the most adamant about the need to get profitable fast, came at 1 p.m. Friday. Just as Corzine’s deputies had feared, the agency soon made clear its intention to announce a downgrade. CFO Steenkamp appealed the decision in a lengthy “Dear Al” note he emailed to Moody’s senior analyst Al Bush, just a few minutes before midnight on Saturday.

It didn’t work. Moody’s announced a downgrade to one notch above junk early Monday afternoon, three days before MF Global’s scheduled earnings announcement. Moody’s executives insisted they hadn’t relied on any non-public information, despite explaining in the downgrade note that they were acting because they’d concluded the firm was “unlikely” to meet its earnings and balance-sheet benchmarks “in the near term.” The note also cited MF Global’s “increased exposure to European sovereign debt in peripheral countries” and its regulatory capital shortfall, warning of further downgrades.

But everyone was worried, even though the stock had only dropped about 3.5% during the day. Corzine decided to tackle all the fears head-on, moving up the Thursday earnings announcement to 6:30 a.m. Tuesday.

But without a preemptive response, the worrisome news had now reached critical mass. By the close of trading, MF Global shares had dropped 48%, to $1.86. Customers were demanding their money and closing accounts; counterparties and lenders were cutting off credit. In a message swiftly forwarded to Corzine, the firm’s head of equity finance for Europe reported from London that HSBC bank had “temporarily pulled the stock loan line….They have said no new business going forward and given us to the end of the year to unwind the book.” MF Global was drawing down its $1.2 billion line of credit.

The “break-the-glass” scenario was at hand.

About 7 p.m. Tuesday night, Corzine and Abelow appeared at J.C. Flowers & Co., whose offices were in the same building as MF Global, to discuss crisis-management strategy with Flowers and Schamis. They resolved to pursue two tracks. The firm would start selling assets to free up cash. And they’d retain an investment banker to explore the sale of part or all of the firm.

There was one other step that the four Wall Street veterans discussed on Tuesday night: calling Jacob Goldfield.

Goldfield had briefly worked at J.C. Flowers in the years since he left Goldman. At the invitation of Schamis, Goldfield showed up at a 6:30 a.m. breakfast meeting Wednesday at the Yale Club, and they plunged in.

The Goldfield-Schamis operating principle for MF Global was that they needed to sell everything—and do it as fast as possible. At that point, the firm held tens of billions in tradable assets: Treasury bills, agency securities, corporate bonds—and, of course, the RTMs. If they could actually get rid of everything, all that margin MF Global was handing over to counterparties and clearinghouses would be returned. The hope was that this would generate so much liquidity the business would be impervious to a run on the bank.

Goldfield and Schamis set up shop in a conference room outside Corzine’s office. Both would remain on site for the next six days, almost around the clock, pushing him to suppress the trader’s natural instinct to squeeze the most out of a trade.

Late that night, a team of MF Global executives crowded into Abelow’s office concluded that things weren’t moving fast enough. Abelow called Corzine, who’d finally gone home after a marathon day, to wake him up and bring him back into the office. The message, according to one participant in the meeting: “We need to put our foot on the gas here. He was being a trader, not being a dumper.” Corzine argued it wasn’t that simple—“We need to keep something with some yield around here”—but soon moved to accelerate the pace of sales.

As MF Global labored to save itself, Corzine’s European repos were its biggest obstacle. Because the portfolio was huge and complicated—involving 22 bonds issued by six countries, acquired in 87 separate transactions—it would be hard to sell quickly. In an analysis code-named “Project Plaza,” Blackrock Solutions, the consulting arm of the giant investment manager, concluded that week it would take five days and cost about $280 million in “slippage” to unload most of it.

The CEO seemed in “disbelief” about the liquidity problem, the trustee’s report notes, citing an October 25 email written by Mahajan: “[we] took Jon through the [liquidity analysis] because he keeps speculating where the money has gone and sends Treasury in different directions to investigate.”

In the meantime, fresh margin demands were arriving from the clearinghouses each morning, relayed in polite emails from an MF Global executive in London. (“Please can you provide us with $61mm usd of margin for the RTM business.”) By week’s end, MF Global had $663,925,523 tied up in the bonds; they’d soaked up an extra $206 million in just five days. Huge sums were flying around—according to a later forensic investigation, more than $105 billion in cash moved in and out of the firm just that final week.

Safeguarding customer money is the holy of holies in the futures business. Under CFTC regulations, cash from individual customers is pooled and kept in special “segregated” bank accounts, where it is supposed to remain inviolate, even when a firm goes under. Industry groups routinely boasted that no customer had ever lost a penny because of a bankruptcy.

