Commentary, analysis, and entertainment from QuasiPundit contributors

 

Watkins Skates, Sharks Gather, Vultures Circle

RonK - Seattle

In a triumph of Artistic Impression triumphs over Technical Merit, a congressional panel melts as Sherron Watkins skates over ethical thin ice. Watkins' performance sets the stage for Ken Lay's vaunted "out-of-the-triple-toe-loop" defense of his crown.

FLASHBACK to Camp Enron Report of 2002-01-18:
The big fish could still slip the net on the premise that everything they did was stupid but technically legal, or done on misinformation, or on somebody else's authority, or done "virtually" in places where it wasn't even illegal. Or "auditor ate my homework" defense, or some premature proceeding leaves them with Ollie North immunity. Or they pull a Marc Rich ... or find Jesus, plead out for a slap on the wrist and retire to the Cayman Islands to write their memoirs.

Also recall our suggestion of the Enron Valdez defense: "I wasn't even on deck".

In Iran-Contra, you may recall, nobody was in the loop, from Reagan the delivery boys ... at least on the record. Little fish were just following ultra-secret orders. Big fish never even heard of the operation. Middle fish could not recall "at this point in time". Whatever links the prosecution could cobble together were ultimately blown to smithereens in a barrage of presidential pardons.

Watkins may be stranded in ethical no-man's land ... not in on the original Enron caper, but implicated in the getaway as an accessory after the fact. At any rate, the hunger for telegenic testimony, the dearth of competing witnesses, and her own survival instancts should guarantee sympathetic treatment.

Once thought to be destroyed, recap notes from interviews in Enron's internal investigation suggest big differences between what Lay knew and what Lay said as he exercised PR damage control over Skilling's abrupt departure. See WSJ on MSNBC

Meanwhile, Texas archivist are gradually releasing documents (the "KennyBoy Papers"?) revealing Bush and Lay as penpals. GWB carrying water for ENE in Pennsylvania, Uzbekistan, and Texas ... not necessarily a bad thing for the guv to do for a home-state biz. Enron staff carried water for Bush on political errands, too ... that could be a shade more problematic. Scope of contacts and buddy-buddy tone demolish GWB's "KennyBoy who?" disclaimers. As far as we know Bush has little or nothing to hide ... why work so hard to hide it? "Guilty knowledge"? The Smoking Gun has more originals than you ever want to see.


FLASHBACK to this Short Takes of 2002-01-11, breaking ground for Camp Enron, where I suggested:
For future reference, remember this phrase ... "a Culture of Minimal Disclosure". ... Conventional wisdom says it's just more Hatfields and McCoys. I predict it becomes a major historical turning point.


Most incriminating statement to date!
Not Skilling. Not Watkins. Andersen CEO Joseph Berardino, before the House Financial Services Subcommittee (2002-02-05), fields a softball question re legit uses of off-balance-sheet financing and Special Purpose Vehicles, and answers -- "because a company wants to show a better financial position, perhaps attract a lower cost of capital ... very common". There really are legitimate accounting, business and economic reasons for SPV's ... but apparently none came readily to mind when Mr. B was caught in the glare of the headlights, er, spotlights. An indictment of the system ... if you're looking for Mr. Big, the Culture is the real killer.

(Speaking of SPV's, scuttlebutt around Camp Enron says DOD is field testing a ruggedized all-terrain amphibious version of the Enron SPV for high-risk operations. On background, one source notes "If we only had these babies back in the day, we'd still own Havana, the Philippines, and the Panama Canal.")


"Feeding Frenzy" -- the expression properly pertains to sharks, who can get so excited over blood in the water that they'll bite on anything (including each other). The metaphor extends less than rigorously to pack journalism. But it applies with a vengeance to bankruptcy proceedings, where creditors and other litigious scavengers are at once teammates (trying to maximize nutritional value extracted from the whole carcass) and competitors (elbowing each other for position in the pecking order).

The Great John Nash ("A Beautiful Mind") won a Nobel for formalizing the game-theoretic foundations of such cooperative conflicts. Nash thought he'd found a system of elegant rational solutions ... further examination it revealed a perverse infinite regress of games within games.

FF#1: The ENE creditors committee is dominated by megabanks, who have conflicted motives based on overlapping relationships (including the prospect they'll end up on the defense side of the table with Enron in related cases). A scuffle is brewing between the megabanks, ordinary creditors, Enron affiliates inside the bankruptcy envelope, Enron affiliates outside the bankruptcy envelope, and arms-length transactional counterparties. Bones of contention include disposal of valuable properties, and interim management of the ENE Empire's integrated cash management system (see earlier item on NEPCO).
Barnet Skelton, a Houston attorney who was arguing for the motion to wall off Enron N.A. from the corporate cash-management system, said the creditors committee was not the "watchdog" for all creditors it claimed to be. Rather, he said, it is a "lapdog" for Enron's biggest creditors, Citicorp USA and JPMorgan Chase Bank, who have substantial holdings in Enron Corp. (Houston Chronicle)

FF#2: In a mass consolidation of shareholder lawsuits, the University of California is designated lead plaintiff. Based on coherence and experience, Cal edged out bids by an NYC/Florida coalition, and a four-state combo (OH, WA, GA, AL). Potential for mixed motives here, too, since California is going after Enron for billions in energy market manipulation refunds.

