From the February 01, 2008 issue of Futures Magazine • Subscribe!

Tops & Bottoms of 2007


CME Group

When the Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBOT) announced they would merge in October 2006, it was the climax of more than a century of competition between the two. The plan was built on numerous failed attempts to get together over several decades but seemed a little too easy, given the history of discord between the two. Indeed it would not be easy, as the upstart Intercontinental Exchange (ICE) and its swashbuckling CEO Jeff Sprecher managed to do what the CBOT Board of Directors couldn’t or wouldn’t: get a fair price for the oldest futures exchange in the world (see Fight of the year).

Commodities bubbling over

Many expert analysts declared the commodity bull market dead at the beginning of 2007, as crude oil dipped to near $50 from its 2006 high above $75 and gold corrected. In the words of hedge fund guru Jim Rogers, “those who talk about a commodity bubble didn’t know how to spell commodity a year ago.” All of the major commodity indexes easily outperformed the S&P 500 despite the housing downturn and slowing demand for construction materials. In fact, both gold and oil hit new highs.

Merger Mania

Besides the CME deal, several other mergers closed in 2007.

• Two will do: Prior to its CBOT run, ICE managed to close its purchase of the New York Board of Trade and by year end it closed on its purchase of the Winnipeg Commodity Exchange.

•Never quit: Eurex and parent Deutsche Börse were rebuked several times over in potential deals with the London Stock Exchange and Euronext, so when it announced its planned link-up with the International Securities Exchange (ISE) you might have bet against it. The deal seemed fraught with difficult issues but they were able close the deal by year end.

•Draining the pond: The New York Stock Exchange and Euronext made their link-up official on April 4, however, the stock peaked at $101 on April 3 and proceeded into a six-month slide of more than $30.

•Liberty belle:The Philadelphia Stock Exchange may have held the record for most rumored partners but in the end they signed a deal with Nasdaq.

•Quite a bazaar: In September OMX, Nasdaq, and Dubai announced the most complex merger deal in the history of exchanges. No one seems to know who owns them.

DJIA rocks

This could be a stretch given the way the year ended but the Dow Jones Industrial Average set its all time record high of 14,198.10 on Oct. 11 and finished the year up about 6.5%. This in a year that saw two of the largest one-day net losses for the index, a correction of nearly 1,500 points in the fourth quarter, the subprime and housing meltdowns along with numerous fundamental and technical warning signs for equities.

Record Volumes

Global derivatives exchanges experienced record volumes as the use of listed derivative products moved more into the mainstream. Here is a sample of growth: ICE 44%; ICE Futures U.S. 23%; CME Group 28%; CBOE 40%; ISE 35.9%; Nymex 29% (through November); Eurex 25%; NYSE Euronext 19.2% in U.S., 47% in Europe, 29.9% on Liffe, 70.7% in U.S. options.


Subprime blues

The list of complex derivative products related to the subprime debacle, be they CDOs (collateralized debt obligations), SIVs (structured investment vehicles) or some other acronym (all basically bundles of subprime debt) are surely what Warren Buffett was referring to several years ago when he called derivatives “financial weapons of mass destruction.” However, it is not derivatives that are to blame, but rather the willingness of so many supposedly sophisticated entities to jump into a mess. Here is a brief sketch of subprime fallout so far:

•The subprime crisis, most likely years in the making, became known with the failure of two Bear Stearns hedge funds in June. From that point on the negative news followed in a slow painful drip.

• E*Trade Financial shares plummeted 59%, losing $2.2 billion in market value, after it issued a warning about the company’s subprime exposure and ignited an electronic run on the electronic bank.

• Merrill Lynch accumulated the largest losses in the company’s history, and yet CEO Stanley O’Neal retired with a compensation package valued at $161.5 million.

• Countrywide Financial Corp. stock, which claims to be a #1 home lender, crumpled like bad drywall.

