Expert View: Closer's downfall signals Wall Street's lack of trust

The complex connections in this scandal evoke memories of 1929
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The Independent Online

Or rather, he was. He started the week as chief executive of the trading firm Refco, and finished it being confined by court order to his penthouse, with the press braying outside. His downfall has serious implications for markets.

Mr Bennett is accused of having hidden substantial losses for many years (according to one rumour, as far back as the Asian financial crisis of 1997-98). He allegedly did this by "renting" the balance sheet of a hedge-fund client, enabling debts of about $430m (£245m) to yo-yo on and off the Refco accounts, as necessary.

This was particularly useful, given that Refco was only floated on the stock market in August, enabling Mr Bennett to establish his very considerable paper fortune in the process.

Shareholders have particular reason to feel aggrieved. The shares were suspended from trading on Thursday at $10.85 (around half of the flotation price), although in pre-market trading they had fallen to $8.

Interestingly enough, Mr Bennett has reportedly repaid the $430m to the company out of his own funds, or, as rumour has it, from a bank loan secured on his own Refco holding. Of course the latter is not what it was at $8, giving the banks an interesting exposure. This is one of those viciously circular scandals where nobody benefits.

We seem to be living in an age of such scandal. Some argue this is a consequence of the usual decline in Wall Street ethics accompanying bull markets - in this case in commodities. And what a boom it is, driven on by the explosive consequences of the Chinese industrial revolution. Iron ore is up 70 per cent this year, while over the past two years lead has risen 120 per cent and molybdenum (a metal used in many alloys) by nearly 1,000 per cent.

The Refco scandal sent jitters through all commodity-related markets, but its unpleasant consequences may not end there. The hedge-fund balance sheet for hire, which enabled Mr Bennett to evade the "related party transaction rules", has yet again focused investors' minds on the loose regulation and lack of transparency that so permeate the hedge fund world. There is no shortage of scandals there at present - Bayou Capital, PAAM, Wood River - and all too often the ability to hide losses is central to them. Do investors always understand what they are buying? Equally, the complex interconnections in this scandal should alert all of us to the dangers of default contamination, evoking memories of 1929 and the banking defaults of the 1930s.

Were the banks that lent money to Refco, and indeed to Mr Bennett, the same ones involved in the float? Were they also trading partners with Refco in commodity deals through their trading arms? Or indeed investors in the stock through their asset management subsidiaries? Ditto for the hedge funds.

More and more transactions around the world involve futures and derivatives. There is no counter-party risk in an exchange futures contract (the exchange itself acts as guarantor to both buyer and seller). This is not the case in privately negotiated contracts of the kind beloved by many hedge funds. Default by one party could leave the other exposed. Refco reportedly has about $4bn in customer accounts for banks and hedge funds spread across futures and derivatives contracts to offset exposures to all kinds of markets - US Treasuries, pork bellies, soya, etc.

I come from a long line of City slickers and remember how when I first ventured on to the stock market floor as a raw Blue Button, I carried a pen emblazoned with the exchange's motto: "My word is my bond".

That concept is the very foundation of investor confidence - indeed, of the free exchange of capital. It should not be tampered with lightly. No wonder the market is falling.