Tuesday, October 18, 2005


Refco A Modern Day Bank Run

Slate has a report on the Refco scandal. "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."

"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."

"But it was already too late. Refco was in the business of facilitating trades that are conducted essentially through a digital handshake. The actual exchange of cash—the settlement—takes place within a few hours or a few days. Any company operating in this environment relies on liquidity; the ability to access vast stores of credit instantaneously and cheaply; and on the willingness of other institutions to act as counterparties, to wait a day or two before receiving payment."

"Once the trouble was announced, Refco's customers wondered whether it was wise to do business with a company whose internal controls were so weak that it didn't know its own CEO was hiding a nine-figure debt. So, the demise was swift."

"In abandoning Refco so rapidly, the market proved that creditworthiness is not an absolute attribute that can be proved by showing you have a certain amount of cash on hand, or that your equity-to-debt ratio is above a certain level. Ultimately, creditworthiness is in the eye of the beholder."

"Refco's downfall isn't simply an occasion for a history lesson, or an object lesson for people who make their living in the commodity pits. The entire global economy runs on the lubricant of easy credit extended among companies. And much of that credit depends on trust and reputation. These days, you don't have to be a bank—or even a liquidity-dependent finance firm—to suffer a run on the bank."

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