Refco deals out harsh lesson
Concerns about hedge fund positions in the face of Refco’s collapse have been overstated. The real consequence should be that investors are more wary of what they buy into.
Refco will be looked back on as one of the most incredible puff stories in financial history. Investors, in their greed, were prepared to ignore the company’s patchy record with the regulators. Scarcely a year has passed since the company’s creation in 1969 without the regulators hitting the firm with a financial penalty. From illegal front-running on Liffe to inappropriate cattle futures trading in Arkansas, Refco has transgressed rules and regulations in many of the locations in which it has operated.
Nonetheless, Refco helped satisfy a huge appetite for financial stocks in the US, especially in companies with a strong presence in derivatives. The Chicago Mercantile Exchange kicked off the trend when it became the first US exchange to demutualize and then go public in 2000. Since then, the CME’s shares have risen from an issue price of $35 to a recent high of $346.50. The CME’s stratospheric P/E ratio of about 42 illustrates the demand. Not surprisingly, other exchanges, brokers and niche players, including Refco, have looked to get in on the act.
Many of these companies’ shares took a hit as the Refco news broke, including the CME’s. The fact that Refco was one of the CME’s largest customers made this inevitable and the exchange’s stock plunged by more than 15% to about $285.