History is repeating itself as companies hide debt, blame the market for their failings and expect the taxpayer to pony up
- The Guardian,
- Saturday October 4 2008
Bad experiences are supposed to be good, in a twisted sort of way. That's because we're supposed to learn things that help us avoid the same mistakes the next time around. But it's hard to argue now that anything good came out of the bad experience called Enron. In fact, one thing that is crystal clear amid all the chaos of these days is that the lessons from Enron went unlearned - or were just forgotten.
Start with the Houston-based energy trader's notorious lack of transparency. After Enron's implosion, everyone talked about how important it was to be able to understand how a company makes money. Now raise your hand if you understand how a modern financial services firm makes money. No hands? The truth is, there is no way to understand. These companies are as opaque as Enron. Just as Enron had off balance-sheet vehicles - SIVs - that allowed it to book earnings and hide debt, Citigroup and other financial institutions had structured investment vehicles that did the same. Indeed, Citigroup had to take almost $50bn of SIVs back on to its balance sheet after they ran into trouble. It would be nice if the accounting rule-makers would grasp this basic tenet: if they want to hide it, we want to know about it.
Of course, SIVs are only a small manifestation of the deeper problem, which is the evolution of financial engineering into a dark art. Enron now seems like the canary in the coal mine. After its bankruptcy, Steve Cooper, who was in charge of restructuring it, told the Wall Street Journal his task might leave him "in a wheelchair and drooling" due to the complexity of its financial structures and the "unbelievable amount of debt accumulated around the company". Doesn't that sound like our entire financial system?
Just as Enron packaged bad investments into a private equity fund run by its chief financial officer, Wall Street packaged mortgages given to people who couldn't afford the payments into sleek new instruments called RMBS and CDOs. But Enron's machinations couldn't make the losses go away, and Wall Street's shiny acronyms can't turn a defaulted mortgage into good money.
As for the lessons we've forgotten, how about this one: financial statements aren't supposed to be fairytales. Enron was castigated for its abuse of mark-to-market, or fair value, accounting. This is supposed to allow investors to see what the market says a security is worth, instead of just what the company paid for it. Employed correctly, it makes a company's finances more transparent. But we all joked that Enron didn't mark to market - it marked to myth, to whatever it wanted them to be. In this, the US regulatory agency, the SEC, was complicit, because it signed off on Enron's use of this accounting and never ensured it wasn't abusing the rules.
Today's mark-to-market saga has a new twist. The SEC is facing political pressure to abolish mark-to-market accounting requirements for financial institutions, and some in Congress would like to dig mark-to-market's grave. Said in another way, now financial services firms may be allowed to deceive investors about their status, with the regulators blessing that deceit. (An aside here. Those who say mark-to-market should be abolished argue that because there is no market, firms are being forced to value these securities at artificially low levels. But there is no market precisely because firms aren't willing to sell at a price at which a reasonable investor would buy.)
While for a short period in the aftermath of Enron, we did understand that short-sellers serve a good purpose, we have also forgotten that. Short-sellers were the first to warn there were problems at Enron. But today, nobody is thanking short-sellers like David Einhorn, a hedge fund manager who began to warn investors about Lehman's problems in March, when the stock was worth about $50. Instead, companies say the short-sellers are to blame for their problems. And the SEC has gone along with this and banned short-selling in a number of stocks. Poor Washington Mutual and Wachovia, which plummeted after the ban on short-selling. How will they explain what happened to them now they can't blame short-sellers?
Which leads to the most sobering repeat lesson of all. Most of the believers in the free market only believe in it when it is going their way. When it doesn't, it's someone else's fault. Enron's former leaders often cited their free-market beliefs. Its demise, they said, was due to a short-sellers' conspiracy.
Indeed, when all was booming, Wall Streeters said they deserved their pay because the market said they were worth it. But now things are falling apart, they say the market doesn't work, and we need to stop short-selling, and taxpayers need to pony up. If there is a tiny bit of good in all this, it's that Wall Street, although it was complicit in the Enron mess, managed to walk away relatively unscathed. This time, Wall Street has brought itself down. Then again, maybe it really isn't a good sign for the future that there don't seem to be any smart guys anywhere in the room.