To avoid any shortfall in customer funds—which might result from unmet margin calls or transactions that didn’t go through—firms were allowed to keep some their own money in these segregated accounts as a cushion; this amount could total $100 million or more. The CFTC also required each firm to perform a daily “seg” calculation as of the close of business, which had to be completed by noon the next work day and available for inspection by regulators. This spelled out the amount of customer funds and the size of the cushion. Any breaches, even accidental and momentary, were supposed to be immediately reported. This was also one of the first things regulators checked during their periodic audits.

In October of 2011, Ground Zero for the crisis at MF Global was the 21st floor of 440 South LaSalle in downtown Chicago. This was Edith O’Brien’s domain. The 46-year-old assistant treasurer was the firm’s guru of cash, a sort of air-traffic controller for money. MF Global’s U.S. business had 48 bank accounts at eight financial institutions. Because the firm lacked the sophisticated accounting systems to track customer-account balances in anything close to real time, it relied heavily on O’Brien. Direct and tough, O’Brien also served as the guardian of customer cash. In her distinctively nasal voice, she regularly spoke on industry panels as an expert on the topic.

Normally, O’Brien would be aided during any back-office crisis by Christine Serwinski, the CFO for North America. A chronic workaholic, Serwinski spent so many hours on the job during her 17 years at the firm, often remaining until midnight, that a boss finally hired a personal coach to help her develop her life outside the office. After making strides, she had tendered her resignation in late June, before agreeing to stay on for an extra nine months and train her replacement, who was scheduled to start November 1. In the meantime, Serwinski had left on Tuesday—the day after the Moody’s downgrade—for a week’s vacation in Las Vegas, where she was competing in a national competition in ballroom dancing, one of her newfound avocations.

In addition to all the margin calls and trading transactions, they were also dealing with a crush of worried customers racing to close their accounts. More than $1.5 billion would be withdrawn by week’s end.

But amid the growing desperation and chaos, according to bankruptcy trustee James Giddens, MF Global did cross this line on Wednesday, improperly tapping customer funds during the day, and failing to return the money. According to Giddens, this resulted in a $299 million shortfall, and was the beginning of the improper “under-segregation” in customer funds that would mount disastrously during the week.

At least part of the Wednesday deficit resulted from a simple mistake. An email chain—first described in March by the Wall Street Journal and also examined by Fortune—describes a rushed, late-day transfer of $165 million from a customer account to a firm account at JP Morgan (JPM). Treasury operations staff in Chicago, who entered the wrong account information for drawing the money, tried unsuccessfully the next day to reverse the transfer. But by then, Fortune is told, it was already gone, used to meet other frantic demands for cash.

On Thursday, Moody’s and Fitch both downgraded MF Global’s debt to junk. Regulators descended on the firm’s offices in Chicago and New York, where they camped out with their laptops, asking for records and periodic updates, beginning a sort of deathwatch.

Within hours of the latest downgrades, Morgan placed all MF Global accounts on “debit alert,” dramatically slowing money transfers; terminated its intra-day credit lines, requiring payment up front for trades; and even limited the firm’s on-line visibility into its own accounts, making managing the crisis harder.

On Friday, MF Global’s dealings with Morgan led to another big withdrawal that Giddens says also came from customer funds. Amid the confusion, a dozen firm accounts at JP Morgan in England were overdrawn by a total of about $175 million. The bank was simultaneously preparing to preside over an attempt to auction nearly $5 billion in agency and corporate bonds, as part of Corzine’s accelerated effort to unload assets. JP Morgan had agreed to settle the sales on a same-day basis (instead of the usual one or two business days) to speed the return of cash. But it would only do so if MF Global covered the overdrafts. Barry Zubrow, an old Corzine friend who now served as Morgan’s chief risk officer, delivered this message to his former Goldman partner in a 7 a.m. phone call.

Corzine personally called the Chicago back office, where he spoke to O’Brien, telling her they needed to fix the problem. Everyone, emails reviewed by Fortune show, immediately scrambled to find a way to cover the overdrafts. A manager at the firm’s broker-dealer subsidiary thought he had enough from a settling repo trade to cover the hole. But Mahajan, MF Global’s treasurer, emailed O’Brien that she might need to do it: “Edith, If you don’t hear from London in the next 5 minutes, please provide them funds today to cover this overdraft position.” In a second email, Mahajan underlined the urgency of the matter: “PLEASE CONFIRM THAT JP MORGAN’S ACCOUNT IN LONDON HAS BEEN FULLY FUNDED ASAP – THEY ARE HOLDING UP VITAL BUSINESS IN THE US AS A RESULT.”

“What account – where to??” O’Brien replied.

O’Brien then forwarded this email to others, adding the message that she was dispatching the funds “Per JC’s direct instructions.”

