The Parallel, Enron and The current Financial Crisis.

I was watching 60 minutes the other evening which aired an episode about the rise and fall of oil prices and why they managed to go up and down in the erratic way that they did. Derivatives, the dirty word of our time came up again and again as the explanation for the apparent disconnect between energy prices and the supply and demand of energy.
The demand and supply for energy derivatives drove the price for energy up and down NOT the demand and supply for energy itself.

What was even more interesting and something I had forgotten about was that Enron was the “inventor” of these energy derivatives and had lobbied for the deregulation of the energy markets. This prompted me to revisit the Enron Story that I had read years ago and which is popularly referred to as “The smartest guys in the room”.



And this is where I noticed the parallel between the current financial crisis and the collapse of Enron. The familiar statement “fool me once shame on you, fool me twice shame on me” applies perfectly here.

What struck me most was the sharp contrast between the action taken against the Enron chief executives and those taken against the executives of the current perpetrators even though many of the events show an uncanny parallel. Not to speak about the negligence of our current pompous congressional pontificators who were all there at that time indignantly questioning the Enron executives but never recognized the identical symptoms that caused the current malaise.

Yet to state that what the banking executives did to cause the demise of an entire nation was not far different from what the Enron executives did is an understatement.

Enron misled their stock holders about the company’s performance, so did the banks. They wiped out their shareholders equity and their employees 401k’s, so did the banks.

Enron used special purpose vehicles to hide losses, so did the banks. For example the Merrill Lynch transaction referred to as the “Lone Star Transaction” where Merrill sold a CDO at inflated prices to a special purpose vehicle which they financed with a loan from themselves. Most CDO’s were issued through special purpose vehicles taking the debt of the books of the banks. Most derivatives (CDO’s) on the banks books were artificially inflated, so were Enron’s



Enron’s Auditors Arthur Andersen and the Lawyers signed off on many of these Enron transactions, so did the auditors of the Banks. Worse, the rating agencies which the investment community relies on for valuing and rating debt were hand in glove with the banks and issued “flawed” ratings.

Enron artificially inflated energy prices through manipulation of the energy markets, so did the commodity exchanges and Warburg. How else can one explain a swing in energy prices of over 300% within three months?

The Enron executives “raped” the company thru bonuses and stock options, so did the banks. The banks with their collective reckless behavior put the lively hood of the entire planet at risk, Enron did not.

There is something really fishy in all this. What the Enron Executives did was considered to be criminal and they were sent to prison for extended periods of time. Why not the banking folks who have endangered an entire global economy with their unethical and reckless behavior?

It appears to me that there is a secret brotherhood that is protecting the “Wall Street” financial community. All the exact same things that Enron pioneered were replicated and imitated by Wall Street without impunity. The Special purpose vehicles pioneered by Enron’s CFO Andrew Fastow were subsequently used to issue CDO’s to take debt of the banks books and or distort valuations of existing assets, just like Enron did. It was a crime then, why not now?

Observing a Wall Street firm like Warburg taking over Enron trading, Enron’s most successful and profitable entity, within days of the Enron bankruptcy at a rock bottom price, reinforces the notion that there was a conspiracy in Wall Street to bring down a bunch of arrogant Texans that were beginning to threaten Wall Street’s monopoly. Especially considering that no one on Wall Street (Warburg) was prosecuted for not honoring Energy futures trade contracts with Enron Trading. Defaulting on these contracts is illegal in the futures markets and accelerated Enron’s insolvency and subsequent bankruptcy.

Why are there no congressional hearings on the scale of Enron for all those “crooked” bank executives that artificially inflated the world’s standard of living and threatened it with a bogus energy crisis? Are the people who are supposed to protect us from all these criminals afraid that we will see them for what they are? A criminally negligent bunch of pedantic pontificators.

There must be some mysterious invisible hand protecting Wall Street that we do not understand.

Given the uncanny parallel of events then and now, either the Executives of Wall Street should be prosecuted, punished and jailed, or the jail sentences of Skilling, Fastow et al should be greatly reduced. What was criminal then should be criminal now.

THE PEOPLES' BANK

Why are the “brains” of this world constantly redefining the problem? We know what the problem is, why don’t we come up with concrete proposals.

The problem is the banks, which were given in excess of $100 billion in Taxpayers money but are still not willing or able to help. $100 billion in Cash assets theoretically creates $1 trillion in credit, assuming a 10 to 1 leverage ratio; they were leveraged at 30 to 1!

Why are they not lending? Are their assets worth less than we thought and the money given them not sufficient to balance their books? Are they using that money to de-leverage? Or are they spending it on the wrong things? They are still paying out dividends and handing out bonuses!

On the other hand they are collecting up to 22% interest on credit card debt and over 7% on mortgages when the cost of money is less than 1%!

Whatever the problem, these traditional and apparently “failed” banks are not functioning and perhaps require a little encouragement by providing them with some competition.

The government should form 10 or more state banks with $100 billion or more of taxpayer’s money and make the Taxpayer stockholders of these banks, not the government, by issuing stock certificates in these new banks to each taxpayer.

The $100 billion or more would create credit facilities of roughly $1 trillion or more at a leverage ratio of 10 to 1 and would immediately unfreeze the credit markets.

These banks could lend to the auto industry amongst other things and take that monkey of the government’s back.

The taxpayer should receive a stock certificate in each of these banks. The banks would be run by reputable individuals including retirees; this would create employment.

