21st Century Bank Run: Watching a $4 billion company fall apart in a week

msn.com ^ | 17 October 2005 | Daniel Gross

[Axhandle]

If you want to know what a modern bank run looks like, consider the case of the giant commodity trading firm Refco. It went public in mid-August, but in the course of the past week it has gone from $4 billion stock-market darling to carcass. The proximate cause of the meltdown was the surprise disclosure on Monday, Oct. 10, that an entity controlled by CEO Phillip Bennett had owed $430 million to the company. A week later, trading of the stock has been halted and vultures are picking over Refco the way hyenas gnaw on the remains of wildebeest. Refco was no boiler-room operation. It's been around and successful for a long time. (Scandal connoisseurs will recall that Refco was Hillary Clinton's commodities broker.) And it had been getting more and more respectable. First, Thomas H. Lee, the highly respected private equity investor, agreed to take a big stake in Refco in the summer of 2004. Then gold-plated underwriters Goldman Sachs and Credit Suisse First Boston brought it public two months ago. Refco was a model 21st-century business—a highly digitized, high-tech services company that traded complicated financial instruments on behalf of customers all over the globe. But its meltdown shows that its real assets were not its New Economy algorithms and brainpower. Rather, this extremely modern company depended ultimately on the kind of assets that built American capitalism in the 19th century: trust, integrity, and the personal reputation of executives. Nothing material changed in Refco's financial situation when it announced that Bennett had secretly owed money to the company, or when it provided more details the next day about how Bennett had hid the debt. If anything, the company's situation improved, since Bennett paid the money back and quit the same day.

[Axhandle]

I was shocked to actually stumble across a decent article on msn.com. I'm not sure if slate.msn.com is related to the leftist slate website, but regardless this article raised some great free-market issues - about how the foundation for a successful business is trust, integrity, and competence, rather than shifty schiesters and exploitation of workers. Granted it discusses a business going down the tubes, but it explains why it happened and in the process highlights the fundamentals of successful businesses. This would almost make a good fable for a young kid beginning to learn about economics.

FYI - there are a bunch of hyperlinks in the text that don't show up when I post this at FR.

[b4its2late]

(Scandal connoisseurs will recall that Refco was Hillary Clinton's commodities broker.)

I'm shocked.

[stockpirate]

Thanks I had forgotten that. But the headline is misleading, as the company was not a bank.

[raybbr]

Refco was a model 21st-century business—a highly digitized, high-tech services company that traded complicated financial instruments on behalf of customers all over the globe. But its meltdown shows that its real assets were not its New Economy algorithms and brainpower. Rather, this extremely modern company depended ultimately on the kind of assets that built American capitalism in the 19th century: trust, integrity, and the personal reputation of executives.

[the invisib1e hand]

refco's failure, though shocking in its speed, is equally awesome for its orderliness and nothing could be further from a "bank run" than what happened at Refco. Very few, VERY few of their futures accounts have flown and that business will apparently be picked up by another going concern about as seamlessly as possible.

The sorts of sensationalism that swirls around things like this are really nauseating.

[investigateworld]

Thanks Ax, the writer simplified enough that even my grandkid could understand.
Toddster what's your take on this?

[John123]

What happened to all the accounts of individual traders? Did they recover all the funds in their accounts?

[Toddsterpatriot]

Nothing material changed in Refco's financial situation when it announced that Bennett had secretly owed money to the company, or when it provided more details the next day about how Bennett had hid the debt.

This is incorrect. The $430 million in hidden losses made Refco look more profitable than it really was. If a stock trades at a certain P/E ratio and you find out the E portion of the equation was a lie, you have a problem.

I'd call 8 or more years of earnings lies a material change in their financial situation.

[Cicero]

Just a minor note, but I hadn't recalled this little detail: "(Scandal connoisseurs will recall that Refco was Hillary Clinton's commodities broker.)"

[snowman1]

They must have taken lessons from the Cintoons.

[cake_crumb]

It was a trading company, not a bank. The company was powered by the Clinton school of economics. Refco's assets were based on valuation based on book cooking rather than hard currency. Its demise was so swift because investors knew Refco couldn't pay actual debts or cover assets with virtual cash.

[Thebaddog]

Did Refco have Chicago roots?

[prairiebreeze]

It's bad enough when the CEO hides hundreds of millions in debts. But the worse part of what happened at Refco, and what took them down in the eyes of customers, was the public admission (a necessary admission of course) that their accounting was tainted going all the way back to at least 2002.

[NeoCaveman]

(Scandal connoisseurs will recall that Refco was Hillary Clinton's commodities broker.)

Ping.

[prairiebreeze]

And it had been getting more and more respectable.

This is also true. Many honest and ethical people worked hard toward that goal. All to have it taken down by a couple of slick greedy executives.

[Burf]

That was the philosophy that Clinton had done away with the market cycles. Just make up the numbers you want and by the time it all shakes out, you'll be off on retirement living the good life.

[doug from upland]

That is interesting.

[DoughtyOne]

I personally like that bit about Hillary's cattle futures. "...and it had improved it's reputation..."

LMAO

Yeah, from scurvey bottom, everything is up!

[Toddsterpatriot]

Did Refco have Chicago roots?

I believe they started in the South. They do have offices here in Chicago.