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Early Friday afternoon, according to congressional testimony by a JP Morgan lawyer, Zubrow alerted Corzine that the overdrafts “had been covered by a series of transfers originating with a withdrawal of funds from a customer segregated account.”  Given MF Global’s desperate circumstances, according to the testimony, Zubrow asked for a written assurance that the $175 million actually came from the firm’s cash in the account, not customer funds. The bank sent Corzine a one-page letter for O’Brien to sign.

In his own testimony before Congress, Corzine says O’Brien assured him in a phone call that she hadn’t drawn the money from customer funds. She quickly followed up with an email to the CEO showing a record of the second transfer, to London, noting that the $175 million came from a “HOUSE” account. (It made no mention of the original $200 million withdrawal from the customer account.)

O’Brien advised Klejna late in the day Friday that she was “swamped dealing with customer wires,” and emailed Ferber that she couldn’t deal with the matter until later because “I have numerous moving parts under critical deadlines.” After the close of business, Klejna finally spoke to her about the latest draft. “She was able to discuss for less than a minute,” he reported back to Ferber in an email. “While it’s better she said she wouldn’t sign it as is.” Klejna passed on this news to the bank. “How did they react”? Ferber asked. “Quite disappointed,” Klejna replied.

JP Morgan sent MF Global a third draft of the letter over the weekend, narrowing the language further, but it was never returned.

The funds from the segregated account were never sent back either. Giddens would later conclude that the $175 million sent to London that Friday had indeed come from customer funds, but no one has been charged with wrongdoing.

By Friday, Corzine had unloaded billions in MF Global assets (including a few of the RTMs), while presiding over the darkening situation with his usual air of equanimity. But it was too little, and far too late. Even as the firm lightened its balance sheet—a step that should have freed up cash—liquidity kept drying up.

An internal memo on Saturday morning showed that, despite all the asset sales the day before, net liquidity had fallen by $451 million, to just $233 million. The London Clearing House, meanwhile, would demand another $310 million for the RTMs by Monday.  An effort to sell the entire portfolio to Carl Icahn (at an estimated $187 million loss) was going nowhere.

A sale was the only way to salvage anything. Over the weekend, the list of prospective buyers—which initially included JP Morgan and the Jefferies Group—shrank to just one: Interactive Brokers. After years of unrequited pursuit, Thomas Peterffy might finally own MF Global.

The deal would work like this: MF Global’s holding company would file for Chapter 11 reorganization. Peterffy would provide debtor-in possession financing, take over all the customer accounts, guarantee full payment, and be the presumptive acquirer in the final reorganization, for $1 billion. This would give Corzine time to sell everything else, including the rest of the RTMs, without taking a bath. MF Global’s shareholders might even get something.

But everything would have to happen fast, before trading opened early Monday in Europe. All the regulators would have to sign off; all the legal documents would need to be prepared; all the financing would have to be arranged. Despite its sorry state, MF Global was still trying to drive a tough bargain. Could Interactive come up with $1 billion for debtor-in-possession financing by Monday?

As everyone worked to tie up details in New York, there was just one troublesome hitch, back in Chicago: the customer-funds numbers weren’t adding up.

The first rumblings of trouble had come Thursday. Christine Serwinski, keeping in touch with the turmoil from Las Vegas, says that’s when she was advised of an unexpected plunge in the cushion of house money kept in the customer accounts. She was told it resulted from an internal loan to the broker-dealer division that hadn’t been repaid by the close of business, according to her later congressional testimony.

By Friday morning, the two CME auditors at 440 Lasalle had received the segregated-funds statement for Wednesday, showing an excess of $116.2 million. But in the week’s frenzy, the records were a mess, and MF Global still hadn’t produced all the backup documents they wanted. Late that afternoon, the statement for Thursday arrived, showing a cushion of $200.2 million, despite all the cash rushing out the door. Reassured, the auditors left for the weekend.

On Saturday, Serwinski testified, she was told that the segregation report for Friday showed a shortfall, but that her colleagues blamed it on “reconciliation errors” and insisted the firm wasn’t really missing customer money. On Sunday morning, just before boarding a flight back to Chicago a day early, Serwinski was advised that the hole was nearly $1 billion. Her reaction? “I thought that such a huge number could only be the result of an accounting error.”

But CFTC chairman Gary Gensler, who had once worked for Corzine at Goldman Sachs, was zeroing in. Safeguarding customer money was a hot-button issue for his agency. Over the weekend, he began pressing his deputies for the Friday seg report, which hadn’t yet been handed over, and the documentation to back it up.

Unsatisfied with the company’s response during a conference call with regulators, Gensler amplified his demands: “This is the chairman of the CFTC!” he thundered. “I need two numbers! What is supposed to be there. And how much is there.”