FF#3: One subset of Enron employees and retirees aren't getting paid on the deferred compensation plan they bought into and worked for in years past. Another subset cleaned up on up-front salary and bonuses shortly before ENE filed bankruptcy. Money in the bank? Yes. In the clear? Not necessarily. The first group may have a case against the second group, since payments made in contemplation of bankruptcy may be unwound as "preferences".

FF#4: Enron's tax history goes under the scanning electron microscope. Did ENE net $381M in tax rebates over five years (as claimed by Citizens for Tax Justice)? Did ENE pay $112M net taxes (mostly AMT) last year alone, as they claim? Or did ENE pay relatively modest amounts in net taxes, as ENE financial statements suggest? Enron agrees to waive privacy and turn over tax records for thousands of subsidiaries and partnerships back to 1985. By my reckoning we're looking at millions of pages of tax returns in umpteen national jurisdictions with no central clearing house, and no direct way to backtrack the offsets and reconcile competing claims of fact, equity and priority. (See previous item re PGE.) When the facts are sorted out, competing governments will chase money that's no longer in ENE's vault. Where is it, and how far will they chase it? Looks to me like at least a twenty-year case ... the kind that stimulates development of novel litigation technology and artificial intelligence ... maybe even a lively futures market in Enron tax liability swaps.

FF#5: Finally and hilariously, Enron is as Enron does. Some enterprising post-Enron jackal tried to file a (forged) deed in Galveston County, transferring title to $15M in (genuine) properties owned by Ken and Linda Lay -- three houses in (appropriately) Pirate's Cove -- to the "Enron 401(k) Employee Trust".


Is Ken Lay really broke? We really don't know. Disclosures of previously unreported stock sales (under a reporting exception where the buyer is the corporation) undermine the "poor KennyBoy" storyline ... but suppose Lay was cockeyed optimist enough to plow the proceeds into frothy tech stocks on margin? Leverage works both ways. The sob story could be essentially true if Lay continued investing borrowed dollars, on borrowed time, into a collapsing bubble.


Access of Evil?
UCC presses FCC to vacate and reopen a $7,500 wrist-slap settlement of Enron's 49 wireless licensing violations. (United Church of Christ is active in digital divide and other public media access issues, through their Office of Communication.)


And "In public policy, it matters less who has the best arguments and more who gets heard -- and by whom." (Ralph Reed memo to Enron)


And just outside the Enron envelope, "Not that he owes me a vote, but he owes me a phone call." (Trial lawyer Dickie Scruggs in re Sen. John Edwards, D-NC).


Remember Rudy G's venture with Ernst & Young to provide crisis management consulting to distressed businesses and agencies? WSJ reports Giuliani Partners declines invitation to help a distressed Enron. OK, then, how about Global Crossing?

Coming soon -- how Al Gore nearly saved Enron AND Global Crossing!

More Camp Enron lore can be found in Slate.com's discussion area, The Fray. See The Legend of Camp Enron: Joey Butafuco and the PUHCA, and tales of Campaign Enron Finance Reform.


posted by Anthony at 3:33 PM | permalink | "The Refuge"

 

Skilling is toast

RonK - Seattle

I'm with Will, let's pile on Wall Street, kick 'em while they're down!


Skilling's Mom doesn't buy his story:

"When you are the CEO and you are on the board of directors, you are supposed to know what’s going on with the rest of the company,” Betty Skilling, 77, told NEWSWEEK in an interview before the hearing. “You can’t get off the hook with me there ... He’s going to have to beat this the best way he can.”

Worth magazine publishes an annual list of the "50 Best CEOs".

In their scheme, "Best" has a lot to do with "the vision thing". I've been thumbing through these ranks of visionary corporate leaders (Jeff Skilling, #2 in 2001 ... Ken Lay, #36 in 2000), and finding a lot of visionary losers. At least they never bit on GX.

One sign of the times (today's NY Times) -- "flamboyant leader", i.e., Worth CEO W. Randall Jones, "struggles to keep his publication alive".

I recall this little gem from games-maven/poet/philosopher Danny Kleinman:

"Concept precedes,
Temperament conquers Technique.
Vision laughs at Counting"

Well, yeah. But good vision tells ya when to start counting.

Former Enron CEO Jeff Skilling's congressional testimony last week drew mixed reviews. Some thought he played his overeager interrogators like a Stradivarius. Others thought he put himself in direct jeopardy of a perjury conviction. By my scorecard, he:
(1) lost points in the court of public opinion,
(2) failed to win even grudging adversarial respect from prosecutors,
(3) failed to gain bargaining power as the "indispensable witness" against other defendants,
(4) failed to reach the threshold level of telegenic sizzle we demand of our career celebrity villains, and
(5) screwed himself royally in the probitive legal department.

But perjury? Prosecutors won't have to fall back on anything as lame as the last-resort, sour-grapes reprisal tactic of a perjury indictment.

Skilling opened by telling us he was "devastated" and "apologetic". He closed by telling us he wouldn't change a thing. To FORTUNE magazine's Andy Serwer, Skilling has a "Nixon problem" -- either he was in it up to his eyeballs, or he was a total nincompoop ... and nobody thinks he was a nincompoop.