Not such a sentinel

On Aug.13, Northbrook Ill. based cash management firm Sentinel Management Group sent an evasive letter to investors basically announcing a halt to redemptions. Soon thereafter Sentinel filed for Chapter 11 bankruptcy protection. Prior to this, however, it managed to sell its most valuable assets to hedge fund giant Citadel at a discount, a move many of its customers claimed it had no right to do. Next the Securities and Exchange Commission (SEC) filed a suit charging Sentinel with fraud, mismanagement and misappropriation after finding large discrepancies and shortfalls in the pools of money Sentinel managed. In October Sentinel bankruptcy trustee Fred Grede filed an action seeking $350 million from defendants Philip M. Bloom, Eric A. Bloom, Charles K. Mosley and other Sentinel insiders. The suit claims the insiders “operating through a pattern of criminal conduct, committed a long-term, massive fraud against Sentinel and its customers.” Sentinel originally told its clients its problems were due to the credit crunch.

Housing meltdown

In October, the housing bubble burst and the S&P Case/Shiller Home Price Index showed its biggest year-on-year decline in the 20-year history of the index. While a 6.7% decline may not seem huge, the housing bubble was being held up in part by interest only loans dependent on continued growth in housing value.


We are entering the eighth year of the Bush Administration’s “strong dollar policy.” Here’s how the policy worked in 2007.

Who you gonna trust?

The joint Finance and Judiciary committees’ report “The firing of an SEC attorney and the investigation of Pequot Capital Management” confirmed allegations that the SEC mishandled the investigation into hedge fund Pequot, fired the SEC’s lead investigator for reporting “evidence of improper political influence on the investigation,” and failed to conduct a “serious, credible investigation into the fired attorney’s allegations.”

According the joint committee report, the SEC delayed Morgan Stanley Chairman and CEO John J. Mack’s testimony in the Pequot investigation for more than a year, and past the expiration of the statute of limitations. Mack, who served as CEO of Pequot for a month in 2005, probably would not have been able to secure the top spot at Morgan Stanley, where he had worked for 30 years previous to this, had he been under an SEC investigation. After conversations with Mack, Pequot CEO Arthur Samberg made roughly $18 million on a series of trades that strategically benefited from the GE/Heller Financial merger, which Mack was intimately acquainted with as CEO of Credit Suisse First Boston at the time.

Don’t fall for this: Freddie Mac, which has taken a beating in the subprime fallout, has put together a You Tube video describing a common fraud by scam artists preying on mortgage holders at risk of foreclosure.

Unusual bailout or tragedy averted: In January 2007, three days after crude oil dipped below $50 per barrel for the first time since May 25, 2005, President Bush announced plans to double the strategic oil reserve. Big oil companies, which have seen multiple record annual profits in the years since Bush took office, faced the prospect of mere obscene profits rather than grossly obscene profits before this bold action. Alas crude rallied above $55 and a tragedy was averted.

ICE Age: ICE Chairman Jeff Sprecher vowed while wooing the CBOT to maintain the CBOT brand name. He apparently made no such commitments to Nybot, now ICE Futures US, or Winnipeg Commodity Exchange — now ICE Futures Canada.

Meet the new boss, same as the old boss: NewsCorp, parent of the Fox News Channel, has completed its purchase of the Wall Street Journal. We wouldn’t worry about changes, at least not on the editorial page.

How low can you go? One hedge fund manger’s holiday card had a drawing of a dad reading a story to his kids, saying “...and the good little boys and girls got coal, and the bad little boys and girls got dollars.”

End of an era

•ICE’s board of directors voted to end open-outcry trading for futures contracts on the former Nybot in 2008.

•After more than 280 consecutive profitable quarters, Morgan Stanley posted its first quarterly loss: $9.4 billion.

•As part of the CME/CBOT merger, the CME will move its two trading floors to the historic CBOT building. The one contract that lifted the fortunes of the exchange, and which is indelibly linked to the CME, will not have a home. Pork bellies will trade exclusively on Globex. God speed piggies.

