the CAMP ENRON Report

... gateway to the next Progressive Era?

Some say it's nothing but a train wreck ... roll in the big cranes, clear the track, see what the crew's been smoking. If I thought so, I'd not be writing this ... and if they thought so, they'd not be drumming so hard.

For a brief orientation, see this
Welcome to Camp Enron

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Camp Enron Archives
01/01/2002 - 02/01/2002 02/01/2002 - 03/01/2002 03/01/2002 - 04/01/2002 04/01/2002 - 05/01/2002 05/01/2002 - 06/01/2002 06/01/2002 - 07/01/2002 07/01/2002 - 08/01/2002 08/01/2002 - 09/01/2002 06/01/2003 - 07/01/2003

(2) All "major" articles of older material have now been imported, some with updates worth perusing. We'll keep it all on the main page for a while, will add a few loose pieces of history, will trim the main page and index the archives for convenience later.


free agent, loose cannon, pointy stick ... taking an imposing analytic toolkit out of the box, over the wall and into the street ... with callous disregard for accepted wisdom and standard English

reading the tea leaves from original angles, we've led with uncannily prescient takes on the federal surplus, the dotcom crash, the "Energy Crisis", the Afghan campaign, the federal deficit.

More where those came from ... stay tuned.

For brief orientation, see this
Welcome to CP

... gateway to the next Progressive Era?

For a brief orientation, see this
Welcome to Camp Enron

Many thanks to Tony Adragna and Will Vehrs, still shouting 'cross the Potomac at QuasiPundit. Early Camp Enron material can be found in QP's Dispatches department.
Thursday, March 28, 2002

--- Up-Checking Lou Dobbs Again ---

Yesterday, CNN's Lou Dobbs claimed Andersen had already accepted the Volcker Plan, and trashed a respected guest expert for suggesting otherwise.

As of this morning, acceptance was a topic of lively debate -- some of it public -- among Andersen partners (who must approve any such plan).

After several hours in teleconference today, Andersen agreed to implement the Volcker Plan. Or did they?

They apparently did agree to spin off non-audit lines of business (or die trying ... it's not clear how much liability might follow these units, effectively blocking the transfers). That's a key part of the Plan ... the "organ donor" model.

They apparently did not agree to replace top management with Volcker's Magnificent Seven. That was also a key part of the Plan. Volcker is expected to comment tomorrow morning.

They have no control over DOJ's pursuit of obstruction of justice charges. Getting charges dropped was an indispensable part of the Plan.

They did agree -- not altogether agreeably -- to keep noncompete agreements in force, preventing the crew from jumping ship. Otherwise they have no leverage, and can't extract any price for units sold.

No word on a decision to launder the corporate carcass through Chapter 11 bankruptcy ... though that seems essential to separating assets from liabilities prior to negotiated sale.

"Another meeting will be held on Tuesday, during which key decisions will be made". (Bloomberg)

For Dobbs and other Orange Shirt sympathizers crying over the slaughter of innocents -- blaming DOJ for destroying 85,000 jobs -- a little data check is in order. Of those jobs, roughly 28.000 are in the US. International affiliates are cutting their own deals all over the map.

Of those 28,000 US jobs, maybe half are in the audit practice ... the only line of business Volcker proposes to keep, even under the best possible outcome.

Of those 14,000 jobs, the new "boutique" audit practic would retain emaybe 20%. The new Andersen won't be equipped to handle multinationals. They won't keep many big-cap clients. They'll compete with the second-tier firms -- newly fortified with Andersen refugees -- for third-tier clients, and the competition can offer broader complementary lines of service.

Those 2,800 survivors will still be saddled with old Andersen liabilities. The best and the brightest will probably buy out to pursue more exciting work under less gruesome conditions.

So 82,000 of those 85,000 jobs were gone anyway, under Andersen's own most optimistic scenario. 25 S&P 500 audit clients already bailed out ... what's that, about 1/3 of what they had in January? [UPDATE: I'm told the audit practice is closer to 40% of current headcount, so jobs at stake are closer to 2,240]

If Andersen wanted to maximize jobs, they'd read the writing on the wall and cut everybody loose. Waive the noncompete clauses, let people start finding jobs in places they can help their friends find jobs. Forget trying to conserve partnership capital ... the feeding frenzy is going to get it all at the end of the day anyhow, why work so hard to keep it in a nice neat stack for 'em?

Or throw the audit practice to the sharks -- it's tainted meat. Pull together the non-assurance assets into a decent business consultancy. Get out of the BIg Five, drag it all through bankruptcy, incorporate, go public. Push the creative/aggressive/innovative envelope ... tell other people how to run their businesses, make PowerPoint presentations till the cows come home, and never sign anything, ever.

--- Dobbs Shouts "Jump, Humpty, Jump!" ---

CNN's Lou Dobbs blew up on air again yesterday ... interrupting, misinterpreting, lecturing, browbeating and dismissing a James O'Toole of the USC Marshall School of Business Center for Effective Organizations (CEO), an expert in leadership and corporate culture who declined to endorse Lou's views re Andersen's institutional culpability.

Dobbs and O'Toole agreed on nothing, including whether Andersen had accepted the Volcker Plan. "As a man who's been researching this quite extensively over the past few weeks" Dobbs assured O'Toole "... you've been given extraordinaly bad information". At the end of the segment, O'Toole pointedly declined to acknowledge Lou's sign-off.

Who was right? O'Toole was working from public information. Andersen had not -- and at this writing still has not -- announced acceptance of Volcker's proposals. Independent reportage this morning confirms the Volcker Plan is gaining support in partnership ranks, but is by no means a done deal. (The question may or may not be settled in teleconference today.)

Dobbs, on the other hand, was operating on inside information and/or wishing thinking. CNNfn datelined a story -- "Andersen to take on Volcker reforms" -- just minutes after Moneyline went off air, citing outgoing CEO Berardino and other unnamed sources.

Granted, Lou has the inside track. He scooped everybody Tuesday with Berardino's live broadcast resignation. Of course he's worked hard for these scoops ... abandoning any pretense of journalistic neutrality, abandoning even the niceties of respectful debate, pitching in shamelessly as on-air champion of Andersen's brief.

Dobbs should recuse himself from further comment. His reflexive contempt for most organs of government is well known, but is there something more to his unhedged, unhinged advocacy in this case? An undisclosed emotional or pecuniary interest? A close relative, all of whose nest-eggs are in the Andersen basket?

Dobbs's high-profile cheerleading may even contribute to Andersen's demise, egging them on in a defiant "you can't touch us, we're Andersen!" act. At every turn, at every level, Andersen failed to take the situation seriously enough ... always refusing to take the big fall, and setting themselves up for bigger ones.

Documents filed in the Waste Management civil suits suggest Andersen could have faced criminal sanctions in that matter. Pleading out for a fine and a severe warning, they've already had their quota of slaps on the wrist ... and learned nothing. Their driving is still terrible; their attitude's gotten worse. Yank thier license and book 'em!

O'Toole did squeeze in a couple of insightful obsevations. One is the contrast between Andersen's grand show of unity and its objection to firm-wide indictments as guilt by association.

The other is a parallel between the Andersen accounting scandals and the Catholic hierarchy sex abuse scandals. (I've been meaning to note this.) Both institutions are tasked as instruments of propriety in their respective domains; both are steeped in protocols of examination and disclosure; both, in moments of crisis, were unable to confess the pattern of recurring miscreant behavior in their own ranks ... perhaps because of their roles as exemplars of the Good.

Wednesday, March 27, 2002

--- Small Victories: Kopper "validly removed" ---

Bloomberg reports
Michael Kopper was "validly removed" from control of a partnership the company is accused of using to hide debt, according to a judge's opinion. ... Delaware Chancery Court Judge Jack Jacobs ... wrote that Kopper's "thinly based" arguments advocate what he "believes the law should be rather than confront the law as it actually is." ... Investors have said Kopper transferred $4 million from LJM2 to pay his annual management fee, although he was only owed about $70,000, the day before he was voted out as general partner.
Kopper and his domestic partner apparently netted millions as stooges in Enron's scheme of passive self-dealing with essential fictitious business entities.

When all is said and done, who will take home our Camp Enron Follies coveted Chutzpah Trophy? Kopper is certainly in the running.

