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The stunning crash of the futures brokerage Refco ( RFXCQ) this month has cast an unflattering spotlight on the important but little understood world of high-stakes commodities trading.

It is a world where hundreds of billions of borrowed dollars change hands around the clock to speculate on the direction of currencies, hedge the price of corn and cattle, and bet on the volatility of the U.S. stock market. And it is a world where the fortunes of veteran pros and precocious amateurs alike can be won or lost faster than you can say "eurobond."

One speculator who knows both sides of this world better than anyone is Victor Niederhoffer, a hedge fund manager who made hundreds of millions in the futures market for customers from the early 1960s to the mid-1990s, and then lost a bundle in a single ill-fated day. His name has surfaced in the past week in connection with the demise of Refco, and so it seemed appropriate revisiting to try to understand the brokerage's blowup from his perspective, starting with his business relationship with Refco eight years ago.

More than 200 major brokerages across the globe will let you set up an account to wager on futures, including giants such as Goldman Sachs ( GS). But for more than two decades, the cool sophistication and low prices of Refco made it the house of choice among both private traders and swashbuckling hedge-fund managers. In terms that stock traders can appreciate, it combined the cheap trades of an E*Trade Financial ( ET) with the strong customer service of a Charles Schwab ( SCH).

Striving to Be No. 1

Niederhoffer opened up an account at Refco for his own trading not long after ditching the professorial life that he had enjoyed for a short while at the University of California, Berkeley. A statistics whiz, he developed a unique approach to making money by quantifying the predictive properties of daily and hourly movements between stocks, bonds and other markets. His style attracted the attention of industry lion George Soros, and soon he was trading an account worth more than $100 million for Soros and others.

He spoke with Soros up to 10 times a day. The work was challenging but lucrative. An iconoclast, Niederhoffer soon spread his wings and figured out how to apply his techniques to markets as far afield as Turkish bonds, the Mexican peso and Japanese stocks. He also bought and sold private companies, made venture-capital investments and earned numerous awards en route to making his partners increasingly wealthy.

In 1996, he explained his methods and took a bow by writing an autobiography called The Education of a Speculator . Although the book was well-received, he came to see its publication as an act of hubris, for the very next year would prove to be the start of his undoing. "My big mistake was that I strived too hard to be No. 1," he said.

In 1997, Niederhoffer became enraptured by the siren of emerging markets, which was to that era what the Internet would become two years later. He made major speculative investments in Thailand, and when its stock market and currency fell 50%, he applied his usual technique of buying into the panic. By midyear, as the Asian currency crisis ravaged the region, he was losing money in illiquid investments there rapidly, and though he tried to pare down his positions, he could not get out.

His capital position worsened over the summer as the contagion spread to the U.S. markets, driving them steeply lower. Still, he kept trading here as he always had, using an against-the-tide strategy that had frequently in the past taken him to the brink of ruin before paying huge dividends. He says he had a deal with his longtime Refco account manager at the Chicago Mercantile Exchange that if he were to receive a margin call, he would have several days to raise the cash to meet his obligation.

Refco's willingness to make accommodations to its best customers was part of the reason for its success, and it may have played a role in its undoing.

'The Worst Situation Imaginable'

On Oct. 27, 1997, the stock market closed at 3:30 p.m. for the first time in modern history on a "circuit-breaker" rule due to sharp losses. The situation was unprecedented and chaotic. No one knew the proper way to price relatively illiquid derivatives. Niederhoffer received a margin call that afternoon. Refco told him that prior arrangements were no longer in force because of uncertainty over how their authorities would calculate their own liquidity. Refco wanted cash from Niederhoffer to serve as a buffer from further market losses.

The next day, Niederhoffer said he thought he could get out of his positions successfully, but because of setbacks in Thailand he could not produce liquid collateral. Despite 15 years of working together through similar problems, he said Refco proposed that it resolve the situation by trading his fund's positions for their own account and transform some of them into cash. He reluctantly agreed. In a flash, Niederhoffer was out of business.

As you might expect, Niederhoffer contends that if Refco had just held on to his positions a few hours longer, they would have become very profitable, as the market rallied violently that afternoon. But he recognizes that the company believed it could not take the chance that the position would go the other way, leaving it exposed to the danger of being out of compliance with capital requirements. "I requested that I be given time to liquidate in an orderly way so we'd both be better off, but they had their own agenda to make sure the thing didn't snowball," Niederhoffer says. "It was the worst situation imaginable."

Niederhoffer's business was wiped out, but he says it was never clear what became of his positions. In addition to his options on futures, there were numerous other assets, including up to 10 million shares in two private companies that would go on a few years later to have successful initial public offerings. One of them is now worth $3.7 billion. Depending on how the options positions were marked to market, he figures Refco ended up with anywhere from a sizable gain to a $40 million loss.

Although TheStreet.com and The Wall Street Journal quoted anonymous sources last week who claimed that part of Refco's troubles -- which include a $450 million phantom debt -- stemmed from this episode, Niederhoffer asserts that it is virtually impossible. He notes that two days after the asset transfer, he came to a contractual agreement with Refco, in talks with then-chief executive Phillip R. Bennett, that fully released him from all liabilities and responsibilities. He owed only $2 million in personal margin debt, which he repaid a year later. Niederhoffer also points out that the transaction was scrutinized by several regulatory agencies at the time and audited thereafter. There were no loose ends.

The succeeding three years were painful. He says he had a "substantial net worth" at the time the fund closed, and that he was never close to personal bankruptcy. But he lost his livelihood, his reputation and, in some measure, his self-confidence. He also was forced to sell his world-class silver collection and other prized possessions. But over time he reached a settlement in a suit against against the Chicago Mercantile Exchange and repaid substantial amounts of his customers' losses.

A Bullish Matador

Today, Niederhoffer is back on his feet, handling a nine-figure account that he bootstrapped mostly from scratch. His new offshore Matador Fund is listed by hedge-fund rating firms as the world's top performer over the past one and three years, with a 50% return in 2004 and a 41% return so far in 2005.

In my opinion, Niederhoffer's return to the arena should be cause for celebration, not scapegoating. His success, defeat, reflection and re-emergence are all emblematic of a cycle of persistence and ambition over entropy and adversity that characterizes our best American myths. With any luck, Refco will survive too, chastened but stronger.

As someone who has firsthand knowledge of the extreme disruption that a financial crisis can cause, Niederhoffer said investors today need to understand that much of the recent stock market decline has derived in large part from the forced unwinding of highly leveraged positions either held by Refco or its customers. "There are a lot of bottom-feeders and vultures who specialize in profiting from liquidations," he said Sunday. "When the dust settles, there will be a great rally. Dislocations like this one happen rarely, and on average leave the market in a positive position." He added, with a self-deprecating twist: "I'm always bullish, yet I'm more bullish now than usual. But don't forget, I've been wrong before."

What's the difference between his methods now and pre-1997? "The main thing now is that I don't trade in Thailand," he said.

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Jon Markman, writer of TheStreet.com Value Investor, is the senior investment strategist and portfolio manager at Greenbook Investment Management, a division of Greenbook Financial Services. Separately, he is publisher of StockTactics Advisor, an independent weekly investment research service. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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