Shortly after noon, Klejna blamed the holdup on a “system test that delayed data feeds,” and insisted the material would be available at 2 p.m. When that deadline passed, CFTC lawyer Bob Wasserman, who was at MF Global’s New York offices, emailed Ferber, Klejna, O’Brien, and others at 3:40 p.m. “Dear MFG colleagues:  Please understand that the lack of data is driving adverse inferences. We really need this information, and then underlying support, immediately and very shortly indeed. Respectfully, Bob Wasserman.”

“I understand we are making progress,” replied Ferber at 4:16 p.m. “…We will update you soon.”

By that point, there was no choice. Bolan told Hughey they were already “walking through this with Wasserman….letting him know we are likely under in Seg.” The Chicago staff had also finally shared this information with regulators there.

Still, Chicago insisted the $952 million “deficit” was no cause for alarm—surely just a computational error. This explanation was offered to regulators, company directors, and executives.

Meanwhile, everyone raced to finalize the Interactive deal, even completing a draft press release about 6 p.m. The statement detailed plans for the voluntary bankruptcy filing of MF Global Holdings; Peterffy’s financing of an $800 million “capital infusion”; Interactive’s agreement to ultimately buy MF Global’s assets for $1 billion (barring a higher bid); and the prompt transfer of all customer accounts to Interactive. MF Global subsidiaries, the draft noted, would “continue reducing proprietary positions in an orderly manner.”

The firm’s board remained on an open conference call, as the executives wrestling with the numbers in Chicago relayed periodic updates throughout the night. The problem had to be mistake—some kind of reconciliation error. They’d found it! No, they hadn’t. Back from her vacation, Serwinski arrived in the Chicago office to help O’Brien at 9 p.m. “Such a large deficit,” she later told Congress, “was simply inconceivable to me.”

About 1 a.m., Serwinski and O’Brien made it official: they’d concluded the deficiency was real. O’Brien had even prepared a document listing the cause of the missing customer funds, including the $175 million transfer to cover the overdrafts in London.

“On with all 8 regulators at the moment,” the CFO replied at 1:10 a.m.

The Interactive deal, of course, was history. Thomas Peterffy, having discovered that its books were in “shambles,” was no longer interested in MF Global, even after its investment banker offered to cut the $1 billion auction price to a dollar. Flowers woke up at 2 a.m., and emailed Schamis, asking how it was going. “Very bad,” he wrote back.

A Gensler deputy got him out of bed at 2:30 a.m., so he could join a marathon conference call to figure out what to do next. MF Global pleaded for a final opportunity to cover the gap with cash that would surely arrive first thing Monday, from some of those slow-to-settle trades. “There’s money out there that we’re owed!” declared Steenkamp. The board held off filing for bankruptcy for a few hours.

 

Epilogue

On the evening of Monday, October 31, the exhausted finance staff in Chicago coughed up its final daily segregation report for the now-bankrupt MF Global: as of Friday, it noted, the firm’s customer accounts were short $891,456,650.

Corzine left on November 4 without severance pay, after the board demanded his resignation. After a second trustee was named for the holding company, the directors were also discharged.

Under the federal statute covering the liquidation, the firm’s 318 securities account-holders are likely to soon get all they’re owed. The prospects for those who traded commodities at MF Global are less certain. As of June, Giddens had enough in hand to pay about 80 cents on the dollar to most customers, and has announced that he’s tracked down virtually all the missing money. The trick is getting it back.

That leaves about $700 million. The single biggest bloc of that is at JP Morgan, through which billions flowed in MF Global’s final days. But the bank is also MF Global’s biggest creditor, with a legal basis to keep money—even if it came from segregated accounts—unless it had reason to know that it belonged to the firm’s customers. Giddens’ negotiations on this touchy issue have already extracted $168 million. He continues talks with Morgan regarding “other claims,” but large sums aren’t expected. Recovering money from the dozens of other banks, counterparties, exchanges, and creditors who received the money of MF Global customers will be even more difficult. Says one person briefed on the situation: “There aren’t any big pots out there.”

But some may come from former MF Global executives. In his report, Giddens says he is considering a collaboration with private plaintiffs attorneys to bring civil claims against Corzine, Steenkamp, and O’Brien (among others) for breach of fiduciary duty and negligence.

Whatever money he sets his sights on, Giddens may also have to fight over some of it with Louis Freeh, the trustee for MF Global’s holding company, whose charge is to recover money for all the firm’s creditors.

Many of the central figures in the MF Global drama have testified during six separate congressional hearings. In each of his three appearances, Corzine pointedly noted that none of the sovereign bonds underlying his RTM investments have defaulted. That’s little solace to MF Global shareholders, who will end up with nothing. Chris Flowers, who once expected to double his money, calculates his fund’s loss on the investment at $48 million.

Now 65, Corzine remains in an unaccustomed state of limbo. “This is someone who had a great legacy,” says his old Goldman friend Dan Neidich. “Now he has to get through this, and there is no legacy. He has to figure out what to do with the rest of his life.”