--- Enron Leans on UBS Warburg to Save Emperor's Fashion Cred ---

UBS Warburg has provided Henry Waxman with smoking e-mails in the Chung Wu firing incident:
UBS PaineWebber broker Chung Wu was dismissed for violating company policy by e-mailing 73 clients shortly after midnight last Aug. 21, telling them that he felt Enron was in financial trouble ... Enron ... contacted PaineWebber on Aug. 21, 2001, to bring Mr. Wu's e-mail to the Firm's attention," ... By the end of the day, Wu was fired. ...The firm kept its "strong buy" rating on Enron until Nov. 28, four days before the energy trader's bankruptcy filing. ... new policy was instituted in Houston stating that "financial advisors should, rather than give their personal opinion, refer their clients to any relevant [company] analyst's report."
"So sue me", right? Of course right. Suit claims UBS PaineWebber misled investors:
The lawsuit ... on behalf of PaineWebber clients who invested in Enron, says the firm failed to adequately warn them of Enron's worsening financial condition last fall because it did not want to jeopardize its relationship providing services to Enron employees and executives.
OK ... smoking gun? Check. Bullet hole in wall? Check. Body on floor? Check. Still doesn't prove that bullet from that gun induced the demise of that body ... but my money's on Mr. Wu and friends for a nice settlement, and maybe a book deal.

Incidentally, UBS Warburg Paine Webber's Houston office handled Ken Lay's personal brokerage account. UBS Warburg acquired the EnronOnline trading operation out of bankruptcy, amid many claims of conflicts and preferences ... we haven't heard the last of that one, either.

Tuesday, March 26, 2002

--- Berardino Steps Down ---

Andersen CEO Joe Berardino annouces his resignation. Painful to watch ... a slow-motion train wreck, well past the point of no return.

--- Watkins vs the Genius of Capitalism ---

AP covers this quip by Sherron Watkins, as she polishes her act for the rubber chicken circuit:
"Some would argue ... that the marketplace caught Enron in the act ... and punished them," Watkins said at a luncheon meeting of the Women's Economic Club in this Detroit suburb. "That's about like saying, 'we don't need drunken driving laws, that the habitually drunk drivers will eventually kill themselves.'"
Ah, the genius of capitalism. Good soundbite, augurs well for the $500K book advance.

Monday, March 25, 2002

--- No Sympathy, No Reform, and No Heroes ... Yet ---

Joe Berardino fails in leadership before and after the fact. Before the fact, failing to scrub Andersen squeaky clean after a series of probationary plea bargains in other cases. After the fact, failing to recognize the black-hole gravity of the situation, and bidding for cheap buy-off's and quick slaps on the wrist.

Paul Volcker fails in the art of the possible ... demanding indictments dismissed, top management replaced (but refusing to answer whether that means Joe B), liability capped and claims settled on the cheap, partner/client/affiliate defections stopped in their tracks, and a name change. Of these, only the name change is feasible -- and that won't fool anybody.
Speaking of name changes, how's this for "BrandStorming": Accidenture ... Accusature ... Accomplicetrix ... Accessoreon ... Accostia ... Accursacon ... Accordionet?
Andersen fails, period. The War Room map is lighting up with wildcat defections, voiding any opportunity to use what little leverage the firm has left -- mainly the noncompetes and buy-out provisions in engagement agreements, partnership agreements, affiliate agreements, and affiliates' partnership agreements. It's too late ... turn out the lights, the party's over.

Harvey Pitt fails, reading the SEC roadmap at every turn from a Big Five perspective (despite his best intentions). "A man's got to know his limitations", and one of Pitt's limitations is that he will never be taken seriously in this role. Like Newt Gingrich with the Murdoch book deal, he's the only guy in the room who doesn't realize he's a shill. Losing composure and erupting about his critics' "big lie" campaign didn't help his case. He can delay the inevitable, but that may only harden the fall.

Paul O'Neill fails, inveighing against the evils of new law and new regulation, stacking all his chips on the square marked "personal integrity". If integrity was the solution, there wouldn't be a problem in the first place. How do you promote integrity in a reward system stacked against it? A corporation relies on oversight and controls to save the 3rd shift cashier from temptation. How does O'Neill propose to elevate the personal integrity of officers and directors?

The Council of Institutional Investors fails to press any pressing questions, as it has O'Neill over for coffee this morning. These are the shareholders' advocates, they're being taken for a ride, and they seem comfortable enough going along with it.

Credit rating agencies fail, pointing fingers elsewhere. Of all the gatekeepers, they have the best shot. Unlike those who audit and attest on a pass/fail basis, they can already apply grey-scale evaluation. They can demand inside info, unlike security analysts who (in theory) can't use it. Of all the overseers, they have the broadest latitude to act on the totality of evidence ... including questions like "can these ratios possibly be right?".

Lou Dobbs on CNN is fulminating endlessly and pointlessly, bewailing the injustice of it all. Claiming Volcker's plan could have worked (it couldn't), ranting that nobody's been charged except for obstruction of justice (they will be), acting as if DOJ was the straw that broke Andersen's back (as if).

First-generation reforms are failing left and right, as should be expected. Houston Chronicle's Laura Goldberg provides an extended digest of what's on the table and how little is getting done.
On balance, said Sen. Jon Corzine, D-N.J., former chief executive officer of investment bank and financial firm GoldmanSachs, post-Enron results will be "someplace between the illusion of reform and modest reform."
Pension reform will be watered down to trace amounts -- a few PPB. Options reform -- even the small-potatoes reform of applying the same accounting to taxes as to earnings -- is going nowhere. GAAP reform is driving around in a fog ... it's not clear the key players even realize it's foggy out. Audit reform, board reform, other corporate governance and disclosure will get minor cosmetic surgery, and players will mind their p's and q's for a season or two. Security analysts are safe for now, as are derivatives (abusive or not), securitizations (ditto), SPE's (ditto), offshore structures (ditto), executive compensation (abusive).

We can't get serious about audit reform without GAAP reform, and can't do that without some sort of definitional epiphany involving accounting "truth" (or at least "conformance"). How can we disclose what we don't understand?
Accounting is no longer reducible to bean counting -- how many beans in a can, how many cans in a case, how many cases on the shelf, whose are they, when did they get there, what did you pay for 'em, what are they going for these days, how many of 'em are likely to go bad.

Derivatives are contracts under which money (and other valuable considerations, but mostly money) may flow either way, or both, depending on all manner of compound uncertain future events. What's it worth, and how do we label the flows of value? It's no longer possible to distinguish revenues from loans from investments from repayment of loans from appreciation ... it's all proceeds per contract, and those numbers tell us none of what we (lenders, shareholders, taxers) need to know.
Looking ahead, I figure 2-3 years for the factual investigative phases to mature, 2-3 campaign cycles for issues to crystallize, 2-3 administrations for reform leadership to overcome status quo conservatorship. Heroes will be made tomorrow, but no heroes today.

Saturday, March 23, 2002

--- An Open Letter to "Andy's Kids". ---

You say DOJ's Andersen indictments are "simply unjust". (What does a double page ad in a major publication go for these days, anyway?) Please, yer just breakin' my heart.

You want my sympathy? Tell me first, has any comparable-sized group shown less sympathy to its less strategically-positioned fellow humans? I know, you have a code of ethics: stab everybody else in the face, but stab the client in the back. In slack time, "Androids" entertain each other by ridiculing their respective clients ... it's a competitive pastime, often honed to a fine edge. By and large, they show even greater contempt for the ordinary working stiff with an ordinary job, an ordinary wife, ordinary house and ordinary kids in an ordinary school.

Everywhere they've gone marauding, Andersen has made enemies ... and ripped the poor suckers' throats out ... and left them bleeding, helpless and voiceless ... and gloried in doing so. And now, fallen on hard times, the Orange Shirts want our sympathy.

Andersen was never shy about exploiting a foot in the door (often an audit practice foot) to charter a consulting project, pyramid it with add-on's, staff it stuff it with overpriced rookies, rake millions out the door, and depart with advice to the client that his cost structure is too high.

Andersen was never shy about orchestrating the biggest projects (and biggest failures) in history, and rotating every new chimp-in-a-suit through them until on paper everybody's qual's looked like King Kong's.

Andersen was never shy about winning on the golf course what they lost in the conference room, or about exploiting alumni "sleeper agent" leverage in management circles.

Andersen was never shy about tilting the tax code -- and then gulling credulous clients with slanted interpretations -- to "kick the crap out of the independents".

Andersen taught a generation of managers (including many Andersen alum's) that consultation equals predation. On whatever territory Androids couldn't hold for themselves, they poisoned the wells.

As the conniving, conscience-free Dogbert character in Scot Adams' Dilbert comic, the Andersen consultant is a modern cultural icon.

Andy's Kids aren't all bad kids ... they just fell in with a bad crowd. But kids in a bad crowd will do terrible things. They can't explain afterward why they did what they did, why they went along with pranks that got out of hand ... but they can spin up the dangdest excuses. It's always somebody else's fault.

