THE
REAL CAUSE OF ENRON’S COLLAPSE
The first political scandal of the Bush Administration is at
hand. The bankrupt Enron
Corporation and its C.E.O. Kenneth Lay were as close to George Bush
Junior as anyone, as well as to politicians of both parties, conservative
and libertarian think tanks and others.
Now that the company has so spectacularly unraveled--and in such
a way as a lot of “little people” have been hurt--these relationships
will come under much more scrutiny.
An often circus-like atmosphere (you know it’s a circus when the
Right Reverends Al Sharpton and Jesse Jackson are also involved) will be
the fare for months to come.
Congressional committees, citizens groups and others will trip
over each other in attempts to show that, by golly, they’re going to
“get” somebody!
And, some of them might succeed. God knows that there are
probably scores of candidates for a couple years’ vacation at Allenwood,
Danbury, or one of the other minimum-security federal prisons. Perhaps we’ll even see a
couple people fairly close to the president offered
up.
In addition, we’ll hear lots of talk (but will see little
meaningful action) relating to making companies give the public a more
accurate picture of their finances.
We’ll probably see legislation aimed at “shoring up”
American workers’ retirement plans; I’ll comment on those down the road
as they come up.
Other fallout will certainly come from all of this mess. Government will get bigger
still to “protect us” from creative accountants and speculators. We’ll probably see some kind of
lousy, so-called “campaign finance reform” now have a much better
chance of passing; the alternative for Republicans will be that if
either the House or the president stop this reform now so obviously
“needed,” they’ll be crucified in November.
In all of this, though, a
few key truths will unfortunately be lost, or swept under the rug. The biggest of these
truths is that Enron’s very character and growth as a company, which
took on frighteningly speculative attributes over the last few years, was
made possible chiefly by the Federal Reserve and our fractional reserve
banking system.
In fact, the nature of this system virtually required Enron to
do much of what it did!
Enron’s big problem is that it was a few years late in building
itself into the speculative trading vehicle that it eventually
became. Had it embarked
on its multi-faceted activities of arbitrage, derivative creation and
trading and the rest during the 1990's--and then sat back a while--its
timing would have generally coincided with that of the broader economy
and financial markets. But
while the latter peaked in early 2000 and have since been contracting,
Enron apparently thought it could continue building what became a
veritable skyscraper of cards
with one risky scheme and one form of “investment” on top of
another.
The sobering thing is not that such a “corporate strategy”
unraveled where Enron was concerned--and caused the biggest corporate
bankruptcy in history--but that it has NOT yet unraveled in countless
other corners of the economy.
You see, we live and operate in what has been described as a fractional reserve monetary
system. It is this
system that has created, in a broader sense, the ultimately unsustainable
asset and credit bubbles over the years.
It is also a virtual requirement of this system that--in order
to perpetuate its very existence--the many ways in which “money” is
created must over time become more complex, numerous (and risky)--just
to keep everything going.
(Refer back to my March, 2001 issue for my most recent version
of my “Understanding the Game” essay that details how our funny money
system works.)
ENRON, OTHERS TAKE
“THE GAME” A FEW STEPS FURTHER
As time has marched on and as total levels of debt have soared
inexorably higher, it’s been necessary for the banking and financial
communities to find ever-more-creative ways to create even more
“wealth” on paper. It is
this “wealth” which has made it possible for America to plunge ever more
deeply into debt, in order to keep the fractional reserve system chugging
along. As the stock market
soared, new “money” was seemingly created in the form of larger market
values for many companies’ shares; “money” even above and beyond that
which was created by the banks.
Many companies during the 1990's used this “money”
(artificially inflated share prices) to buy out hosts of other companies,
creating even more paper wealth in the process.
In addition, Wall Street, investment banks, hedge funds and
others have invented ways to use the generally inflationary environment
on Wall Street and in the credit markets to invent new fangled types of
“securities” that would similarly multiply “wealth.”
A few of you are old enough to remember a time prior to the more
recent credit expansion when things were fairly simple.
If you wanted to own a company, you bought stock.
If you wanted to loan
money to a company, you purchased a bond or note.
If you didn’t want to do either, you put your money in the bank
down the street, or under your mattress. Anything beyond that was
generally unheard of.
The overall growth of our fractional reserve-based monetary
system has taken us to quite a different “extreme.”
Bonds are now purchased, for example, by an investment
house--and then that investment house breaks the bonds into pieces in
various ways, and creates separate securities (derivative contracts) out
of them. In some cases,
these have been layered, one on top of another, as means to create even
more funny money on paper.
Other types of “trading” contracts have been created, which are
(as best as I can describe it, folks) bets, on top of bets, on top of
bets concerning everything from interest rate levels, to currency values,
stocks and bonds, and even future energy
prices.
