Afternoon:
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Stock markets have delivered a massive vote of confidence, or perhaps it was thanks, to JPMorgan Chase for its bailout of stricken investment bank Bear Stearns. One suspects it is something both it and the purchaser will live to regret, for as anyone tempted by the January sales will have learned to their cost, just because something is cheap does not make it a bargain.
The declared reason JPM chief executive Jamie Dimon wanted Bear Stearns so much was that he coveted its business with hedge funds. The way this business works is that the investment bank lends large sums of money to a hedge fund to enable it to gear up its funds, and in return the hedge fund channels its sales and purchases through the investment bank without quibbling much about the charges. Thus it is that hedge funds account for half the dealing fees paid on the London Stock Exchange, but nowhere near that proportion of the bargains.
The flaw in Dimon's grand plan is the assumption that hedge funds will survive this storm in any numbers. Relatively few have gone bust yet, but that is not the point. What matters is that the hedge-fund business model does not work without gearing, and it will be years before debt is as freely and cheaply available again.
The debt is needed because most hedge fund strategies consist of running on to a motorway to pick up pennies. Only if those pennies are leveraged by debt is the return worth the effort. That is why the Carlyle fund that blew up last week had been leveraged 30 times.
That is also why one New York practitioner said yesterday that two-thirds of hedge funds would be out of business by the end of the year.
It's money down the drain, Jamie.
Indie exchanges are under threat
The headline said it all yesterday. Amid the reports of mayhem and tumbling markets, it announced that the Chicago Mercantile Exchange - the world's largest futures market - had sealed a deal to buy Nymex, the New York exchange that trades most of America's oil and was one of its few remaining independent rivals.
"CME to control 98% of US-listed futures with $9.4 billion Nymex deal," it announced baldly. You have to wonder how that can possibly be allowed. The US has a history of notable zeal in attacking monopolies and breaking up business combination that could act against the consumer interest. How can it possibly serve this interest to have one body in effect controlling the entire US exchange-traded futures industry?
How can it be that the regulators have not already jumped on the CME and at least asked what it might be doing to protect the consumer interest? Cynics might note a correlation between contributions to political candidates and the effectiveness of political lobbying, though the CME would presumably take a different view.
We might also ask what is happening to the Justice Department probe, announced a few weeks ago, into the CME's control of the clearing house through which all trades are processed. This silo allows the exchange not only to capture all the revenues accruing from a trade and its subsequent processing, but is also a powerful barrier against competition emerging in the future.
Without access to clearing, there is almost no chance for a rival trading floor to gain a foothold from which it could mount a challenge. So if the Justice Department ordered divestment of the CME's clearing operation, it would be a start - although observers say pigs will fly first.
We shall see. Meanwhile, the development of the CME powerhouse is having repercussions in Europe. As pushed by the UK, EU policy is to keep trading separate from clearing so that customers have a choice of both trading platform and back-office work. This model is now under huge pressure as it is much more profitable to have all these activities under one roof, and since exchanges want to make a profit.
Thus it is that ICE, the owner of what was the International Petroleum Exchange, now ICE Futures, is seeking to build its own clearing engine and ditch its arrangements with the London Clearing House. Liffe - now owned by Euronext, which is in turn owned by the New York Stock Exchange - likewise wants to go it alone, though this has been disguised in a murky deal under which it will allegedly outsource clearing to LCH. But LCH clears its trades at the moment, so the only point in such a deal is that Liffe becomes a silo without admitting it publicly.
Thus the European open-access model is under severe threat, the future of LCH. Clearnet looks bleak, and the exchanges everywhere look dead set on becoming monopolies and exploiting their position. It is time, indeed past time, for the US and British competition authorities to bring them to heel.