So now you kids want sympathy? You think you're the good guys? You're not the good guys. You think you're the victims? You're not the victims. You think you're innocent? Nobody is innocent. You ran with a gang that did more damage than you can possibly pay for in your lifetimes. Ordinary kids pay restitution. What do you want ... subsidies so you can pay your country club dues?

You say you never worked the Enron account? That means squat. Andersen traded on its good name, deep resources and AA ("aggressive accounting") culture ... its willingness to push the envelope, to muscle in with weak capabilities and inflated qual's. That's your trade, that's your name, those are your resources, that's your culture, that's your envelope, and those are your qual's. You never worked the telco's? Or WMS? Or Sunbeam? Or Arizona Baptist? Or any one of the other US or EU or Aussie debacles? Or came close to the edge without falling over? Or profited by association with those who did? You never gave that culture your nod of silent approval? Give it a rest.

You say you have mouths to feed and lifestyles to maintain? That means squat. More than a few of you have sounded off on the moral hazards of bailouts for everybody from pregnant teenagers to stranded industrial facilities. And now you want a "get out of jail free" card? Spare me!Don't worry, you'll do just fine ... you'll be working this time next year, and five years from now, and most of you would have been upped or outed by then anyway. Think of this as a valuable opportunity, an internship in real life.

You say your clients need you? If they really do -- and some of them do -- they'll find you. If not, you've been a drain on their competitiveness from Day One.

You think it's an options game? That the upside is winner-take-all, but society pays on the downside? Hmmm, maybe you're not logging enough time at libertarian websites.

No sympathy here. Don't ask, don't even think about it. Practicality is another question altogether. Does the destruction of Andersen have any deterrent effect? Maybe not. Does it leave the industry less competitive? Maybe so. Does it eliminate streams of revenue that might be tapped to make restitution? Possibly. Does it foment a crisis of confidence in capital markets? Maybe yes, maybe no. I've laid out some planks of that case in earlier articles ... gimme a hand here, willya?

But don't drag Andy's fresh-faced kids to Washington on full fare tickets, pleading "Daddy needs a job"! Remember, these are the faces that launched a fleet of "Die, Yuppie Scum!" bumper stickers. No sympathy. Like they say in the re-engineering, outsourcing, downsizing game: "Nuke 'em, Danno"!

You can add this to your knowledge base: we have serious problems with one of our legacy systems ... and you are that legacy system. So stop whining ... it's not one of your core competencies. Fix what's broken. Model that process, lift that constraint, re-engineer that value chain, innovate that solution, and present a credible business case for it. Give us a viable alternative to "business as usual" ... or get a job ... but whatever ya do, quit breakin' my heart.

Friday, March 22, 2002

--- Rats Leave Sinking Ship, Take Payload to Adjoining Vessel ---

Houston Chronicle's Tom Fowler reports Andersen's efforts to reorganize ... may include plans for No. 2 accounting firm KPMG to acquire much of the Houston-based energy audit practice. ... key managers and staff members could transfer to KPMG along with their clients.

This would appear to transfer the primary economic assets (human capital, organization, client relationships, future earnings streams ... excluding only partnership capital) without taking on the corresponding liabilities.

We presume Andersen's rotting creditor-ravaged corpse gets something out of the deal ... but at distress-sale prices.

Looks like an especially egregious version of the scenario framed by's Will Saletan in "The Suspect Protection Program".

One wonders what a bundled virtual asset like this would be worth if securitized in a Special Purpose Entity, under "Braveheart" accounting principles.

On the other hand, it's hard to imagine how any of this group's true economic value would ever be realized -- to anybody's benefit -- in situ.

As on-book tangibles become less important in valuation of the "New Economy" enterprises, existing tort and bankruptcy law may fail to do justice for yesteryear's consequential stakeholders and/or bag-holders.

Thursday, March 21, 2002

--- "One of us! One of us!" ---

We've called attention in past items to the right most estimable Michael M. Thomas, of New York Observer "Midas Watch" fame. Thomas sizes up the essentials of Enron here:
a typical example of that stage of competitive evolution at which share of market ... can only be maintained by giving the arithmetic native to a given line of business a bit of help. Since–in an uncolluded market–trades and commissions are priced competitively, the only way to do this unilaterally is to crank up the leverage and start trading for one’s own account.
... suffers a Vinson & Elkins flashback here:
Now a law firm that thinks in investment-banking terms is going to be more concerned with "Yea!" than "Nay!", more with facilitation than rectitude, more with what can be gotten away with than what shouldn’t be done in the first place, more with serving as enablers than as counselors.
... and casts the Enron saga in historical light of the 1960 GE/Westinghouse price-fixing scandal here:
... the key element in the context is Enron’s triangulation with the events of Sept. 11 ... the International Terrorist Conspiracy is the foe; 40-odd years ago, it was the International Communist Conspiracy. ... A proud and grieving nation will not suffer swindlers or profiteers gladly in wartime.
The Midas Watcher's classy stream-of-upper-class-consciousness ruminations have gone a-bloggin' now, at

--- Cruisin' for a Bruisin', continued ... ---

[REUTERS] California prosecutors say that when they pried open 940 boxes of documents subpoenaed from bankrupt energy giant Enron Corp. ... "What we found were discarded Kleenexes, old pizza boxes, garbage," California Attorney General Bill Lockyer told reporters. ... From the 940 boxes, "we got one piece of paper, one document, in response to our subpoena" ... Lockyer won a court order in January requiring Enron to preserve all paper and electronic documents subpoenaed by state officials.

Could this report be a snippet of sarcasm inadvertently picked up as news? If legit, it certainly makes an impression.

What's next, smallpox blankets? "Freedom's just another word for nothin' left to lose". Therefore approach a tapped-out adversary with caution, whether it's Enron or al Qaeda!

[2002-03-22 UPDATE: The Reuters item apparently conflates two allegations. In the first (January 2002), California A.G. Lockyer asserts Enron provided only a single page of subpoenaed information, and threatened contempt action.

In the second (this week), teams representing CA, WA and OR attempted to retrieve subpeonaed material from Enron/PGE in Portland, OR (where 125 energy traders used to operate). The states assert they found a limited number of originals boxes (thousands of pages of documents of unknown suitability, with no useful index), a larger number of recycling boxes (including embedded garbage and extraneous documents), and a lack of computer records and other requested materials.

Lockyer has a press release here ... Broadcast reports indicate Enron contests these claims (I haven't found anything solid on the web, and Enron website press releases date only to mid-February) ... they'll get a chance to make their cses in court.]

Wednesday, March 20, 2002

--- FOLLOW-UP: Gramm out of the running at Texas A&M ---

As speculated here 2002-01-13, and as foreshadowed 2002-01-27 by the Texas A&M Chairman's declaration that Enron does not necessarily disqualify retiring Sen. Phil Gramm (R-TX) from consideration for his life-long "dream job" as university President, one-time favorite Gramm failed to make the short list (though he ws among 125 interviewees).

Enronitis? Possibly. Or Gramm may have a lead on better-paid opportunities. (Dinners may become more important than honors, considering wife Wendy's direct losses and potential liabilities as a member of ENE's Audit Committee.) Or A&M may have concluded a hard right intellectual leader at an already conservative campus would hurt their chances of cracking the "top ten" rank of public universities.

--- Enron Affair RESOLVED!!! ---

"RESOLVED: The Enron Affair is the Logical Result of Deregulation" ... A formal debate, moderated by WSJ's Al Hunt, at National Press Club today, 5:30.

Robert Kuttner (The American Prospect) and Robert Borosage (Campaign for America's Future) for the Left; Grover Norquist (Americans for Tax Reform) and Bruce Bartlett (Columnist, The Washington Times) for the Right. True to Dumbell Configuration traditions, the advocates are outward exemplars of their respective polarities, and will probably fall into gratuitous off-topic sniping.

The resolution itself is premature ... it will take years of forensic reconstruction before we can say with any certainty how much responsibility to assign to deregulation, versus conventional securities fraud, self-dealing, irrational exhuberance, acts of god, and so on.

I've already laid out much of my surmise of what we'll find when the evidence is in:
(1) Long before it became a financial disaster -- and independent of that disaster -- Enron was a wildly successful criminal conspiracy to create and manipulate certain deregulated markets (aided and abetted by the politically fashionable but economically unfounded popularities of certain deregulations).