Off the charts

Don’t bogart my bonus, dude: According to the Wall Street Journal, while Bear Stearns’ management tried to salvage two hedge funds crippled by subprime exposure, CEO James Cayne was out of the office 10 of 21 workdays playing golf and playing in a bridge tournament in Tennessee. Cayne reportedly mellows out after the bridge sessions by smoking marijuana.

Nice work if…Just when it looked like we would have to pass the hat around for the growing list of recently unemployed investment bank CEOs, we hear Goldman Sachs Group Inc.’s CEO Lloyd Blanfein received a $67.9 million bonus for 2007. This can be a model for others: See what can happen when you manage not to lose several billion dollars.

Weather futures: Newswires reported a research paper entitled “Gone with the wind: Chicago’s weather and futures trading,” presented at the Asia Pacific Futures Research Symposium in Shanghai, showed how wind velocity affects the performance of traders. It found that on days with higher than normal wind velocity, traders tended to sell more often. It also found that traders made more profits on sunny days than cloudy days. Perhaps the “BIG WIND” award should go to whoever managed to gain funding for this study.

Impractical jokes: SEC Chairman Christopher Cox sent out a mock press release as an April Fool’s Day joke announcing plans to require public companies to reveal the pay and perks of the top 100 people at their firms. The joke, an attempt to bring levity to the often mundane workings at the SEC, was out of character for the regulator that came under increased criticism as more and more people viewed the workings of the SEC itself as a joke.

Just in case the Fed runs out of money:

• China Investment Corp. invested $5 billion for a 9% interest, and the investment converts into Morgan Stanley stock in 2010.

• The Abu Dhabi Investment Authority invested $7.5 billion in Citigroup.

• Temasek, a Singapore based investment fund was in talks to invest $11 billion in UBS.

Beware end-of-year prognostications: Jordan Kimmel’s newsletter for January 2007 predicted the Dow would hit 15,000 in 2007 but also said: “We are seeing the first signs of an improving housing market in the U.S.”

Fight of the year: CME vs. ICE

On the Ides of March, while preparing for a media breakfast during the Futures Industry Association's annual conference in Boca Raton, Fla., CBOT Chairman Charlie Carey received a phone call from ICE Chairman and CEO Jeff Sprecher informing him of ICE's bid to purchase the CBOT. The breakfast was curtly cancelled and a surprisingly tough four-month battle ensued for the hearts and minds of CBOT voting members.

CME Executive Chairman Terry Duffy stubbornly refused to consider raising the CME bid at a press briefing after the Merc brass met with CBOT members and tried to convince them that because it had a stronger currency, the CME offer was superior despite the ICE's all-stock bid being approximately $1 billion higher.

The CME did raise its bid several times but with ICE stock rising and CME stock falling, the ICE bid remained higher. The one problem for ICE was that every time it became apparent that it had the upper hand, the ICE stock would fall.

But it wasn't until ICE announced a deal with CBOE that would resolve the longstanding exercise rights issue between CBOT members and the CBOE and Sprecher met with CBOT members - answering questions for several hours after the meeting ended - that ICE's bid began to pick up steam.

CBOT members didn't like the particulars of the ICE/CBOE deal but respected the effort. One longtime CBOT member exclaimed that he wanted the CME to match the ICE bid, but after hearing Sprecher, the CME would need to pay a premium; "This is a man of vision," he exclaimed of Sprecher. When Australian base fund manager Caledonia Investments, the largest stock holder of the CBOT, made clear shortly before the July 9 vote that it would not support the CME bid as it was presently constituted, ICE seemed to pick up momentum. But from the outset, it always seemed within the CME's power to end the battle, and on July 6, the Friday before Monday's scheduled vote, the CME bumped its offer for a third time and with both the CME and CBOT boards, as well as Caledonia, approving the new offer it was game, set and match.

Off the charts

Oops! In early 2007, Merrill Lynch became the largest underwriter of subprime mortgage-backed securities when it purchased First Franklin Financial for $1.3 billion. After assurances that subprime exposure is “limited, contained, and appropriately marked,” Merrill announced a quarterly loss of $2.24 billion after $7.9 billion in subprime related write-downs.

