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Strategies & Market Trends : John Pitera's Market Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: John Pitera who wrote (7223)	10/16/2005 5:06:53 PM
From: aknahow	Read Replies (1) \| Respond to of 33421

If the unwinding has cause softness in the commodity markets in general is it logical to believe this is because the large traders were bullish in commodities? But, we all know that the largest professional short positions were in silver and gold. For customers back in April of 2005, REFCO was bullish on both silver and gold. This does not mean their own position was long. We will soon see how this will shake out, but just can't help wondering.

To: John Pitera who wrote (7223)	10/16/2005 7:58:15 PM
From: robert b furman	Read Replies (1) \| Respond to of 33421

Hi John, Any guess as to how low a lowball one would have to make to scalp a profit on buying Refco'S bonds? 5-10 cents on the dollar? Bob Thanks for your excellent coverage on what may be a "Black Tuesday" melt down . Most do not associate the melt down that the Hunt brothers created back in 87 - I've enver forgotten it as it almost killed me. Bob

To: John Pitera who wrote (7223)	10/21/2005 6:12:19 PM
From: John Pitera	Read Replies (2) \| Respond to of 33421

Refco's Collapse Underscores Risks Inherent in the Derivatives Market October 19, 2005; Page C1 A month hasn't gone by recently without some regulator or obscure commission sounding an alarm about privately negotiated derivative deals. If you wade through their speeches and reports, you find out there's a small problem with these fast-growing markets: Traders don't have a clear idea about who ultimately is on the other side of derivative trades that aren't executed on regulated exchanges. The debacle at Refco, the commodities and securities firm that filed for bankruptcy-law protection this week, gives us all a reason to care about this stuff. So far the spectacularly rapid flameout has been mere spectator sport for most investors. There has been little market fallout. There is good news: Refco doesn't appear to have been a significant broker in the main area of regulatory concern, credit derivatives, where investors buy protection against bond defaults. And the longer the markets go without panicking, the lower the risk. The bad news is that painless lessons tend not to stick. Derivatives are designed to make markets more efficient and spread risk, and mostly work well. In their most vanilla form, a derivative allows you to, say, offset the risk of owning ABC stock, worth $55 a share, by buying the right to sell ABC shares for $45. That's called a put option, and those aren't a problem. But derivatives get endlessly more complicated -- defaults can be mind-bending, involving a cascading series of risk buyers -- and regulators are concerned, rightly, about that market's growth. The main problem is inadequate record-keeping. Joe Buyer sometimes doesn't know who the ultimate seller is, so he's taking it on faith the seller will make good on the deal. That's why brokers like Refco are so important. They are go-betweens that can put up money to make the deal go smoothly. If the market loses faith in the broker, watch out. This problem is multiplied by the risk appetite of short-term investors who borrow to increase returns, primarily hedge funds. In February, the Financial Services Authority -- the United Kingdom's Securities and Exchange Commission -- warned about all this. In September, the FSA asked banks for an update on how much progress they were making in improving the processing of credit derivative trades so they know their true counter parties (i.e., keeping track of who's ultimately on the hook in trades with multiple layers of risk transfer). The answer: Not much. Over on the U.S. side of the drink, the Counterparty Risk Management Policy Group (say that 10 times fast) issued a report in July, iterating similar concerns. New York Fed President Tim Geithner, who has been warning about investors' high appetites for such risk and the lack of controls, gave another speech on this topic just yesterday. The market seems to think he's Chicken Little. It turns out Refco, a major broker in futures and more-complicated derivatives, woefully underinvested in its "back office," the folks who are supposed to keep track of all this buying and selling. That's not comforting for a firm that is an agglomeration of more than a dozen smaller firms, acquired rapidly. It clearly isn't alone. That there hasn't been contagion is gratifying, but the firm's troubles are barely a week old. The regulated futures brokerage has a takeover agreement with private-equity fund J.C. Flowers. The area that could pose more problems is the firm's unregulated prime brokerage business. That unit makes its money arranging private "over the counter" trades, including derivatives, without the transparency of an exchange, like the Chicago Mercantile Exchange. Refco has frozen its customer accounts in this unit indefinitely. "Everything is in suspended animation," says Bianco Research president Jim Bianco. "Refco was a big company with lots of customers. One of them surely must have been in midst of a margin call or operating on fringes of the business." That means markets will have to wait for the moratorium to be lifted before we know whether there are buyers out there that can't make good on their trades and whether that causes other dominoes to fall. Even though it wasn't regulated, the prime brokerage business was supposed to be fairly low-risk. This is the area under law-enforcement scrutiny, however, since it is where the hidden $430 million receivable from former CEO Phillip Bennett resided. Mostly, the business was to help customers such as hedge funds trade in U.S. Treasurys or in foreign-exchange markets. The financial-statement line detailing Refco's receivables (what its customers owed) should have jumped out at investors who read its initial public offering documents. (There must be someone out there who did beforehand, right?) That now-unreliable document said receivables related to "foreign currency and other OTC derivatives transactions" took a gigantic leap to $811 million as of Feb. 28, compared with just $38 million a year earlier. That's Refco's derivatives exposure -- the money it put up to make all those deals go through -- and raises potential risk to entities on the other sides of these trades. One outstanding area of risk is what the true character and amount of the trading was that Refco did with its own money. According to its business model, Refco didn't make directional bets on markets. But Refco sometimes took positions that allowed it to profit from the difference between rates of return when facilitating its customers foreign exchange and Treasury trades. In the seven months ending in February, it recorded $161 million in revenue from such bets. Its stated model notwithstanding, this essentially is proprietary trading risk, and that's how Refco was required to account for it. What we don't know is how much of these bets are outstanding, and whether Refco can make good on them.