(2) Enron's financial failure was triggered -- with ironic justice -- by the collapse of an overprovisioned broadband fiber-optic industry which would never have executed this capital-destroying ballistic trajectory if it had matured under time-proven principles of common carrier network economics (including regulation and other government interventions).
C-SPAN willing, I'll attend today's premature slugfest with interest, and may share a few comments in days following.

Tuesday, March 19, 2002

--- Andersen Agonistes ---

Say it ain't so, Joe!

"These are terrific times. Exciting times for our clients and our people." So sayeth Andersen CEO Joe Berardino in this June 2001 highlight package.
Berardino was elected CEO of Andersen in January 2001 for a term expiring in August 2004. Joe has been a member of the Andersen Worldwide board of partners since 1998.

... he was an architect of the firm’s Global 1000 client base expansion. ... a director of the Foreign Policy Association, trustee of the United States Council for International Business ... Fairfield University ... Advisory Council for the Mayor of Shanghai, the Conference Board, ... British American Business Council ... Economic Club of Chicago ... Field Museum ... Ohio State University Accounting Hall of Fame ... National Center for Education Accountability ... American Institute of CPAs and the New York Society of CPAs.
Meanwhile, WSJ on MSNBC dissects a widely-read Andersen white paper on accounting for telecom swaps:
[Andersen spokesman] "Andersen auditors provide accounting advice. They don't structure or promote transactions."

... The white paper includes a disclaimer, saying it doesn't constitute legal or expert advice.

... if the two companies each structure the transactions so that the capacity sold is an operating lease, and the capacity bought is a capital lease, Andersen interprets the companies as having not acquired "equivalent interests." ... It is then possible to start booking revenues over the life of the contract ...
OK, this is kinda like the Yates case. The defendant is clearly delusional. We can't honestly believe punishment will deter any similarly situated actor in the indefinite future. We can't just let it go, either. There are no asylums for accounting methodologies gone stark raving mad. And focus on Andersen keeps us comfortably distracted from all manner of woulda-coulda-shoulda's.

"I'm not an accountant" swears former Enron CEO Jeff Skilling. A lineup of Vinson & Elkins partners pleads "We're attorneys, not accountants". "We only work from the numbers in the financial statements", claimed security analysts who rated Enron a "Strong Buy" all the way to Chapter 11. It's not the Enron scandal, "it's the Andersen scandal", say right-of-center pundits concerned that Enron tar might stick to some of the wrong people.

OK, right, but if you raised five kids and changed zero diapers ... in the immortal words of criminologist Henry Lee: "Something wrong!".

Enron is a train wreck. On Enron's tail, Andersen is a train wreck. Global Crossing is a train wreck. As GX tumbles down the slopes of Mt. Telecom, it may derail Qwest on a parallel track. Switches are being thrown frantically to keep other providers and provisioners from sliding into this mess. Behind those, certain engines of global finance are rolling with a full head of steam and nowhere to go. The boxcars are rocking, the whistle's blowing, the wheels of commerce are throwing sparks.

When one train wreck follows another, it's time to ask hard questions about the track, the signals and the dispatch logs. Is this any way to run a railroad? No ... so by all means, lets punish somebody. Hey you, Andersen, get over here ... and bring your playbook!

Andersen objects, specifically to DOJ criminal indictments of the firm for obstruction of justice based on document shredding. Andy may have a good case.
Documents were shredded, but were they material to the investigation? What investigation? Was there reasonable expectation they would become subject of investigation? Were they irreplaceable? Were they enjoined? Who gave the order? Was there an order? Or was it a miscommunication? Or routine procedure? Was there a conspiracy? If so, by whom? A couple of rogue partners, or the whole firm?
DOJ Criminal Division chief Michael Chertoff cut his teeth on hard-core mob cases. He's imprinted with the formative experience of grilling suspects who are guilty and know it ... getting them to crack ... you just have to produce enough living witnesses, unintimidated jurors and unbought judges to make it stick. As Senate Whitewater committee counsel, Chertoff repeatedly embarrassed himself with toothless ambush attacks ... leaping out from behind some metaphorical filing cabinet with documents in hand, shouting "AHA!" at his intended victim, and shooting blanks.

Chertoff clearly means to send a message and set an example: "Don't mess with DOJ, you country club weenies!" But Andy doesn't think Andy is guilty -- at least not criminally guilty -- at least not as a firm -- at least not in the shredding caper -- and (like O.J.) asserts the right to a speedy trial. If Chertoff has no more ammo than what's visible in the public record, he's chosen a hard road to hoe ... and an early loss could dampen the fear factor he needs to turn witnesses in real meat-and-potatoes prosecutions to come.

If Chertoff does have an ace in the hole -- which is entirely possible -- it's a whole 'nother ballgame ... but the timing is curious. Andersen is toast anyway, with or without the felony rap. But a message must be sent, especially given their cavalier attitude, especially with the ink barely dry on Andy's Waste Management plea-bargain.

Andersen made several game efforts, but -- in a series of premature strategic appearances -- Berardino appeared under-prepared, under-planned, under-penitent ... and over-eager to shed the baggage and get back to the business of selling more business.

SEC isn't on the same page with DOJ. They're concerned with industry stability, and worried about the flood of incomplete, untimely and unaudited financial statements that will hit the floor if Andersen folds everywhere at once like the Taliban.

At CNN MoneyLine, Lou Dobbs objects ("high dudgeon" is Dobbs' best color) to "punishing the innocent" -- 85,000 employees and 5,000(?) US partners, most of whom didn't screw the Enron pooch. I'm less sympathetic on two grounds.

First, most of these innocents will suffer nothing more than a par-for-the-course job dislocation, followed by increased demand for their services, and many will end up with the same clients.

Second, Andersen is a partnership. That means sharing the good (the goods and the gains, ill-gotten or otherwise) -- and sharing the bad (fines, probation, responsibility). With no collective consequences in this system of collective responsibility, there'd be every incentive to look the other way ... and no incentive to maintain a high-integrity culture enforced through peer standard-setting and systemic internal vigilance. The punishment, for many, is out of proportion to the crime ... but that's life on the streets.

Will punishing Andersen make a difference the next time temptation rears its ugly head at one of the surviving Big Four? Next time, yes ... time after that, maybe ... as time goes by, no. Similar pressures will lead similar actors to push the envelope. The bigger they are, the harder they fall, and they are getting bigger, not smarter.

So Andersen gets the corporate death penalty, leaving four surviving "auditors of global reach". Suppose we bar consulting and auditing with the same firm. And suppose we mandate periodic rotation of audit firms. That leaves the typical large corporate client with consulting engagements in progress, and an audit transition on the calendar, with only one alternative for either. When the Big Four become the Big Three, there are no alternatives.

Andersen affiliates operate in nearly a hundred national jurisdictions, in conformance with local governing law and conventional forms of business. Some were grown organically, most were local firms acquired and assimilated. The "mother ship" is the Swiss-chartered Andersen Worldwide Societe Cooperative -- "a coordinating entity that holds together a loosely banded network of member firms" (WSJ), sharing methodology, leads, leverage, a little money, and the holy grail of 21st century commerce: branding.

By most accounts, international affiliates bear little jeopardy in US litigation. Maybe they can re-flag themselves on the fly, like so many Afghan warlords, and hoist the KPMG banner.

[As an emerging theme in the era of mobile global capital, intangible assets, arbitrary accounting and multinational enterprise: Who can audit a global corp any better than they want to be audited? Who can tax them, unless they choose to be taxed? Who can regulate them? Who can litigate them? Who's to enforce sanctity of contract? Who can collect what they owe, except as they choose to pay?]

In a Slate Frame Game column, Will Saletan raises another troubling tangent. Most of Andersen's assets -- human capital and client relationships -- reside outside the enterprise envelope. No court can attach them, if Andersen partners simply disperse and regroup elsewhere. Likewise any ill-gotten gain -- mostly on partners' personal balance sheets, very difficult to attach, with little cash in their respective partnership capital accounts. It's an "asset light" enterprise model, leading to relative impunity. Very, very hard to punish the guilty in this case -- or the innocent, for that matter.

Don't just stand there ... round up the usual suspects!

Thursday, March 14, 2002

--- Confirmations ---

As speculated here 2002-01-13, Kent Bentsen fell out of the Texas Senate race in Tuesday's primary, missing by about 4 points and only breaking even in his home county (Harris). Enron effect or ethnic politics? Close call. Dallas Mayor Ron Kirk and vanity candidate Victor Morales in a run-off next month. (That's Victor Morales, who finds most issues "mind boggling", not to be confused with legit but unsuccessful Gubernatorial candidate Dan Morales.) Kirk the stronger candidate, but Morales polled 45% against Phil Gramm in '96. (Looking forward, Enron looks to affect 2002 politics in big states Texas, California and Florida ... look for some NY reverb in later chapters of the saga, as megabank lobes of the meta-scandal reach maturity.)