The banks survival would be guaranteed by the government for a determined amount of time, say three years.

After a certain amount of time, say five years, these banks would be returned to the market through an IPO and capitalism would be restored and the taxpayers holding the stock certificates would get their money back and most probably make a decent profit.

This proposal has the following advantages and does the following things;

1)- Create new and competitive financial institutions that are not too big to fail and continue the mantra of creative destruction.
2)- Immediately unfreeze the credit markets and provide $1 Trillion or more in credit facilities and perhaps help the American automakers.
3)- Provide banking jobs to thousands of people.
4)- Maintain the capitalist system by providing the taxpayers with stock certificates and thus create oversight by taxpayers and not government.
5)- Ensure a return to the taxpayer by spinning these banks back to the open market through an IPO.

I realize this proposal is controversial and out of the box, but I firmly believe it is feasible and would be more effective than the current solutions of pouring good money after bad.

Alternatively Lets start our own PEOPLES' BANK

Thank you for providing this platform and look forward to your comments and or your support.

Bou van kuyk, Dallas, TX

BUY AMERICAN

Why do we keep bashing Detroit based on a number of myths?

Ford and GM are still two of the world’s largest and most successful automakers. They make and sell cars all over the world not just in the USA!

They do make good and reliable cars and have beaten foreign makes in quality and durability.

They do make Hybrids, the Ford Escape has been around before the Toyota Prius and more of the big three are launching new hybrids like the 60 MPG Ford F150.



They do not only make gas guzzlers, I drove a Ford Fiesta in Europe that did 65 miles to the gallon and there are US models like the Focus that are well above the average in miles per gallon.

They do make cars that Americans want. Unfortunately the American market wants large gas guzzlers like the SUV's. Every automaker in the world has been trying to bring successful SUV's to the American Market.

The government is blaming the big three for making cars that the market wants! This is what a capitalistic corporation is supposed to do; sell cars that people want and make a profit doing it!
It is true that the cost per automobile is too high, I am not sure though that the cost comparisons to foreign car makers is not an exercise in comparing apples and oranges.

Social costs of foreign labor are measured differently. Most foreign manufacturers have a government taking care of health care costs and pensions which are paid for by the taxpayer. The big three are all carrying the full burden of these costs (health care and pensions) that in most other countries are carried by the government.

The current problem of the big three is exacerbated by the current financial crisis. Credit is tight, it is hard for them to rollover/renew their credit lines and their ability to raise new capital has been greatly diminished by the precipitous decline in their share price.

The problems of the Detroit three is not a lack good, quality or fuel efficient cars that the people want, it is their burden of taking good care of their current and past employees and the current economic crisis; the government should help them.

Housing caused a Financial Problem, Greed and Stupidity made it a Crisis

There are derivatives and derivatives, most are clever instruments that are extremely efficient in generating leverage and spreading risk. It is in the way in which some of them were used that created the financial crisis.
Credit Default Swaps CDF’s:
Stupidity is issuing Credit Default Swaps insurance without setting aside any reserves.
Greed is accepting fees and payments for them without doing anything to legitimize their existence.
Stupidity is entirely relying on ratings and still not setting aside reserves to cover the risk of defaults.
Greed is allowing parties unrelated to a transaction to place side bets on defaults in order to receive fees and payments.
As a result of not setting aside reserves more CDF’s were issued than the issuers could possibly cover.
The taxpayers are now funding the liabilities of the issuers of these CDF’s (AIG and others) because the insurers were too greedy for fees and too stupid to set aside reserves when they should and could have.

Collateralized Debt Obligations CDO’s:
Stupidity is not balancing a portfolio by combining low risk/low interest CDO’s with high risk/high interest CDO’s.
Greed is having only high risk/high interest CDO’s to maximize returns without regard to the potential exposure of being wiped out.
As a result of this greed and stupidity the banks are holding worthless high risk/high interest CDO’s that have caused them to be greatly over leveraged and unable to lend.
The taxpayers are now funding the Banks that were overexposed to these worthless CDO’s because the banks were too greedy and too stupid to maintain a balanced portfolio of low risk/ low interest CDO’s.
So instead of behaving like rational prudent human beings, the management or guardians of our financial system were driven by greed and stupidity. Instead of treating one of the greatest inventions of our time, derivatives, responsibly and with care to expand credit and the economy, they instead turned them into a lethal weapon that changed a simple financial problem into a global nightmare.


What are Collateralized Debt Obligations, CDO’s ?

The instruments or Derivatives that were used to bundle mortgages issued by banks to homeowners are called Collateralized Debt Obligations (CDO’s).
These CDO’s were resold to other financial institutions to finance additional lending or issue more mortgages.
Each CDO was divided into roughly three slices or coupons. Coupon#1 was the safest guaranteed/low risk and thus carried a relatively low interest rate e.g. 5%, Coupon #2 was not entirely covered, held more risk but carried a higher interest rate e.g. 7% and the Coupon #3 was high risk and thus carried the highest 11% to 13% interest rate.
In case of any default or shortfall, holders of Coupon #1were the first to get paid and any surplus went first to coupon #2 and last to Coupon #3. Therefore, if any trouble or shortfall occurred the first coupon holders to get wiped out were those holding Coupon #3.
One of two things happened Coupons #1 and #2 were easily sold to prudent investors and the banks got stuck with coupon #3 or the banks were so greedy that they held on to coupon #3 because it had the greatest payout even though it carried the highest risk.