"The Smartest Guys in the Room"

[Beet]

I am currently reading this book by journalists Bethany McLean and Peter Elkind, about the fall of Enron, written in 2003. It is shocking. I would say it is as good as anything written today-- better, actually, than most of what is written-- at explaining the current economic crisis.

Basically, McLean and Elkind show how Enron gradually morphed during the 1990s from a natural gas company to a giant hedge fund posing as a natural gas company, how they pioneered tools like mark-to-market, securitization, special purpose vehicles, effect rape of GAAP accounting standards, incestuous relationships with the people who were supposed to be overseeing them, and other financial shenanigans to create a ponzi like mirage of false profits. In the process, Enron became more of an investment bank than a utility company. Because of massive distortions in pay incentives across the company, the CEO, Jeff Skilling, and his top executives, became obsessed with the short term stock price, the actual productive parts of the company were sold off or dwarfed, and they just kept taking on more and more hidden debt and counting that debt as profit until they imploded.

Further, McLean and Elkind show how what happened to Enron was part of much larger and broader forces in the US economy, beginning in the 1980s and exploding in the 1990s. It wasn't just a few bad apples like Lay, Skilling, and Fastow, or even just Enron and Arthur Andersen. The fraud at Enron was aided and abetted by banks and Wall Street, lawyers, and even many analysts. Furthermore it was symbolic of broader trends and it was out in the open for anyone who cared to take a close look at Enron's reports-- only very few actually cared enough to do so. Anyone who had read this book in 2004 or 2005 must have had some inkling that all was not right on Wall Street.

In retrospect, Enron was the Canary in the coalmine. But the collapse of such a large company and the publication of this book, which warned of all of the above weaknesses, failed to prevent Wall Street from repeating Enron's behaviors. The reason is probably that while a few Enron executives went to jail, many others made thousands of even millions and got to keep them. For example, Rebecca Mark, who led Enron's international ventures to $2 billion in loses in her 10 year career, sold $80 million worth of Enron stock at the top and got to keep most of it and avoid charges. In other words, no matter how public, how clearly fraudulent some of this financial behavior is, it will continue to be repeated so long as it is rewarded.

If Geither & Bernanke are borrowing money just to finance more consumption, then there is at least one similarity between Enron and the entire economy, even now: taking on more debt for non-productive purposes, to roll over problems into the future. I don't think it will have an Enron-like end, if only due to the U.S.'s superpower status (which is, at the end of the day, resting on our unchallenged military might) and the fact that our debt is denominated in our own currency. But it's hard to see how it ends well and it's time to start turning the ship immediately.

IMO, a fall in the US dollar and a rise in import prices, even if it causes some inflation in the short term, would not be the worst thing in the world. It would incentivize the US to produce more and consume less. This is where the market was naturally dragging things in 2006 and 2007...

[Beet]

...

There is a subtle difference. Regulation hurt the railways' core business by preventing them from taking the physical steps necessary to adjust to changing market conditions (which in some cases, union contracts that tied the hands of the Detroit Three worked the same way).

In this case, Enron's core business (natural gas) was sound, but deregulation of the financial side of its business caused a basic change in incentive structures. Rather than work to try and create the best product in the most efficient way, Enron employees tried to simply make money by trading and manipulating financial numbers. This in turn may or may not lead to significant changes in physical behavior. The key point though, is that it is very widespread that individual actors, even a large number of them, acting in their own self- interest do not necessarily do what is good for the company, or the economy as a whole, in the long run. Financialization, while in theory supposed to make markets work better, because of its complexity is easily manipulated and thus allows the separation of individual payment from value added.

[Beet]

...

There is a subtle difference. Regulation hurt the railways' core business by preventing them from taking the physical steps necessary to adjust to changing market conditions (which in some cases, union contracts that tied the hands of the Detroit Three worked the same way).

In this case, Enron's core business (natural gas) was sound, but deregulation of the financial side of its business caused a basic change in incentive structures. Rather than work to try and create the best product in the most efficient way, Enron employees tried to simply make money by trading and manipulating financial numbers. This in turn may or may not lead to significant changes in physical behavior. The key point though, is that it is very widespread that individual actors, even a large number of them, acting in their own self- interest do not necessarily do what is good for the company, or the economy as a whole, in the long run. Financialization, while in theory supposed to make markets work better, because of its complexity is easily manipulated and thus allows the separation of individual payment from value added.

I believed I mentioned those differences in my first post. I wasn't arguing for or against deregulation I was arguing for caution and reason and that we enact sensible legislation that solves our current problems but doesn't lead to unintended consequences like the impact on small business owners who are hurt the most by regulations.

Oh, I agree. Sorry that I missed your last sentences in the first post. Another issue is that even if you have the right laws in place, they can be subverted if you have the wrong people/people dynamics.