I think it's worse, and more transparent, on an angle I have not seen picked up anywhere else.

Skilling asserts the company was in "strong financial position" when he left in mid-August. Not only was he uninvolved, he had no knowledge of any financial sleight of hand, or corrupt conflict of interest, or sham transaction, or circumvented financial control, or make-believe SPV with make-believe revenues, or fraudulent statement to investors. He was in the dark ... in one instance, quite literally. So far so good for Skilling -- assuming this claim stands up against the inevitable drip, drip, drip of documentary evidence and testimony.

Skilling then asserts the company was brought down by outsiders -- the predations of creditors, and lawyers, and a liquidity crisis -- a "run on the bank". OK, plausibly consistent. He might reasonably have believed that on 2001-12-02, assuming he was in the dark when he left on 2002-08-14.

Skilling further asserts the company is still viable, but misunderstood. Uh-oh. Who left that in the script? That's a problem, because now he is aware of several chapters of the financial cookbook, and those disclosures don't change his opinion of ENE's financial condition. This makes no sense. Will he claim the affected transactions weren't material? That won't fly. Will he claim they were legitimate? That won't fly either, and it would obviate his reason to claim ignorance in the first place.

Maybe I'm missing a subtle turn of strategy ... is this performance the preface to an insanity plea?

Call it the "Enron Valdez Defense" -- "I wasn't on the bridge ... wasn't even on deck ... I was in my cabin ... must have dozed off ... heard shouting ... woke up with such a headache ... they should have known better than to hire a guy like me ... but the ship never ran around ... people are just saying that to make us look bad".

I figure Skilling is going down hard unless ... unless ... no ... no reason to go there. The bill of particulars on Skilling is yet to be written, but doors are closing behind him ... week by week he'll find himself with more rope and less wiggle room ... and the prosecution has all the time in the world.
posted by Anthony at 8:45 PM | permalink | "The Refuge"

 

Camp Enron Mission Statement

RonK - Seattle

The coroner investigating the Global Crossing incident has called in special agents from the X-Files team. Elsewhere, financial bloodhounds are sniffing at some extremely odd terms in a series of Citigroup credit-linked notes. The plot thickens -- and broadens ecumenically -- in ways that affirm this writer's view of the matter. This is not just the Enron melodrama, it's a metastasizing meta-scandal, a takedown of the prevailing meta-context ... a revelation of latent defects so crippling and openly exploitable as to subject The System to the possibility of product recall. The geniuses of ENE and GX have demonstrated a devastating hack attack on corporate governance. Was this a simple case of buffer overrun, one we can cover with a patch? Or is there a gaping set-theoretic hole in the platform security model, rendering the entire architecture untenable? In either case, how far from shore should we sail in our theoretically-leaky boats?

I'll stick out my reputational neck. In history's rearview mirror, Enron may loom larger than 9/11. The contest depends on things yet to be. In 21st century history, will "terrorism" and the "war on terrorism" play out as coherent themes? Or as anecdotal clutter? As major or minor motifs? Will they be eclipsed by related conflicts, and seen later as mere links in a chain-reaction? Or will unrelated issues eclipsed them entirely? Same questions for "Enron". Which will more strongly influence the emerging global meta-context? There's a reasonable case to be made for WTC, a clear sentimental favorite ... but my money's on Enron.

Camp Enron coverage will include ample servings of highlights and sidelights ... politics (including PPD), and courtroom drama, and soap opera, and farce, and even sport. But keep in mind that Enron itself is merely the chimerical sideshow poster child for a three-ring circus of misplaced devotion.

In the main I'll attend to the larger and deeper implications (which are emphatically large and exceedingly deep). Our topic in a nutshell: How will republican democracy and market-based capitalism escape being eaten alive by their own demon spawn?


And so the Plot Thickens ...
Global Crossing's collapse seemed at first an unrelated matter, coincidental except as convenient to die-hard ballot-boxers looking for a Democratic tat to match the Republican tit of Enron. Deeper inspection reveals a unifying theme, one that will draw a great many other matters into its orbit. Let's lay out the "coincidental" case first ... later we'll demolish it under the weight of analysis.
ENE hyped a neoteric smoke-and-mirrors business model; GX was constructed as a real business for real customers.
ENE was a counterproductive business; GX was a productive business that (along with its peers) built too much useful capacity.
ENE collapsed when trading partners realized its balance sheet was bogus; GX collapsed when real revenues didn't cover fixed charges.
ENE accounting was fictive; GX accounting (also audited by Andersen) was aggressive.
ENE used off-book sham transactions with foreign shell partnerships; GX presented its results on its own books.
ENE tried to hide bad results with ever wilder fabrications; GX owned up and bailed out.
ENE tweaked politicians to avoid regulation; GX tweaked politicians to establish regulation.
ENE politicked more aggressively than anyone else in its sector; GX politicked on par with its telecom peers.
ENE was overwhelmingly partisan; GX was evenhanded. GOP ex-Pres Bush41 got in on the same ground floor as DNC Chair-to-be McAuliffe. GX's chief promoter was a neocon/futurist Reaganaut. ("If you don't like capitalism," said Mr. McAuliffe in defense of his windfall, "move to Cuba or China." ... but if you DO like capitalism, move to the Caymans or Bermuda?)
[Note on terms of reference: In bankruptcy, Enron ("ENE") trades OTC as "ENRNQ". Global Crossing "GX" now trades as "GBLXQ".]

