Friday February 14, 2003
The Guardian
There have been three major changes in financial markets in the past 15 years.
First, financial instruments became increasingly complex and were used to
manipulate earnings and avoid regulation. Second, control and ownership of
companies moved apart as even sophisticated investors could not monitor senior
managers and even diligent senior managers could not monitor increasingly
aggressive employees. Third, markets were deregulated.
Yes. And fourth, debt-laden stock-lead consolidation in the most deregulated industries, starting with the financial industry itself. This was a key factor in the drive to misrepresent earnings, keeping stock values high and debt ratios low to fund not just executive take-outs but short term accumulation.It is also a main cause of high defaults and bankruptcies and the reason why the worst is not yet behind us.
The merger mania of the 1980s,
driven by leveraged buyouts in which an acquirer borrowed heavily to buy a
target's stock, involved straightforward transactions in stocks and bonds.
The merger mania of the 1980s lead by LBOs paled in comparison to the
post deregulation stock as currency merger mania of the second half of the 90s.
In sum, the 1980s were a relatively primitive period on Wall Street. Life was
uncomplicated if aggressive. The financial markets became increasingly
competitive and profit margins dwindled.
Which is precisely why banks turned to mergers and acquisitions and
corporate debt issuance for higher fee business. Trading revenues on government bond and swaps did decline as spreads tightened. That's why lots of government bond traders were either fired or became corporate bond traders - corporate
bonds being less homogeneous than government bonds, therefore
having more profit maneuvering room.
A special committee appointed to decipher Enron's collapse spent several
months reviewing documents and interviewing key parties, but its 200-page
report covered just a few of Enron's thousands of partnerships and was filled
with caveats about its own incompleteness.
Gutless - but that's the basis for a much longer critique.
A close analysis of the dealings at Enron leads to three key conclusions, each
counter to the prevailing wisdom about the company.
First, Enron was in reality a derivatives trading firm not an energy firm, and
it took on much more risk than anyone realised. By the end, Enron was even
more volatile than a highly leveraged Wall Street investment bank, although
few investors were aware of it.
That didn't need a close analysis. The top energy trading awards
are split year after year between Wall Street and energy companies. It's not hard
to figure that out. Enron won energy derivatives trading house of the year for 2001.
Goldman Sachs won the same award for 2002. Same difference.
Instead,
in late 2001, Enron was hoist with its own petard, collapsing not because it
wasn't making money but because institutional investors and credit-rating
agencies abandoned the company when they learned that Enron's executives had
been using derivatives to hide the risky nature of their business.
No. It's stock value which was used to back so many of these deals was
plummeting from mid-2001. Margin Calls. Triggers for special purpose
vehicles hit. Enron was the highest volume trader in the corporate arena. They
built the most used energy trading system. It was all out in the open. These
people offered risk management consulting services to other corporations, so
they could trade derivatives with them. It was known in the industry.
Third, Enron was arguably following the letter of the law in nearly all of its
dealings, including deals involving off-balance sheet partnerships and
infamous special purpose entities. These deals, which blatantly benefited a
few Enron employees at the expense of shareholders, nevertheless were
disclosed in its financial statements, and although these disclosures were
garbled and opaque, anyone reading them carefully would have understood the
basics of Enron's self-dealing - or, at a minimum, been warned to ask more
questions before buying the stock.
There were several Enron partnerships in which they were specifically
not following accounting standards, notably maintaining a 3% independent
ownership in their partnerships. If anyone investigating had the guts to make the case
stick, there are technicalities that makes these dealings illegal. Beyond the issue
of whether acts that are deliberately misleading are illegal.
To the extent that Enron, its accountants and bankers were aggressive in
transactions designed to inflate profits or hide losses, they weren't alone.
Dozens of other companies were doing the same kind of deals - some with
Enron - and all had strong arguments that their deals were legal, even if they
violated common sense.
Absolutely, And they didn't violate common sense from the companies
perspectives. On the contrary.
Enron's dealings were not illegal, they were alegal, and Enron was a big
story - not in itself but as a symbol of how 15 years of changes in law and
culture had converted reprehensible actions into behaviour that was outside
the law and therefore seemed perfectly appropriate, given the circumstances.
Not all their dealing were illegal. I'd argue as above, that some were.
And, certainly the 15 years of deregulation were major contributing factors.
So was not learning from the past:
"Money was so easy to get. The public was so eager to buy equities and pieces of paper (bonds) that money was…pressed upon domestic corporations…"
Otto Kahn, of Kuhn Loeb.
Though that statement could easily have defined the stock and bond fest of the late 90s, it was made in 1929.
Nomi
