New York’s Other Big Win? Connecting Dots in the Clearinghouse Raid

Includes: CME, NMX
by: Greg Newton

It’s 80 years more or less since the Department of Justice last hit Chicago quite so hard. But whatever grief Elliot Ness visited on the city’s racketeers in the 1920s, it was like a brief summer storm compared with the financial massacre triggered Tuesday when the department’s antitrust division woke from its long nap and rolled a smoking grenade into the cozy not-so-little futures clearinghouse racket.

Apparently, the exchanges’ control of their own clearing operations “may have inhibited competition among financial futures exchanges, potentially discouraging innovation and perpetuating high prices for exchange services.” And given that keeping competitors out and perpetuating high prices is the business model, the high-flying Chicago Mercantile Exchange (NASDAQ:CME) took the kicking of its five-year life as a public company.

Its stock dropped $103.55, or 17.6 percent, Wednesday, closing at $485.25; its decline from Tuesday’s high of $624.51—reached after the exchange unleashed another record earnings report that morning—was almost $140, or 22.3 percent. The New York Mercantile Exchange (NMX), already snuggling into the CME’s warm embrace, also dropped more than 17 percent Wednesday.

Given that the bureaucrats who were suddenly shocked, shocked to discover monopolistic exploitation going on at futures exchange clearing houses were the same ones who blithely waved through last year’s merger of the Chicago Board of Trade and the Chicago Mercantile Exchange, it’s probably worth examining a few widely-overlooked observations:

Noted with interest I:

The antitrust division grenade is dated Jan. 31; it’s unclear when the document was actually released, but its existence was certainly not widely known until Tuesday afternoon, Feb. 5, when the John Lothian Newsletter published a Special Report.

The original document was couched as a response to a Treasury Department request for comments on the ‘Regulatory Structure Associated with Financial Institutions.’ That little exercise is part of Treasury secretary Hank Paulson’s plan for “a more effective regulatory structure that can adapt to the dynamic U.S. marketplace while improving oversight.”

Noted with interest II:

What did the CME know, and when did it know it?

On Thursday, Jan. 30, CME nominated two Washington insiders as new members of its board. Former House speaker Denny Hastert (R. Ill), who will not seek re-election this year, is already a wholly-owned subsidiary of the CME; he will be joined by Timothy Bitsberger, treasurer of Freddie Mac (FRE), but, most notably, a former Treasury assistant secretary for financial markets. The timing of those appointments is obviously just a coincidence, but a convenient one.

It may just have been me, but CME chief executive Craig Donohue didn’t look as perky as usual when he did his CNBC dog-and-pony-quarterly-results show on Tuesday morning; perhaps he’d just put his shoulder out patting himself on the back...or, perhaps, he was by then contemplating the Reg FD implications of the CME failing to address the regulatory challenge in its 2008 guidance.

(The CME held a hurriedly-convened conference call with analysts Wednesday; its stock price seemed to stabilize around the time of the call, but continued its fall later in the day when the rest of the market rolled over.)

Noted with interest III:

Why the Damascene conversion at Justice?

The CBOT had a documented history of anti-competitive behavior, particularly in defense of its US Treasury futures contracts, for several years prior to its merger with the CME. Yet the merger was approved, with hardly any questions asked. The dramatic change in mood within a few months raises the valid question: who got to the antitrust regulators?

The answer to that question appears reasonably obvious. Shortly before Christmas, The Wall Street Journal reported that several big-foot bond firms—including, in no particular order, Bank of America (NYSE:BAC), Citadel Investment Group, Citigroup (NYSE:C), Credit Suisse (NYSE:CS), Deutsche Bank (NYSE:DB), JPMorgan Chase (NYSE:JPM), Merrill Lynch (MER) and Peak6—would use an eSpeed platform to build a new exchange that will compete with the CME. While that consortium could generate significant liquidity merely playing among themselves, its chance of emerging as a significant competitor would be greatly enhanced should they not have to face the CME’s demonstrated competition-choking expertise.

This one will run and run. If nothing else:

  • It will be fun watching the behemoths beating each others’ brains out;
  • Any plans the CME might have had for racking its rates any time soon are on hold; and
  • Let’s hope whoever caught that $714.48 tick on Dec. 10 had a tight stop on.

Review of the Regulatory Structure Associated with Financial Institutions
US Department of Justice, Antitrust Division
Jan. 31 2007

Selected coverage:

CME, Nymex Tumble 18% After Justice Antitrust Opinion
by Matthew Leising
Bloomberg Feb. 6 2008

DoJ challenges ownership of clearing houses
by Jeremy Grant
The Financial Times Feb. 5 2008

CME-Nymex: The Regulatory Clouds Gather
by Aaron Lucchetti
WSJ Deal Journal Feb. 6 2008

CME statements:

CME Group Analyst Call
Feb. 6 2008 (Registration required)

CME Group Statement
Press release Feb. 6 2008

CME Group Inc. Reports Strong Fourth-Quarter and Full-Year Revenues and Net Income
Press release Feb. 5 2008

CME Group Inc. Names Slate of Director Nominees
Press release Jan. 30 2008

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