Now, how did GX make money on paper ... without actually making money?

Suppose Will Vehrs borrows $10, buys a collectible Warren Buffett bobblehead doll, and sells it to Tony Adragna for $1000. Will's financial statement shows revenue = $1000, cost of goods sold = $10, debt = $10, cash-on-hand = $1000, and net profit = $1000.

Now suppose Tony sells it back to Will, again for $1000. Tony got out of the game even. Will has revenue = $1000, COGS = $10, debt = $10, cash-on-hand = $0, and assets = $1000. Will's profit, by GAAP, is still $1000. (The doll is effectively marked up as a $1000 asset on Will's books, whether valued at cost or "market".)

Next suppose Tony buys a Warren Buffett doll, Will buys a Paul O'Neill, and I buy a Robert Rubin, at $10 each. We can make similar trades pairwise (as GX did with Qwest, only with fiber-optic capacity instead of bobbleheads), or in three-way swaps, or we can invite more friends to play in our rotisserie "Geniuses of Capitalism" fantasy league. In the token economy, "on paper", we all get rich. In the real, utilitarian economy, we're idiots ... but no specific transaction or bookkeeping entry violates any specific rule of accounting. The scheme as a whole may have violated first principles of accounting, and economics, and even law (depending on how Will raised that first $10) ... but those are separate questions.

We could have played the same game, but left the bobbleheads in the box, on the shelf, or even in the warehouse ... trading "bobblehead swap" contracts for whatever beneficial interest might attach to owning a bobblehead. The bobbleheads don't even have to exist, as long as our speculative enthusiasm does exist.

ENE played a very different game. The players were captive entities, dressed up to look like arms-length counterparties. ENE explicitly created structures that made ENE revenues dependent on the price of ENE stock. And they explicitly structured the closing dates on derivatives contracts to keep the upside of a given transaction on one financial statement, time period and/or taxing jurisdiction, while slip-sliding the offsetting downside result into a different statement, period or jurisdiction. Even done right -- and ENE didn't always dot all the i's -- this violates rules, principles and laws.

The two schemes have one thing in common, something that blows away the "coincidence" thesis and raises legitimate concerns in seemingly unrelated quarters.

Both schemes depend on reciprocal patronage. I buy your stuff, you buy my stuff. This isn't necessarily evil. There's nothing wrong with ATT buying IBM computers and IBM buying ATT telecom. Direct or indirect reciprocal patronage is the essence of market economics. But it is a context that bears close scrutiny.

ENE's version was obvious corrupt practice. The GX/Qwest round-trip swap falls somewhere in the darker end of the grey scale. In better camouflage -- in three-way swaps or staggered round-trips -- it might have ranked well up in the light-grey range and escaped notice entirely, even in bankruptcy.

These "light grey" corruptions are subtle. They work when a whole community shares the same unfounded enthusiasm. The imputed value will never be brought to ground so long as it is honored by all, and so long as there's never an occasion to spend the "proceeds". Call this illusion the Categrorical Derivative ... vice that's as good as virtue, as long as everybody acts alike. [Kant believe I wrote that!] For obvious reasons there are strong social pressures against spoiling the game, against pointing out that the Emperor has no clothes.

What other systemic shadings depend on the mutual backscratch of reciprocal patronage?

Think about market bubbles (endemic even in simulated markets where, in theory, they ought not exist). Think about bull markets in general.

Think about the IPO game, and how little of the "take" ends up capitalizing the enterprise a public offering is ostensibly meant to finance. Think about the derivatives game (then read Frank Partnoy's FIASCO, and think some more). Think about the whole publicly-held equity game, in which most successful firms span the arc from launch to collapse without actually disbursing anything to shareholders (who value their shares according to the firm's theoretical capacity to disburse dividends).

Think about the Japanese economy, where everybody is too big -- and too interrelated, and too deep in the hole -- to count their losses and fail.

Think of the "managing class", the echelons of desk-jockeys who squeeze disparate compensation out of their firms' equity investors, customers and thier fellow employees -- because they and their peers write all the world's staffing and compensation plans.

Think of Citigroup, who issued near a billion dollars in ENE credit-linked notes ... securities that behave almost exactly like ENE corporate bonds except for one thing -- they pay less interest! In other words, securities nobody in their right mind would ever buy under any circumstances, no matter what condition Enron was in ... unless there was a hidden agenda. As NYT's Daniel Altman astutely recognizes, the real mystery isn't "did Citigroup take advantage of inside information on ENE partnerships?", it's "who the hell bought these notes?" (was it Enron, or an ENE partnership?) and "why?" (was this deal part of some extended quid pro quo pro quo pro quo ... ?).

posted by Anthony at 7:20 PM | permalink | "The Refuge"

 

The "Byrd Rule"

RonK, Seattle

The O'Neill/Byrd exchange (I have not seen it in full) had bizarre qualities, but cognoscenti across the aisle will know Byrd was standing up for essential institutional and constitutional prerogatives. More on that below.