As speculated here earlier this week, the Deloitte Touche Tohmatsu deal is declared dead. Somebody might concoct a cleer way to save one of the Big Four combo's, but what's the acquirer's upside? By doing nothing, all four can pick up their proportionate shares of Andersen accounts and Andersen talent ... without paying for it and without incurring any risk or taint of Andersen successorship.

Tuesday, March 12, 2002

--- CFTC Bloodhounds on Enron Trail ---

In a significant development, the Commodity Futures Trading Commission "inquiry" of last fall has progressed to "formal investigation" of Enron trading practices. (multiple sources) CFTC will tag-team with DOJ, SEC, FERC, and probably other fed/state/local agencies, parties and experts as the probe proceeds. CFTC is probably the agency with deepest experience in pertinent territory, and is the least-swamped investigator going in.

Assume they start with Enron's NYMEX activity in conventional regulated commodities, but extend the probe into non-regulated over-the-counter activity.

This will challenge CFTC resources -- as millions of documents and thousands of hard drives are implicated -- and jurisdiction, since the key segment (OTC energy trading) was exempted to create the "regulatory black hole" and nontransparent market in which Enron operated as market maker and as the predominant buyer and seller. CFTC still retains fuzzily-defined, poorly-tested authority to peer into the black hole looking at patterns of fraud and manipulation outside.

It's also a challenge as the first major investigation of trading patterns in a private web-deployed trading network.

And it raises a challenge of complexity, since the biggest scheme -- if it occurred -- would have been a multimodal tandem manipulation across three or four "energy pipeline" commodities -- natural gas, gas transmission capacity, electric power, and possible electric transmission capacity --each in multiple markets, and in nonmarket transactions.

Going beyond the available facts, just reading the wind, I think they'll confirm a complex pattern of abuse behind the so-called California Energy Crisis. (I say "so-called" because the crisis was manufactured, and because it extended far beyond the confines of California and the oddities of that state's deregulation model. The average Seattle electric customer is burdened by $2,000 in debt incurred during this "crisis" interval, and stands to lose thousands of dollars more in disadvantageous forward power contracts signed during this period.)

The circumstantial evidence is compelling, but it's possible Enron was not behind this game ... or even that there was no game.
(1) The Game might be the work of primary eneregy and fuel producers and dealers, and Enron might have been nothing but a channel through which their tactics were executed. In this scenario, Enron would have enjoyed windfall profits from high volumes and generous margins in a panicky, illiquid market, and there are indications they gouged both sides of the trades in ways that warrant wire fraud prosecutions ... but they weren't Mr. Big.

(2) There may have been no overt collusive manipulation. In this scenario the requisite harmonious withholdings by independent players were emergent behavior, like that of a flock of birds flying and resting in advantageous concert without explicit leadership. The customer still got screwed, but nobody planned it.
These alternatives seem unlikely considering Enron's dominant role -- 30% to 70% of the action, depending of commodity and region. CFTC will investigate, or will advance the ball to the point where another agency can pick it up, or will get somebody to crack and spill the beans. If this reveals explicit market-rigging, the effects could include extensive criminal penalties, and several tens of billions of dollars in civil liabilities, to be satisfied ... where?

--- Darkness Shadows White ---

Joshua Micah Marshall has us primed for a Public Cititzen bunker buster concerning Army Sec'y Thomas E. White, Jr. Hmmm. Could this be a "smoking gun" document in the Fort Hamilton energy privatization fiasco? From 2002-03-10 NYT
"There was some perception that Enron was able to negotiate out of the contract some of the terms that were the reasons why other potential bidders decided not to go forward"
Or a revelation that White had a bite of one of those Chewy partnership vehicles? Or something more about White's foot-dragging in ENE stock divestiture? Or an "I know what you did last summer" criminal probe creeping up on him in connection with his Enron tenure?

Do we need a smoking gun? Isn't it enough that White's a poster-child nominee for both the Capitol revolving-door syndrome and Dilbert's "clueless boss" syndrome?

--- "Anron", anybody? ---

Deloitte Touche Tohmatsu acquisition of Anderesen assets looks about as viable as the Enron/Dynergy merger -- too many skeletons in the closet.

The "White Knight" panel led by former Fed Chmn Paul Volcker cut short its review process and released rescue recommendations prematurely, under the prospect that events may overtake and moot it. (WP)

Volcker endorses the "chop and shop" approach, busting the conglomerate into multiple partnerships along separate lines of business, trying to preserve an uncompromised audit presence. Volcker's contract requires Andy to follow his recommendations (unless they're illegal, etc.) ... this should be interesting!

SEC has been lobbying to rescue Andersen, too ... basically begging for mercy on Andy's behalf, trying to avoid a pancake collapse. SEC Chmn Harvey Pitt has an appearance problem, given that he used to lawyer for Andersen.

If Andersen lives, all agree is needs a new name. Hmmmm. "Anron"?

--- Darkness Falls at Enron Broadband ---

Annual operating cost, $30M ... annual revenues, $10M. Enron Broadband Services receives bankruptcy court approval to unplug what was once a cornerstone of the ENE pyramid. The few existing contracts are sold to third parties competitors (Dynergy) for "more than $491K".

[Around the circuit today, multiple fiber broadband purveyors are reporting sucky financials and/or SEC inquiries into their accounting practices.]

ENE Broadband was the intended platform for the ENE/Blockbuster "Project Braveheart" video-on-demand venture, in which CIBC invested $115M (US) on the promise of almost all the profits and none of the losses (ENE would "guarantee" the original investment).

Enron used structured shell-game shenanigans to morph CIBC's "no risk" loans into current period reported revenue (it's money in the bank, isn't it?), and used those skyrocketing revenues to chum the investors ... including CIBC.

CIBC should have known better. You know better. Your mom knows better. "If it sounds too good to be true, it probably is." If anybody -- the most admired CEO in America, or some guy in a bar after the Dare to be Great seminar -- offers to cut you in on a can't-miss, can't-lose proposition, close out your tab and walk out the door (unless you're a bigger con man than he is).

Monday, March 11, 2002

--- Andersen: Organ Donor to the World of Auditing? ---

With major client defections, imminent criminal indictments, and multiple nine-figure non-Enron exposures, it doesn't look like they can stop the bleeding at Andersen. Forward prospects hinge on separating the assets, leaving the liabilities behind, and maybe separating the septic lines of business (audit, maybe tax) from consulting lines that might be easier to salvage.

Latest buzz involves a business combination with Deloitte Touche Tohmatsu. A tricky save ... who wants to inherit Andersen's reutational baggage? How much of the client base can Andersen bring with them? How do you make sure the liability bloodhounds won't find a way track Andersen's scent to your door? And assuming the separation is achievable, how do you value the assets, considering the traditional audit/consulting synergy is broken, and the future regulatory and liability regime is full of unknown unknowns

If anyone can structure the deal, these folks have the know-how. But a direct combination -- if it works at all -- leaves the industry more consolidated and less balanced. is it more feasible to carve the body into smaller pieces ... maybe down to individual client level ... and dispose of them in an open auction and swap-meet with the surviving Big Four plus major regionals?

Sunday, March 10, 2002

--- Skilling -- Still Cruisin' for a Bruisin' ---

Houston Chronicle reports In a letter Friday to Rep. Jim Greenwood, R-Pa., chairman of the oversight and investigations subcommittee, [Skilling attorney] Hiler attached a column from the Philadelphia Inquirer, mocking lawmakers' ignorance about business issues.

As we've pointed out, these criticisms are ill-founded. [I've not been able to locate the column in question.] But suppose the ridicule was dead-on ... how does shaking something like this in the Chairman's face conceivably help Skilling's prospects? Or is this just another set-up for a reduced capacity defense? ("It's not just that I'm crazy, your honor, my lawyer's even crazier ... and you oughta see the guy who tunes up my Lamborghini!")

--- Insurance-Mediated Audit Engagement ---

Prof. Joshua Ronen of NYU Stern School of Business floats an intriguing market-oriented solution to the auditor independence problem, in a 2002-03-08 NYT op-ed.

In Ronen's scheme, corporations would purchase "financial statement insurance". To rate the insured risk and set rational premiums, the insuror would employ auditors. Disclosure of coverage and premiums would signal the public as to the relative quality of financial disclosures, and would presumably exert elastic pressure on management to eschew the less transparent financial structures (some scams, some wishful thinking, mostly legit but mind-boggling).

