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.
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!"