What was O'Neill doing? Fighting for rule of men over rule of law, proceeding on immature instinct ... "the rule that gets in my way is a bad rule". And he was fighting foolishly ... fighting without knowing the stakes, the terrain, or the opponent.

Congressman Sonny Bono once popped off in a Committee meeting, complaining "I don't see why we have to be so legalistic". One of the old bulls (Henry Hyde?) set him straight, explaining that's what they're there for -- deciding what's legal, and how it's to be decided what's legal. Practical machines are almost always more complex than apparently necessary, usually because the problems they solve are more difficult than is immediately apparent. The same is true -- in spades -- for legislative mechanics.

As he has done in other contexts, O'Neill exposed ignorance of essential facts and principles, buttressed by ignorance of both sides of the argument. He was oblivious to constitutional foundations of bicameral budget-making and execution. He was oblivious to the historically recent and valuable innovation of budget reconciliation. He was oblivious to the intervening history of procedural gamesmanship that put reconciliation in jeopardy. He was oblivious to the innate difficulty of suppressing gamesmanship while preserving reconciliation, or the exquisite craftsmanship of the current solution -- the Byrd Rule.

All O'Neill sees is that Congress wants to tell him how to spend the money, and he dosns't like it. In some particular instance the "Byrd Rule" got in the way of doing it his way. Bad rule. Hold it up to ridicule. Portray it as a Lilliputian stricture, and those who weild it as Lilliputians.

This may sound like a cheap shot, but it's dead on: O'Neill's logic is Enron's logic. O'Neill's solution is Enron's solution. Does a rule get in our way? Does it the Byrd Rule -- like the Enron Code of Ethics -- "restrict the realization of human potential"? Waive it, ignore it, get rid of it ... the CEO equivalent of "if it feels good, do it".

Related reading:
A brief intro to the Byrd Rule

And a less brief intro

Comprehensive study might take years.

CORRECTION: ERROR! ERROR! In the never-ending effort to find my errors before somebody else does, I woke this morning with a "did I say that?" feeling. Mea culpa, "mistakes were made".

Previous items refer to $2.6B in Enron losses borne by financial services giant (mostly brokerage) Morgan Stanley. The company with the $2.6 loss is financial services giant (mostly banking) JP Morgan Chase. However, Morgan Stanley was a leading architect of derivatives shenanigans through the 90's, and Mr. Purcell is affiliated with Morgan Stanley (as stated).

The two Morgans are related by parentage going back to the last great paradigm-shaker in corporate governance -- the 1920's boom, securities manipulation, the 1930's bust, and the Glass-Steagall Act of 1933. The Act restricted banks to the banking business, and has been eviscerated by recent "anything goes" deregulation. The world breathes in, the world breathes out, in the never-ending cycle of rascality and reform.

ADDENDUM: More "Camp O.J." connections:
(1) O.J. "Dream Team" attorney Johnnie Cochran is on the scene, this time for the plaintiffs. (Will we find Alan Dershowitz scouting out sympathetic test cases for his "torture is OK under certain circumstances" thesis ?)
(2) If taken down and sued to smithereens in civil actions, Enron executives may retire to lifestyles of the rich and notorious -- a la Mr. Simpson.
(2a) Key executives enjoy multimillion-dollar external private pension and insurance contracts, untouchable in civil litigation. WSJ -- by subscription -- has a good piece in yesterday's 2/7 edition.
(2b) Texas, like Florida, provides extremely generous "homestead exemptions" in personal bankruptcy. Houston sees a minor boom in high-end residential construction as "Exron's" frantically hammer multimillion-dollar additions onto their multimillion-dollar estates.
-- RonK, Seattle

posted by Anthony at 3:02 PM | permalink | "The Refuge"

 

Camp Enron salutes Camp O.J.

RonK, Seattle

Michael M. Thomas, a Yankee Optimist and Texas Oil Patch kindred spirit of GWB ( "I Understand Bush Men" ), shares priceless observations on the The Roots of Enron [current in New York Observer; perm archive link will differ]. MTM recalls long-past encounters with Vinson & Elkins ("more concerned with 'Yea!' than 'Nay!'"), traces the whole financial bloodbath to O.J. Simpson -- by way of W.J. Clinton -- and wraps up with a cite from J.R. "Rudyard" Kipling:
... They denied that Wishes were Horses; they denied that a Pig had Wings.
So we worshipped the Gods of the Market who promised these beautiful things. ...

Vinson & Elkins have deep pockets, but are they too well-connected to take the fall? ( HoustonChronicle.com )

Bracewell & Patterson, also a Houston legal powerhouse, cites conflict of interest and severs ties with Enron. B&P is home to (non)lobbyist RNC Chairman Marc Racicot and Texas GOP A.G. candidate Greg Abbott, among others

Prosecutor's wetdream, continued. The suspects themselves are zealously preparing white papers laying out each others' misconduct in painstaking detail. With defendants like these, who needs on-budget staff?

Who are the "partners" in hundreds or thousands of Enron-related entities? Don't ask Enron , but Joshua Micah Marshall has more (more acute questions, that is).