[Other proposals now in play would have the stock exchanges engage the auditors, as a condition of listing ... or attach the auditors to a broader self-regulatory organization ... or even a public agency.]

Poking holes in Ronen's net seems easy enough:
  1. It may be difficult to define the indemnified events (misrepresentations). Big-ticket frauds are rarely simple frauds -- writing down a '7' instead of a '1'. Exactly when do the terms of an off-book trust's derivative contract cross the line into material misrepresentation?

  2. It may be difficult to standardize these definitions across the market, so that "we're insured" means what it appears to mean, preventing collaborative low-bid insurors from surrendering in the footnotes whatever assurances they advertise on the title page.

  3. It may be difficult to agree in applicable cases that a covered loss has occurred, and to quantify damages. It seems to come down to a contest of opinions re material representations ... you can't just base it on lost market capitalization, for instance, since that usually happens for other reasons.

  4. A single claim might produce a huge loss, perhaps three orders of magnitude greater than Lloyds of London would underwrite. Coverage would necessarily be in token amounts, pennies on the dollar, and premiums might dwarf current audit fee structures. This would seem to exacerbate an existing problem, in that auditors' potential liability losses are perhaps too big for anybody to stay in business in the long run.

  5. Claims history would be sparse and large-grained, with statistical fluctuations towering over the "law of large numbers" effects on which the insurance game is premised.

  6. Covered risks are correlated ... the worst kind. Misrepresentations rarely engender losses in boom times; in slack times, the leakiest boats all run aground at once.

  7. Massive reserves would be required, and must be invested ... where?

Classic insurance market issues must also be considered. In this case, moral hazard -- the propensity of the insured to act less risk-averse -- doesn't look like a major problem. Neither does adverse selection -- the propensity of bad risks to buy more insurance -- or does it? The propensity of insurors to enter the business with optimistic lowball premiums, and then find themselves unable to cover the ensuing claims, is a more serious concern (usually addressed through regulatory oversight).

It's far from "easily implemented" (as Ronen suggests), but the principle deserves further consideration. Can we synthesize decision-theoretic incentives to tilt the tables in favor of higher quality information flow, and drain some of the risk and remorse that currently attaches to believing your eyes when you read a financial statement? Can we apply the same principle to other markets for professional examinations and expert opinions, such as securities analysts and bond rating services?

[2002-03-10 2:44 pm UPDATE: Ronen indicates a forthcoming paper will address these questions, and hints that "easily implemented" is NYT editorial shorthand for "all the news that fits, we print".]

Saturday, March 09, 2002

--- Seattle Angles ---

In Houston, Judge Harmon appoints two Seattle law firms, and Lynn (good cop) Sarko and Steve (bad cop) Berman individually, as lead counsel for Enron employees. Berman and Sarko teamed up on Exxon takedowns after the Valdez incident. Berman helped scare the tobacco industry into the multi-state mega-settlement.

Berman -- aka King of Class Actions -- exemplifies at once the best and the worst of our civil litigation system. The best: going after evildoers and bringing them squealing to justice. The worst: deploying technology to launch boilerplate shareholder lawsuits on any major drop in a high-flying stock.

In the local press, Berman has engaged in hot talk re the Public Securities Litigation Reform Act (PSLRA) of 1995 and the Securities Litigation Uniform Standards Act of 1998, accusing WA Senators Murray and Cantwell of setting the stage for Enronitis by passing legislation which discourages corporate responsibility by tilting the table against shareholder suits. Ironic, since the legislation is in large part a reaction to Berman's push-button litigation habits ... and off-target, incidentally, since Cantwell was not in Congress when either measure was enacted. For some reason, Berman's op-ed on the subject is not available in Seattle Post-Intelligencer online archives.

Speaking of counsel you would not want to find on the other side of your case, Washington A.G. Christine Gregoire (lead for the states in the tobacco case settlement) is ticked off at Enron ... on multiple counts. Gregoire reinforces a point I raised earlier, re the combined effect of (approximately symmetrical) hedged long term forward commodity derivatives and (wildly asymmetrical) treatment of contracts in bankruptcy.
As a corporation in Chapter 11 bankruptcy, ... Enron can keep those contracts that are profitable to the company (we pay Enron), and reject those contracts that are not profitable (Enron pays us).
If this hole isn't plugged, it creates intense incentives in favor of deliberate bankruptcy.

On a Seattle tangent, the WSJ editorial page has engaged in a full-tilt pissing contest versus Fannie Mae, with FNMA getting the best of it by virtue of Franklin Raines' rebuttals and rebukes, independent testimonials to FNMA integrity, and WSJ's own poorly crafted cheapshots at FNMA accounting and risk management practices. In additional to being the man at OMB when the US turned the corner from deficit to surplus, Raines is one of several notable graduates of Seattle's Franklin High (an urban core public school). I daresay if Raines had been Enron CEO we'd hear none of this "don't ask me, I'm no accountant" posturing.

--- "Status Quo is Not an Option" ---

OK, Campers, lets see how those projects are coming along ...

Enron-related reform proposals are percolating in scores of congressional committees, executive departments, think tanks, courtrooms, Wall Street conference rooms, self-regulatory bodies and ivory towers. Topics run the gamut of business practice and governance: executive compensation -- general, deferred, options, bonuses, loans, pensions, insurance ... general employee options, pensions, 401(k)'s, ESOP's ... board of directors composition, compensation, standards of conduct and liability ... personal bankruptcy, lavish homestead exemptions and executive retirement shelters ... corporate bankruptcy, including its asymmetric effect on symmetric swaps ... swaps, derivatives in general, regulation, disclosure, accounting ... Special Purpose Entities, especially offshore, applicable disclosure and consolidation thresholds ... tax accounting for options ... "trust preferred security" tax schemes ... new classes of sham transactions, especially those using tax islands as ports of call ... international holding company cash management systems ... unregistered private banks and hedge funds ... securitized lending portfolios and related off-book devices ... synthetic leases ... exotic OTC trades ... SEC disclosable events and deadlines ... security analyst independence ... white collar criminal penalties ... white collar litigation curbs ... credit rating integrity ... audit standards and auditor independence ... corporate consolidation and oligopoly.

No clear prognosis on specific measures, but "The status quo is not an option". (Senator Torricelli, to a quartet of prominent security analysts determined to sing "We're OK, blame the accountants" despite strong correlation between their firms' investment banking revenues and their "Buy" recommendations.)

It's as if we spotted a few drips, thought we had a leaky pipe, then got a whiff of the acrid smell, then tested positive for PCB's, and asbestos, and heavy metals, and radionucleides. Tracing the plume upstream we learn the whole town sits on a toxic waste dump, and it's seeping into the aquifer, and we're not the only town in the same fix. If Enron is more than an aberration, we're living atop the financial equivalent of Love Canal ... what do you do first, and how do you keep it from happening again? Expect a lot of talking -- and fingerpointing -- before any serious doings.

Current initiatives -- knee jerk first drafts -- won't lead to much directly. It will take time and work to mark the holes in our value and feedback cycles, and more time yet to plug the holes without gumming up the works ... and more time for opposition to polarize over competing solutions, and for one side to overcome the other, and then we commence the cycle of unintended consequences. But the status quo is not an option.

Trial balloons are floating from SEC and Congress, from Merrill Lynch, from the exchanges, from SIA, from FASB, from AICPA. GWB offers a mumble-something shareholder protection plan, weaker than Paul O'Neill's. None has much snap.

At SEC, Harvey Pitt lumbers reluctantly into the fray. "I do not believe that we need legislative action". He correctly notes SEC doesn't have the staff to do the job right, the job keeps getting bigger (even without Enron), and staff pay is far below scale for comparable jobs in industry or government.

All Big Five have voluntarily split -- or declared intent to split -- auditing from consulting. More radical measures are on tap: audit firm term limits, exchange-funded audits, public-funded audits. The industry as a whole is fighting mandates, clinging to "good citizenship" models of self-regulation.

The Enron dig itself proceeds slowly. The scope of issues, sheer mass of records and cast of characters is unprecedented. FBI and other white collar sleuths are swamped, and will be.

Reform has no center of action as yet ... no select committee, no blue-ribbon panel, no polarizing crusader of national stature.

My nominee for the role of Moses -- GE patriarch Jack Welch -- turns out to be an Enron dove, and has enough problems of his own right now. But he does suggest that underneath the dotcom bubble is a scandal "50 times" the magnitude of Enron. I tend to agree. Add in the fiberoptic crash, and make that ENE x 100. There are bigger, deeper scandals, and I think they'll coalesce.

