Tops & bottoms of 2007

Futures, Feb 2008 by Collins, Daniel P, McMahon, Chris

It was another banner year for the futures industry with record volumes, mergers and increasing share prices. The subprime crisis hit (the complete impact of which is still unknown); the commodity bull resumed and Chicago's major futures exchanges merged. Here is our annual offbeat look at some of the events of last year.

Tops [black triangle up]

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, page 67).

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 Borse 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 sixmonth 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.

Bottoms

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 deriva- i tives "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 sub- I prime 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.

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.

* 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 111. 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.