Ken Lay cancels scheduled appearances before Congress ... and at World Economic Forum's "Davos on the Hudson", where "Among those who want to know more about Enron are business leaders from developing nations. They have been urged for years to ... emulate Western capitalist practices." ( HoustonChronicle.com )

In the Senate, Fritz Hollings (D-SC) goes over the top, railing about "cash and carry" influence peddling. In response, Gordon Smith (R-OR) spins out, insisting it's a business scandal, and ... it happened on Clinton's watch. A careless gift to Smith's opponent in this fall's competitive re-election bid, in a state stacked with Enron victims.

Democrats want to play Enron up as a political scandal. Republicans want to confine it to a business scandal. Self-inflicted damage continues. Political scandals undermine the "party of government". Business scandals -- if they loom large enough to make any popular impression at all -- undermine the "party of business".

FLASHBACK, 2000-12-14: Fortune magazine floated three names for Treasury Secretary under Bush43: Ken Lay, Philip Purcell of Morgan Stanley (lost $2.6B betting on Enron), Hank Greenberg of AIG (recently pummeled for Enron-like accounting).

The Houston Astros, "perceived in the public and cast in the national media as an affiliate (and even an ally) of Enron", are in court trying to get out from under the Enron nameplate ... while Enron stays current with scheduled payments (!) in a possible bid to negotiate sale of "Enron Field" naming rights on their own terms. How about "Global Crossing Field"? "Tyco Stadium"?

Also in the game of registered marks, CNBC's "America Now" (Kudlow and Cramer) unveiled a logo for their own excellent scandal coverage ... including the big cockeyed 'E' fallen over on its back. Now it's gone. Issues?

Dave Barry Does Enron (Q. What does ''leveraging'' mean? A. Lying.)

Speaking of things which I am not making up ... Austin left/populist muckraker Jim Hightower found this ill-timed puff in Texas Society of CPA's Today's CPA, December 2001 issue (composed in October): "Enron's accounting function has been an integral part of its success and vision."
posted by Anthony at 7:43 PM | permalink | "The Refuge"

 

Camp Enron Report: Did Enron Exist?

RonK

There's an unsettling buzz going around Camp lately. Who among us has seen the Enron? Is this expedition yet another Yeti chase, a search for the fabled Lost City of Gold or mythical Atlantis, an elaborate snipe hunt? How do we know it ever existed? Evidence is anecdotal, indirect, circumstantial, but still ... the whole landscape is marked with footprints and relics that beg other explanation, and thick with what everyone swears is Enron scat.

"Everybody knows" the towers of Enron once peeked out through breaks in the clouds, looking down on our present malarial digs. Puzzling, though, that nobody ever found the passage to the bedrock foundations on which these grand towers are supposed to have stood. Locals nevertheless staked their futures to the word "Enron", and trade was often conducted in tokens of this pie-in-the-sky faith -- Pieces of Enron, a.k.a. "shares".

A year ago just one share fetched $80 in trade in local markets, and all shares together amounted to $60B. When a $60B edifice falls down, shouldn't it make a sound? A splash, a crunch, a thunderclap? For perspective, the World Trade Center towers were in the $10B ballpark, and their collapse made a "splash" on the order of $100B.

But Enron's collapse made no such splash. Except for the natives holding now-worthless Pieces of Enron, life went on. The sun came up in the morning, the waterwheels turned, grain grew in the fields, tongues wagged in the square, and the markets were unruffled.

Enough allegory. There's a serious economic enigma here. ENE began as a financial story, and the most perplexing angle was the non-story: "the markets were unruffled". With DOJ's criminal inquiry it became a general circulation story, one of crime, politics, suicide, celebrity liars, celebrity lawyers, Jesse Jackson. We must assume Geraldo Rivera is just around the corner, and so are disclosures of sexual hijinks. But nobody sees $60B of real economic loss ... no discernible reduction in real goods, real services, real capital ... maybe just the opposite!

Arms-length auction markets once valued Enron equity at 0.3% of US tangible assets, over and above 0.2% in on-book and off-book IOU's, mostly in non-market placements with the "smart money". Beyond that, ENE's "handle" in outstanding contingent contracts ran to something like 20% of a year's US GDP. Enron went away, and nobody missed it except shareholders and debtholders. What happened? In the strictest economic sense, did Enron ever exist?

Enron invented itself as a maker of markets in a wide range of securitized commodities and derivatives ... a purveyor of optionality, liquidity, information, trust ... a conqueror of time, distance, uncertainty. This brings us to a paradox in rational market theory regarding value-added valuation of market-makers.

Yes, speculative buyers -- those who buy things not because they want them, but because they expect somebody else will want them -- perform a useful function. So do intermediaries who repackage slices of risk and reward inherent in speculative assets. So do pure market-makers, who maintain continuous auctions in goods where actual quanta of original supply or end-use demand may arrive intermittently.

Yes, they render valuable service, and no, they won't do it unless there's money in it. But no, again, their quantifiable value of this work can't be much above zero ... if the market is strictly efficient, then zero; if marginally inefficient, even the barest margins should bring market makers out of the woodwork.