Where Enron is concerned, you will undoubtedly hear calls from
many big government types that the company’s debacle demonstrates that
deregulation of energy markets is no good, and that the government
needs to step back in. This
is a sham argument--or an ignorant (and politically motivated one) at
best. Energy
deregulation--if practiced as its better proponents have
envisioned--has indeed resulted in many cases in greater competition, and
in lower prices for consumers.
Enron’s debacle was not due to the deregulation of the energy
industry. It really wasn’t
even due that much to its accounting trickery, or its buying some extra
time and favors by greasing the palms of politicians and
regulators.
Pure and simple, Enron’s demise was an example of what happens
when a company that shouldn’t have done it in the first place plays
the excesses of a fractional reserve system to excess.
And lots of Wall Street concerns were happy to create this
financial skyscraper of cards for the company, as they each undoubtedly
reaped hefty fees as a reward.
“The cast of characters involved in Enron's off-balance-sheet
activities is much bigger than previously thought,” wrote Robert Hunter
recently in a story at SmartMoney.com. “Limited partners included
Chase Capital, G.E. Capital, J.P. Morgan Capital, Merrill Lynch,
Dresdner Bank, AON, Credit Suisse First Boston, Morgan Stanley and First
Union Investors, an all-star
list
of Wall Street insiders.
Given the porous walls separating equity research from
investment-banking operations, the suggestion that analysts at these
firms knew nothing about the [Enron] partnerships before they blew up
simply isn't credible...Enron's off-balance-sheet activities weren't the
mystery they've been portrayed to be.”
That’s quite right, folks--Enron was the big vehicle whereby
these Wall Street firms pumped, and pumped, and pumped--but
couldn’t dump. They were
finally dumped on due to the
sheer magnitude and unsustainability of the financial pyramid that
Enron became. The important
thing to understand, amidst all the hand-wringing, finger pointing and
the rest in Washington is that this type of speculation--and subsequent
debacle--is what a fractional reserve system
creates.
ONE MORE
THING
In his item, Hunter went on to say that, “What's striking is how
long Enron was able to get away with these transgressions without
someone blowing the whistle.
People at Wall Street's biggest firms had intimate knowledge of
these dealings, yet no one said a word. Wall Street can keep a secret far
better than anyone could have imagined. How many other secrets is it
keeping?”
On that note, I want to put
before you a thesis I’m working on.
A few years ago, Long Term Capital Management became a pariah in
the financial community.
This hedge fund zigged when it should have zagged, and suddenly
found itself insolvent when its bets evaporated.
This hedge fund had a reported $3.3 billion in assets; hardly
the level of debacle that should have had bankers up in the middle of
the night trying to figure out how to keep LTCM’s collapse from
bringing the whole world down with it.
But that’s exactly
what happened. Led by
Bill McDonough, President of the Federal Reserve Bank of New York,
bankers and financiers had to scramble to find a way to keep LTCM’s
vaporization from having disastrous ripple effects.
There were two key reasons for this: First, LTCM was the
owner/creator of over $1 TRILLION of derivative contracts.
Other players were involved here, too, whose balance sheets were
hammered by those contracts’ going bust. So, much was involved beyond the
level of investors’ assets in LTCM, a hedge fund that could be called
the Enron of its time.
The bigger issue, though, was that the LTCM implosion came as a
complete surprise to regulators, the Treasury Department and the Fed,
necessitating McDonough’s 2 a.m. emergency meeting.
Now let’s look at
Enron. Its market
capitalization was some $60 billion at its peak, dwarfing the assets of
LTCM. Nobody has put
their finger on the “notional” value of its derivative contracts, but I
believe they are also many times greater than those of LTCM.
In spite of all this, though, Enron’s blow-up had virtually none
of the deleterious effect on Wall Street as did LTCM.
Sure, several companies even rumored to have exposure to Enron’s
woes saw their share prices beaten up to one degree or another. But--so far--not even a burp
where the structural integrity of the financial markets is
concerned. Why
not?
I contend that the answer is simple. Wall Street knew very well
what it was doing with Enron every step of the way, in doing things
that are an accepted part today of “wealth creation,” arbitrage and
all the rest. It also knew
months ago that it might have gone too far.
During that time, I believe that several key players--including
some current and former Treasury officials, and perhaps even some
people close to the president--tried to arrange things so as to keep
any major, affected parties solvent when the reality of Enron finally hit
the hardest.
I guess in one sense we might thank these big shots for not
allowing Enron to bring the whole game to an end yet.
However, we must also consider just how stable a system is that
has seen such a chain of events as I’ve described.
In the end, we are dealing with a monetary system that--based on
simple mathematics--is ultimately doomed to at
least a prolonged period of stagnation and deflation.
But don’t hold your breath waiting to hear our fractional
reserve system even mentioned
in any of the rings of Washington’s Enron circus.
Please reply to: chris@nationalinvestor.com
to
Home