The big issues haven't surfaced yet. A hard winter exposed a few unusual artifacts, and we're laying out gridlines for a big dig ... but who ya gonna call? Criminologists? Archeologists? Exorcists?

In the collateral damage department, energy dereg holds its own for now ... that may just be inertia and investigative bandwidth limitations. Major energy bills, including PUHCA-killers simmer in both houses. Sen. Feinstein has a major re-reg bill. Look for refocus later in the year, with more forensic data and immunized witnesses at the table.

Enron put Shays-Meehan/McCain-Feingold over the top, we'll see how it plays out. Won't be simple, no matter what the court does with it. Skeptics, see Mann & Ornstein.

Social Security privatizers are still running as if, but that dead horse won't hunt.

In Scandalsville it's at least Josh Marshall's meta-scandal. The chorus of Endarkened Self-Interest has piped down a bit. Remains to be seen if it's the harbinger of a new Progressive Era ... meta-analysis continues.

Enron big brass sustain their Culture (or is it "Cult"?) of Minimal Disclosure, banking on the out-of-the-loop defense. Lower down the food chain, they're cutting deals and spilling guts. DOJ is holding criminal obstruction of justice charges over Andersen's head, and -- eager to get on with its own battle for survival -- Andersen should turn state's evidence.

Andersen is well on the road to imploding, and will take more hits, as will Vinson & Elkins -- especially if Andersen flips first. And some money-center bankers are losing sleep.

Skilling thought he got away with playing cat and mouse again ... but he's the mouse, and this ain't no Tom and Jerry episode. He's not helping Congress -- who want the case in point laid out so they can argue what to do about future Enrons -- and not helping himself. If nothing else, they'll hang him for that phony trading room caper ("The Sting") ... but I doubt it'll come to that. Lay and others wait for the knock at the door. Watkins may ride it out if she doesn't overplay her role. Baxter is still dead.

The sex angle is heating up, nothing stellar yet unless you count Skilling's marriage (of spousal testimonial convenience?) to Rebecca Carter (former Enron Corporate Secretary and chief control officer, former Andersen auditor, and formerly known as "Va Voom"). A pall of darkness hangs over Houston strip clubs.

In bankruptcy court the feeding frenzy continues ... the latest tussle concerns ENE's budget for legal defense.

Global Crossing stinks higher than Enron, and may take some big buddies down with it. Down the chain of dominoes, one or another a major financial firm may fall ... and then the real fun starts.

For comic relief, Enron pulls a Mariah Carey, charging the Astro's $2.1M to take the Enron logo off their ballpark. Guess that will help peg the going rate for site de-Enron-ification.

Politically, things are pretty quiet. I still predict peak effect in 2012. Army Sec'y White looks like dead meat, and (as Josh Marshall points out) a convenient throwaway. Other names to watch: Ashcroft, Beers. GWB still strangely asserts Lay was a stranger. E-money is still trickling in from political war chests to Enron employee relief funds. (Nobody has picked up the tax angle on these contributions yet.)

In Congress, Tauzin's the showman, Hollings the loose cannon. Greenwood and Fitzgerald look good, Corzine's a major figure, and other reputations will be made and marred.

As hinted here earlier, Enron political operations were underestimated and underreported. First half federal lobbying outlays for 2001, for instance, were $2.5M ... about three times the original reported amount.

Texas has a primary election Tuesday 3/12. Latest polls suggest Enron will twist the Senate nod out of (D) Bentsen's hands, consistent with our analysis. Interesting to see how many protest votes (R) Cornyn's four no-name opponents can muster. The real fun starts this fall, and includes an uncomfortable spotlight on GWB's record as governor.

Speaking of uncomfortable spotlights ... in a hard-fought CA Governor's race, GOP seems determined to hang the Energy Crisis on incumbent Gray Davis. Not where I'd want to aim the spotlight if I were in their boots, considering where the bodies are buried and where the first Enron digs are starting.

Western power wars are far from over. FERC is to investigate Enron trading practices ... with what, when? Just reconstructing the trading log is a multi-year project. Expect heat and possibly fission as they debate how to proceed. There are some good sharp pencils who know how to chase this, maybe they'll show up on somebody's team or as friends of the court.

Some of state A.G.'s are conflicted ... suing Enron for billions in market manipulation refunds on one hand, representing state pension funds holding tons of ENE stock on the other.

Corner opposite, still no reasonable explanation for Alliance Capital Management socking Florida pension money deeper into ENE as it fell, with implications for Jeb Bush's re-election bid.

On fundamentals, still no evidence Enron ever existed as a value-producing economic entity. The markets haven't missed it.

As for economic impact, big names on the street endorse my "lower P/E's and lower E's" double-whammy thesis. Deals (of certain stripes) are inhibited, dividends becoming fashionable, and true cost of capital higher. Traditional US advantages in global capital markets have narrowed, as suggested, but it's too early to say what'll stick.

Flatland bookkeepers are still bamboozled by derivative sorcery, with no viable proposals for corrective action on the table. The fundamental covenants of financial accounting are broken.

Over the next few decades, globalization will exert unrelenting pragmatic pressure for large-scale conformity in accounting, tax and regulatory models. There's already some buzz about EU taking the lead in accounting standards ... never thought I'd see the day. On several fronts, US is the favorite for odd man out.

Tuesday, March 05, 2002

--- Camp Enron Scoutcraft: Flatland meets String Theory ---

In Graham & Dodd's world, security analysts took reported sales and debt as objectively verifiable and comparable ... all else was grist for interpretation. In recent years, we've come to think of cash flow as "real". Today the very foundations of financial accounting are under attack by entities from another dimension. Their technology that can transport sales, debt, or cash in or out of the tightest boxes we can construct -- without leaving a trace.

The problem in a nutshell:
"structured financing" is to conventional accounting
string theory is to plane geometry.
In 1884 Edwin A. Abbott penned "Flatland: A Romance of Many Dimensions", a classic in mathematical allegory and Victorian social satire. Denizens of two-dimensional Flatland could be imprisoned simply by drawing a square around them. Hopping over the enclosing line would have meant a jump into the unthinkable third dimension. So would tying a knot in a string. A visitor from our 3-D world could perform feats of sheer magic, at least from the Flatlanders' limited perspective. Lift the tip of a finger from the paper, for instance, and it seems to vanish into thin air ... only to reappear later outside the circle in which it was "confined"! Impossible? An illusion, perhaps? In 2-D, yes; in 3-D, no. Abbott's thought-experiments helped generations of mathematical physicists learn to "think outside the box".

Modern physics harbors a growing suspicion that familiar fundamental entities -- particles, waves, forces -- might be mere special cases, approximations, or standing-wave nodes of more elaborate structures ("strings") interacting in a space of many dimensions, but naively observed only as their cross-sections linger in our lower-dimensional space (three physical dimensions, plus time).

Like physics, accounting evolved within the shallow waters of low dimensionality. If you own something, you can give it away, you can lose it, you can break it, you can wear it out, you can throw it away, you can sell it, you can let someone borrow it. The possibilities are limited, we know how to account for each (at least in principle), and knowing this is knowing enough. Bundle elementary events into transactions, and the effect of the combination is the combination of the effects. Things have value, things have owners, things can be transferred, value goes with them, transfers can be recorded and the recorded elements must add up. Within this limited perspective, we can "account for" all things that can possibly exist -- within this perspective. What if there's more out there?

Like physics, accounting is now challenged by extra-dimensional possibilities ... and not just in theory. Derivatives are contracts centered on arbitrary mathematical compositions, formulae that can be functions of many dimensions ... even an infinite number. By tweaking the terms and tuning the free parameters of a generic derivative model, the financial engineer may create a broad range of replicants for any "real world" transaction, including some that relabel the components on the fly.

From the advantaged perspective of higher-dimensional space, a conventional sale or loan is just a special case of a derivative ... and depending how the formula is expressed, it might or might not go into the books as a sale or a loan. Whoever masters the extra dimensions can perform "magic" -- like making a liability disappear on one side of a wall, and reappear on the other side of the wall, without ever meeting the reportable transactional obstacle of the wall itself. Impossible? An illusion, perhaps? In the linear, separable, additive world of conventional accounting, yes; in the world of structured financing, no!