Were energy markets so inefficient to begin with that Enron's participation lubricated the wheels of commerce to the tune of $60B value-added? Or were equity markets so inefficient they placed a $60B price tag on something with zero economic value? Either conclusion is unpalatable to adherents of the "market is always right" doctrine ... and likewise to heathens like myself who view markets as remarkably practical self-optimizing devices.


One possibility is that economic loss is real, but diffuse, and recognition of loss is cascading in a slow chain reaction through subsidiaries, business partners, and downstream victims. The full extent of the damage may take time to show up. One problem with this thesis is that most visible damage is evident in the token economy, not the real economy.

A few shards of Enron rubble have turned up in my backyard. Let's start with NEPCO, Enron's chief appendage in the global power plant construction game, "a 64-year-old Bothell company that employs 3,700 people ... Enron bought NEPCO in 1997. It recently listed annual sales of $1.5 billion. Enron ... did not mention NEPCO in its annual reports for the past three years."
[ The Seattle Times: Enron's ruin drags down Bothell firm ]

Technically, we're talking about NEPCO Services International, Inc. (a fully owned subsidiary of National Energy Production Corporation (a fully owned subsidiary of HOUSTON PIPE LINE COMPANY (a fully owned subsidiary of ENRON CORP))). Similar is Thai Nepco, Ltd. (which is only 99.94% owned by N.E.P.Corp.). Related entities include NEPCO UK Ltd. (a fully owned subsidiary of Enron Europe Construction Ltd. (a fully owned subsidiary of EEL Company Ltd. (a fully owned subsidiary of ENRON CORP))). This genealogy as of Enron's 2000 10-K, more detailed and more consistent in format than the 2001 report, in which some parentages have apparently changed.

NEPCO does real work, and falls outside Enron bankruptcy proceedings, but Enron stripped NEPCO's cash accounts before filing bankruptcy.
"NEPCO ... subsequently bounced checks to suppliers ... lawsuit from a German bank that says the company had "no bank accounts or economic existence independent from Enron" ... Enron "swept" the company's cash into its centralized cash-management system ... those funds are now frozen in court. ... In some instances ... NEPCO has had to go back to the client and say, 'Can you give us that money again?' ...".

Next there's the City of Seattle. "City Light" sold Enron about $900K of surplus hydroelectric power in November, and is standing patiently in line with the other creditors. The City also lost an unrealized $2M on in-the-money forward power contracts to Enron. Adding insult to injury, the City also has unresolved claims of perhaps $100M resulting from Enron's alleged market manipulations in last spring's "California" power crisis. The technical and legal basis for these claims looks stronger all the time, even as collection prospects grow correspondingly dim.

The Seattle case raises what will be a recurring theme of unsymmetric effect. Enron acted in the market not as a broker (arranging trades between principals), but as a principal in each trade. It bought contracts from and sold (mostly offsetting) contracts into the same markets. Counterparties whose outstanding contracts are in-the-money will have trouble collecting from Enron. Those who are out-of-the-money are still on the hook, facing ravenous Enron creditors. In some cases these debtors and creditors are one in the same entity, in others they're neighboring entities, or business partners, or outright competitors, and some of them were dealing with Enron, others with subsidiaries, others with "Separate Business Entities".

Then there's PGE ("Portand General Electric"), an Oregon utility Enron assimilated a few years back. PGE calculated its share of income taxes due, about $90M annually, remitted that amount to Enron HQ, and included those taxes as allowable cost basis under regulatory ratemaking authority. But Enron apparently paid no taxes over the same period, garnering over $300M in refunds through its shell games with shell corporations.
[ Enron pockets PGE's tax payments ]

Also in my backyard, Microsoft will slip a nationwide DSL initiative by several months, backfilling for (major regional partner) Enron.

Similar stories will pop up like mushrooms in the business pages of every local paper big enough to have a business page. In Mr. Lay's neighborhood, these items from the Houston Business Journal:

EOTT Energy dampened by Enron's wake

Enron power contracts still in limbo as more twists emerge

In the widely-reported big leagues, Morgan Stanley (itself a one-time Evil Empire of derivatives chicanery) will take a hit on the order of $2.6B.


Beyond the existential enigma, there are darker portents. Market sleuths have been backtracking where Enron's tracks disappeared from the herd. Some of the evidence suggests the affected markets are functioning more efficiently now than they did when back when Enron was "helping".

Energy markets in particular are delivering more product at lower prices. Contrary to the Cheney Energy Plan (by which we need a new power plant ever five days for the next twenty years) we seem to have too many plants under construction, and many projects are going into mothballs.

Quantitative forensics may take years. In the end, other explanations may emerge ... or insiders may spill the beans. For now, proofreading between the lines, Enron may have had negative net economic value.

Paraphrasing a renowned Senate Select Committee Majority Counsel, now in charge of DOJ's Criminal Division, "What about THAT, Mr. Lay, what about THAT?".


posted by Anthony at 6:18 AM | permalink | "The Refuge"

 

Camp Enron Economic Impact Statement...

RonK, Seattle

Thought for the day: Al Qaeda couldn't do it. Larry Klayman couldn't do it. Henry Waxman couldn't do it. But the Enron bunker-buster did it. (Smoked Dick Cheney out of his hole.)