• Bethany McLean is a contributing editor at Vanity Fair and co-author of The Smartest Guys in the Room bethany.mclean@gmail.com
Start with the Houston-based energy trader's notorious lack of transparency. After Enron's implosion, everyone talked about how important it was to be able to understand how a company makes money. Now raise your hand if you understand how a modern financial services firm makes money. No hands? The truth is, there is no way to understand. These companies are as opaque as Enron. Just as Enron had off balance-sheet vehicles - SIVs - that allowed it to book earnings and hide debt, Citigroup and other financial institutions had structured investment vehicles that did the same. Indeed, Citigroup had to take almost $50bn of SIVs back on to its balance sheet after they ran into trouble. It would be nice if the accounting rule-makers would grasp this basic tenet: if they want to hide it, we want to know about it.
Of course, SIVs are only a small manifestation of the deeper problem, which is the evolution of financial engineering into a dark art. Enron now seems like the canary in the coal mine. After its bankruptcy, Steve Cooper, who was in charge of restructuring it, told the Wall Street Journal his task might leave him "in a wheelchair and drooling" due to the complexity of its financial structures and the "unbelievable amount of debt accumulated around the company". Doesn't that sound like our entire financial system?
Just as Enron packaged bad investments into a private equity fund run by its chief financial officer, Wall Street packaged mortgages given to people who couldn't afford the payments into sleek new instruments called RMBS and CDOs. But Enron's machinations couldn't make the losses go away, and Wall Street's shiny acronyms can't turn a defaulted mortgage into good money.
As for the lessons we've forgotten, how about this one: financial statements aren't supposed to be fairytales. Enron was castigated for its abuse of mark-to-market, or fair value, accounting. This is supposed to allow investors to see what the market says a security is worth, instead of just what the company paid for it. Employed correctly, it makes a company's finances more transparent. But we all joked that Enron didn't mark to market - it marked to myth, to whatever it wanted them to be. In this, the US regulatory agency, the SEC, was complicit, because it signed off on Enron's use of this accounting and never ensured it wasn't abusing the rules.
Today's mark-to-market saga has a new twist. The SEC is facing political pressure to abolish mark-to-market accounting requirements for financial institutions, and some in Congress would like to dig mark-to-market's grave. Said in another way, now financial services firms may be allowed to deceive investors about their status, with the regulators blessing that deceit. (An aside here. Those who say mark-to-market should be abolished argue that because there is no market, firms are being forced to value these securities at artificially low levels. But there is no market precisely because firms aren't willing to sell at a price at which a reasonable investor would buy.)
While for a short period in the aftermath of Enron, we did understand that short-sellers serve a good purpose, we have also forgotten that. Short-sellers were the first to warn there were problems at Enron. But today, nobody is thanking short-sellers like David Einhorn, a hedge fund manager who began to warn investors about Lehman's problems in March, when the stock was worth about $50. Instead, companies say the short-sellers are to blame for their problems. And the SEC has gone along with this and banned short-selling in a number of stocks. Poor Washington Mutual and Wachovia, which plummeted after the ban on short-selling. How will they explain what happened to them now they can't blame short-sellers?
Which leads to the most sobering repeat lesson of all. Most of the believers in the free market only believe in it when it is going their way. When it doesn't, it's someone else's fault. Enron's former leaders often cited their free-market beliefs. Its demise, they said, was due to a short-sellers' conspiracy.
Indeed, when all was booming, Wall Streeters said they deserved their pay because the market said they were worth it. But now things are falling apart, they say the market doesn't work, and we need to stop short-selling, and taxpayers need to pony up. If there is a tiny bit of good in all this, it's that Wall Street, although it was complicit in the Enron mess, managed to walk away relatively unscathed. This time, Wall Street has brought itself down. Then again, maybe it really isn't a good sign for the future that there don't seem to be any smart guys anywhere in the room.
• Bethany McLean is a contributing editor at Vanity Fair and co-author of The Smartest Guys in the Room bethany.mclean@gmail.com
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