How relevant? In September Calyon Financial discovered large credit index positions on the books of its New York prop desk subsidiary. The position built up at the end of August was above the authorized limit and cost Calyon €250 million. Calyon reports that “relevant disciplinary measures have been taken.”

Rogues Gallery


While there are plenty of rogues and blame to go around related to the subprime crisis and credit crunch, we reserve this designation for the three major securities ratings agencies:


•Standard and Poor’s


Wikipedia defines “investment grade” as bonds that are judged as likely enough to meet payment obligations that banks are allowed to invest in them. Investopedia defines “subprime” as a classification of borrowers with a tarnished or limited credit history. Subprime loans carry more credit risk.

It is not the act of creating investment vehicles from bundles of subprime loans that is disturbing, as many of the products we write about are highly volatile. Rather, it is that somehow many of these products were given a stamp of “investment grade” by these ratings agencies, who were paid by the issuers of these products, allowing them to be portrayed as safe investments along the lines of, say, U.S. Treasuries.

Awards of a sort

Lack of imagination award: Nymex announced in December the creation of a carbon market entitled the Green Exchange, which will launch in 2008. A simple Google search found multiple Green Exchanges:

• The Green Exchange: A Chicago based commercial real-estate development aimed at attracting green business (copyright 2006)

• The Green fuels Exchange (GFEX): A b-to-b exchange for trading biodiesel and other environmentally-friendly fuels based in Des Moines, Iowa.

• The Green Exchange: South African based exchange for trading carbon credits.

Dumb criminal award: An alleged boiler room, operating out of Georgia and targeting Canadian and European victims, had a little bad luck when one of the targets of their scam offering off-exchange oil, gas and foreign currency options turned out to be Jake van der Laan, the head of enforcement of the New Brunswick Securities Commission. Van der Laan played along with the scam, which promised profits of 750%, long enough to collect evidence that led to a CFTC enforcement action against Georgia based Saxon Financial Services Inc.

Chutzpah award: Former Amaranth head trader Brian Hunter filed a complaint against the Federal Energy Regulatory Commission asking for a temporary restraining order preventing FERC from filing a show cause order against him and Amaranth after FERC made a preliminary finding that Amaranth and Hunter manipulated natural gas futures markets. The former wunderkind trader, who lost $6 billion for Amaranth investors, had set-up a new fund, Solengo Capital Advisors, and claimed the FERC action put the new company on the brink of disintegration.

The kicker: Hunter had lined up 25 qualified investors pledging $800 million for the new fund. Kicker 2: During a lunch break Hunter simply walked out of an interview with FERC, which is seeking a total of $291 million in penalties against Amaranth and Hunter.

The bad penny award: Futures broker Refco imploded in 2005, but reverberations are still being felt. In 2007, Refco paid $145.3 million to lawyers and for restructuring the company as related to its bankruptcy; Goldin Associates declined a $2.4 million “success fee” for work it did on the bankruptcy; the Refco estate sold its 35% interest in Forex Capital Markets LLC to Long Ridge Equity Partners and Lehman Brothers; a complaint filed by Refco FX customers who had accounts frozen after assurances that they would not be affected by the bankruptcy was dismissed and Sphinx Funds was forced to return $263 million after losing a case to Refco that said Sphinx received preferential treatment enabling it to pull out $312 million as Refco crashed.

The dog pound

•Santo Maggio, former president of Refco Capital Markets, pleaded guilty to two counts of securities fraud, one count of conspiracy and one count of wire fraud in late December. He faces a maximum sentence of 65 years and must return $23 million.

•Refco outside counsel Joseph Collins of Mayer Brown LLP was indicted on 11 counts of fraud and other charges related to Refco’s round trip loans, which led to the company’s destruction. Separately, the SEC also accused Collins of failure to disclose hundreds of millions in debt prior to Refco’s IPO.

•Still awaiting trial on conspiracy, fraud and other charges are former CEO Phillip Bennett, former CFO Robert Trosten, and former President Tone Grant.

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