For your amusement and agonization, this

Today's riff supposes that Enron is only a financial accounting scandal, but a BIG accounting scandal.

Enron moved its own stock into shells on some Cayman Island beach that looked like separate firms, but really existed only as separate manila folders in an Enron file drawer. This made price moves in Enron stock look like Enron primary earnings, and these rising earnings gulled Wall Street into kiting the stock higher and higher.

Oldest trick in the book ... and nobody got wise while it still mattered. Not the analysts, nor the banks, nor Moody's, nor Andersen, nor SEC, nor S&P, nor WSJ, nor FERC, nor CNBC. How might this affect the token economy of dollars and shares and IOU's and options? The real economy of material and labor and goods and services and physical capital and intellectual capital?

Let's track a few trains of economic cause and effect in and out of the tunnels.

(1) Every financial report, for every firm, good and bad alike, gets read with greater skepticism, producing lower P/E's across the board.

(2) Accounting practice gets more conservative, lowering the stated earnings on which those lower PE's are applied.

(3) Imperfect information reduces price and volume in capital markets. (Both buyer and seller suspect the other knows more than they do.)

(4) The prices firms pay for externally generated capital goes up (both in absolute measure and relative to retained earnings).

(5) US relative advantage in perceived transparency narrows, and US assets are treated less favorably in global capital flows.

(6) Capital moves less fluidly to the most productive opportunity. Big moves in sophisticated instruments are most strongly affected.

(7) Equity market preference shifts in favor of dividend-payers, moving capital out of growth industries into mature industries, and into
taxes.

(8) Proprietary innovations scale up more slowly.

(9) Proprietors reap less of the potential return on intellectual investment, learning curve, build-out costs and proof-of-concept risks before their innovations are copied, coopted or superseded.

(10) Innovation is reduced.

(11) In sectors accustomed to using stock as compensation, labor gets more expensive and proprietary risk increases.

(12) Regulation and regulatory delays increase.

(13) Product prices increase.

(14) And so on through currency effects, human capital displacements, lifestyle effects ... my apologies for whatever I may have left out.

In particular, any "New Economy" business model becomes a harder sell, whether it makes sense or not. Unfortunate, since we need a whole generation of new models to put the dotcom Humpty Dumpty back together again.

Several popular business practices -- especially transactions using stock as currency -- will be inhibited. Mergers and acquisitions, spin-offs, employee stock options, ESOP's and 401-k's, hostile takeovers, special purpose joint ventures, even IPO's ... both those that make sense, and those that don't. A whole adjunct industry of professional midwives to these transactions may also suffer.

Can we quantify these effects? Hmmm. If somebody had a few thousand unemployed quant geeks and a raft of unused computers, they might take a stab at pricing out a risk mitigation vehicle -- "Enron Insurance" -- and crank that into to a comprehensive econometric model. But as conservative theorists are fond of pointing out, fairly priced insurance raises the moral hazard that buyers will drop their guard, defeating the premium.

On the plus side of all this, we may end up pouring less real capital down the proverbial rathole.

And these effects apply if it's a pure financial accounting scandal ... no assets stranded or economically destroyed (as in half-finished capital projects), and no resources maldistributed (leaving the economy farther from the efficient frontier).

8 ... 7 ... 6 ... 5 ... 4? Suppose it's an accounting scandal big enough to take down Andersen. [Better than even money based on current info. Also better than even money that current info is not the whole story.] Audit firms don't grow on trees, and they don't grow back. I remember the Big Eight ... when, a decade ago? Now there are five. Number Six is an order of magnitude smaller than Number Five. Merging the next 100 audit firms only creates a weak-sister #6. There are no contenders, and no process of grassroots development will produce one.

In industry after industry, big firms are gobbling up small firms, and going multinational. It takes a big outfit to audit a multinational, and nobody knows how to make a new big audit firm from scratch. There will be bigger firms, fewer choices, and more human resources sorted and stratified through internal culture rather than external feedback.

Suppose it's just an accounting scandal, but big enough to inspire conflict-of-interest prohibitions against firms doing tax and management consulting for its audit clients.

Auditing will be more expensive in terms of real cost -- even at the same level of intensity! Auditing and consulting share powerful marketing cross-subsidies. In "Make Audits Pay: Leveraging the Audit Into Consulting Services", AICPA says "intense competition has reduced the audit to a mere commodity that is distinguishable to the consumer only according to price." (thx, WaPo)

And audits will be more intensive, at least temporarily.

On the plus side, freer competition may open the market to better resources, better matched to specific audit and consulting tasks.

What about the void left by Enron, which was a major market-maker in a wide range of securitized commodities. Many observers -- this writer included -- were surprised when the collapse left these markets relatively unruffled. Not just unruffled ... it looks like energy markets in particular began operating much more efficiently in the immediate aftermath of Enron's departure. We'll revisit this when we delve into the question "Did Enron exist?". Meanwhile, a small network of very sophisticated number-crunchers are doing a little delving of their own, which may in time serve up another shock to the system.

And it may take time for the toxic effects of Enron fallout to show up in its business partners. We'll profile a few cases in later dispatches.


posted by Anthony at 10:20 AM | permalink | "The Refuge"