Concrete examples from current events:
(1) High-end investors routinely mimic sales using "equity swaps". The "seller" receives market price for the affected asset, but doesn't sell it. The "buyer" receives future dividends and appreciation or depreciation as if he owned the asset, but doesn't buy it. No sale takes place, and a costly taxable event (or conversely, an embarrassing write-down) stays off the books.
(2) CitiGroup invents contracts -- "Enron credit-linked notes" -- that look like CitiGroup debt, but act just like Enron debt ... only they're not Enron debt.
(3) Enron signs contracts that act just like unsecured loans ... the "lender" transfers a billion dollars to Enron, a set period of time elapses, and Enron returns the same sum of money, plus imputed interest ... but they're not loans! On the surface they're forward contracts for natural gas ... even though no gas will ever change hands, and no loan is ever recorded on either party's books of account. ( This case in point is layed out beautifully by NYT's Kurt Eichenwald, syndicated here. )
(4) Businesses enter into sale-and-leaseback arrangements to transfer assets to foreign parties and back again, in "virtual transactions" that generate streams of favorable tax consequences, thought no physical transfers occur and the counterparties have no economic interest in the assets (or in each other).

We've kicked over the Global Crossing swaps in previous articles, of course, but we haven't heard the last of them.

Similar transactions -- though not derivatives -- let US corporations redefine themselves "offshore", and tax liabilities disappear into the Bermuda Triangle ... even though all the facilities, operations, people and paperclips stay right here where they were all along. (See Josh Marshall's recap of David Cay Johnston's NYT roundup.)

These examples are among the more straightforward structures, and at least some of them are transparent sham transactions. Sheer genius ... sheer madness ... and the end of financial reporting reducible to categorical confinement of proprietary value?
"Go ahead, puny Earthlings, outlaw whatever you want! Perfectly equivalent devices can be engineered to any required degree of disguise. We Masters of the 11th Dimension laugh at your laughable 3-D pigeonholes. BWAHAHAHAHAHAHA!"
And we could outlaw them. Maybe we would, too, if they didn't have so many legitimate practical uses. Bummer.

[Originally posted in The Fray, 2002-02-26 8:58 AM]


The scheme of lending and borrowing disguised as gas trades, cited in the "Flatland" item, is apparently linked to a larger pattern and practice of trades by JP Morgan Chase, now under scrutiny by the Federal Reserve Bank of NY. The model may date back as far as 1987. Related stories by WSJ on MSNBC, among others.

Hartford Courant and others report a similar loan disguised as a contactual swap, by which Connecticut's quasi-public Resources Recovery Authority is left holding a $220M bag of motheaten Enron paper, and contemplates a 31% increase in trash-disposal fees.
[State A.G. Blumenthal alleged] the Enron deal was an illegal, unsecured "$220-millon loan, camouflaged and disguised as an energy transaction."

Blumenthal buttressed his case by saying that before the authority made its deal for Enron to repay the $220 million over 11 years at a rate of 7 percent, it had made a "nearly identical" proposal for a loan in the same amount to Northeast Utilities at 8 percent.

[CRRA President] Wright denied the deal was a loan.

In the 2002-02-27 NYT, Kurt Eichenwald exposes a three-way sham swap. Enron, JP Morgan Chase, and Mahonia (in the Channel Islands, appropriately enough) traded the same derivative contract on natural gas futures on the same day in a circular fashion, to zero net effect. But the opposite flows on each separate leg of the transaction were cash payments on different dates and amounts, effecting a $350M loan at 3.4% interest from Chase to Enron. By this exhibition of extra-dimensional ledger-demain, the net effect on Enron's books was not a $350M loan, but a $350M increment to cash flow!

Things are getting yeastier over at Global Crossing, and some other telecom's, and money center banks, and insurance giants. It's an arms race between disguise and discovery, and -- absent massive restrictions or centralized transparent disclosure and reconciliation -- disguise can always go one better.
"Engage the Cloaking Device!"

--- Welcome to Camp Enron! Blogward and Upward!!! ---

"... a Culture of Minimal Disclosure". We clipped this phrase from the inside continuation headline on a 2001-12-04 WSJ article, an in-depth backgrounder on how Enron ended up on the rocks in its failed Dynergy merger and Chapter 11 bankruptcy. The phrase stuck, and we reprised it a month later when DOJ announced a criminal probe and the story started really hotting up.

Our Camp Enron Reports -- some are excerpted below -- have been accumulating in other forums. We'll collect and extend them here for convenience and continuity. The biggest existing trove can be tapped at QuasiPundit.

[Please bear with us while we import existing material, double-check stale links, and follow up with status checks on some of our early sightings and predictions.]

Enron is a big story, but how big, and what kind? A vocal faction to the right of us insists it's not that big, and it's practically over, and it'll be forgotten by Christmas. A faction to the left of us is gearing up for re-enactment of classic political scandals and scathings and scourgings. We think the first group is absorbed in anxious wishful thinking, and the second group is distracted from weightier possibilities by the unfortunate coincidence of Enron's proximity to Bush43. But that leaves the question pending ... how big?

We think it's really, really big, and more a culture story than a business or political story. A story that'll keynote headlines and history books for decades to come. And ideal branding, really ... a two-syllable, five-letter, easily-pronounced emblem for "what's wrong with this country".
The Fall of the House of Enron is a seminal event, of far greater magnitude than the production of one Blue Dress. A cultural bombshell. A watershed. An end to Business as Usual. The End of an Era. A massive failure of intelligence. A massive failure of epistemology. A tipping point. A Bridge Too Far. A collective epiphany. Losing our religion. Nietzsche's Transvaluation of Values. McLuhan's Reversal of the Overheated Medium. A Hegelian Crisis of Cannibalism. The fall of a dynasty of baseless enthusiasms. A Bonfire of Inanities. A compound fracture of the Pillars of Community, where jagged scissile bones of Unjust Enrichment protrude sickeningly through the riven flesh of Shattered Trust. A Hoberman Scandal. Could it even be a Paradigm Shift?
So what is wrong with this country? And what's to be done about it? That's TBD, as we noted here:
On the way to learning how Andersen failed us and why Everybody did it, a web of assumptions will be examined ... beliefs so pervasive our culture has no names for their alternatives, since we never imagined there might be (or must be) alternatives. Where this journey will take us is beyond the capacity of anyone to anticipate -- even yours truly.
Cultures on the make go through cycles of idealistic hubris, systemic corruption, re-examination and reform. Whether it's the echelons of irreconcilable privilege in ancient Rome, or provincial bureaucrats in Imperial China, or commissars in Soviet Russia, somebody figures out how to game the system 'til it breaks, and it breaks, and then something else happens.

As we capsuled it elsewhere, "How will republican democracy and market-based capitalism escape being eaten alive by their own demon spawn?"

Sometimes "reform" is abrupt and bloody. Sometimes "reform" means centuries of relative disorganization and creeping experimentation far from the mainstream. US tradition favors rapid eras of corruption and reform, with limited bloodshed (except for that Abolitionist phase). No guarantees, but we look to Enron as
an early skirmish -- and a decided upset -- in the battle between what was supposed to come next, and whatever will come next. The early favorite, anarcho-capitalism, blows out a knee in the preliminary heats. Samizdata may have it nailed in their mission statement: "Developing the libertarian meta-context" (and, artfully avoiding any possible confusion) "... for the future". That's exactly what's at work here: creative destruction of the prevailing meta-context ... "for the future".
The questions won't be easy ones, and the answers will lead to more questions. For instance:
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?
This will lead us, among other rambles, to discover how the market for securities analysis experienced a severe case of market failure. And what we find there may lead us to deeper and more disturbing discoveries.
So here we find ourselves, a ragged band of Capitalist tools -- Jenkins, Krugman, Tony, Will (Vehrs), Will (George), RonK, and more -- puzzling over the bones of a fallen giant, trying to discern what it portends for the rest of us ... saying things out loud to see if they sound right, haphazardly agreeing and disagreeing, not yet divided into factions, striking this or that pose of confidence or concern, fishing for the keys by which we can attach meaning to this event without tearing up too much of the chain of meanings we learned and used in the world before Enron.

Our faith enjoins us to place Capital in the hands of those most capable and inclined to use it best, to create more Capital. Something has gone amiss, something we can't comfortably dismiss as an isolated instance, something we can't readily trace to a single defective component. This may take a while.

We're dug in here to track the story in depth as it roots in and branches out. If Enron is forgotten by Christmas, of course, we'll look like idiots ... wouldn't be the first time ... but mercifully, you'll have forgotten that, too.
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.

Enron wouldn't be a big story if we weren't already knee deep in systemic distortions ... but we are. The reward systems have been jimmied, the stage is set for an epoch of unravelings and rewindings. The Enron case(s) may be eclipsed by Global Crossing, and that may be superseded by JP Morgan Chase or CSFB, and that in turn by something else. But by virtue of first mover advantage, pop identifiability and transmissional efficiency, the meme will forever be identified as "Enron".

So "look for the Enron label" ... and stay tuned.