Although it is usually referred to as an energy company, Enron is really more a financial intermediary like a bank or investment bank. It is at the center of a complex web of financial transactions. The experiences of Drexel-Burnham-Lambert in the 1980s and Salomon Brothers in the early 90s in the aftermath of the Treasury manipulation scandal demonstrate that legal problems can set off a death spiral for an intermediary. A big hit to the intermediary's equity makes people less willing to deal with it (for fear that it will not have enough capital to cover its contractual commitments); if enough counterparties back away, equity declines further, leading to more defections, exacerbating the problem further. What's more, as LTCM found to its dismay, when the blood is in the water other firms will trade in anticipation of liquidation of Enron positions (because the decline in equity will require it to reduce its positions), which will put further pressure on the firm's balance sheet. This is especially true because (like LTCM) Enron has alienated a lot of people over the years with its aggressive style; payback is a bitch. Drexel ended up folding. Only Warren Buffet's intervention (and cash) saved Salomon. LTCM cratered. If the SEC investigation of Enron turns real serious, it could end up imploding too.

My reading of the article centered on "transparency". Do you feel there's anything to it? Would regulations requiring more transparency have resulted in less or more problems? Or just more tedious bureaucracy?

There is a fundamental tension regarding transparency. Intermediaries such as Enron (and other trading outfits) are notoriously secretitive, because if they're good, and have better information and better insights, other people will mimic their trades unless they are able to keep them secret. They make markets more efficient by identifying inefficiencies and putting on trades to profit from them; they have no incentive to perform the necessary research and analysis if others can "free ride" off their efforts. That is the bright side of opacity. The dark side is that when things go badly, the lack of information makes them suspect as a counterparty. And as LTCM found out, disclosure when you are in extremis allows others to identify your weak points and trade against you. If you have a huge equity cushion this isn't a big deal--people figure out that you can take a big hit and keep operating. When your equity market value goes down 80 percent, though, people start to have doubts about your ability to take a hit. In the old days, banks in this situation suffered from runs as depositors withdrew their money. Enron could be in this situation if the regulatory heat (and associated heat from shareholder lawsuits that may develop) gets bad enough.

In some respect, financial intermediaries are inherently opaque. They are in the business of producing information, and can't really operate if others can free ride off of the information they produce. Historical experience shows that one consequence of this opacity is that intermediaries are inherently vulnerable to a loss in confidence by investors and counterparties. When this happens, it happens fast and it is very ugly.

Your comments are brief, clear and to the point.

Excellant!

Do you have pamphlets or books written on the new economy since 9-11?

Being less than an economist or a Professor causes me to imagine that the manufactuing system called 'just in time' and all its corollaries are now in question. Without a stable and 'peaceful' world there is no such thing as just in time.

Would the 'system'(just in time) be changed in the following way?

Manufacturing sites will need the Outsourcing companies next to them. Manufacturing sites will produce smaller quantities. There will be more manufacturing sites in the world instead of massive sites that ship all over the world.

Warehousing will grow in this new climate, increasing costs and capital expenditures and raising prices across the board. Normally referred to as inflation.

Is any part of this scenario justified?

Enron Ripe for Takeover, Shell said to be Likely Suitor

October 29, 2001---Once the shining gem of Houston’s energy gulch Enron is locked in a battle for its very survival and the sharks are circling. Reports over the weekend are that the company, burning the midnight oil trying to increase the company’s credit line, was becoming vulnerable to a takeover bid. (10/29/2001)

As the company’s stock ended the week in meltdown, bankers and analysts said that Royal Dutch/Shell was in the running as a likely bidder. The noted that Enron's relatively modest market capitalization--down to $11.5 billion late last week from a high of more than $55 billion--means that Shell and other potential acquirers would have little trouble digesting it whole. Cerris Tavinor, a spokeswoman for Shell, declined to comment. Calls to Enron were not returned.

An M&A banker in London says the Anglo-Dutch oil giant was rumored to have approached Enron unsuccessfully in August. An analyst in New York adds Shell has courted Enron for more than three years. "[Shell]'s downstream power business InterGen has not been as successful as it and its partner Bechtel hoped, especially in the U.S., and this would be a great fit," he continues.

While many energy concerns would love to get their hands on Enron's hugely successful gas and electricity trading business, its forays into water, broadband and pulp and paper, might prove less attractive. Bidders may want to cherry pick the best parts of the business, reasons Peter Fusaro, president of Global Change Associates in New York. Still, he says "there is a distinct possibility that it could be bought outright."

Another obstacle to any sale is believed to be CEO Kenneth Lay's unwillingness to sell the company at such a low stock price. Still, Lay has already given up the executive reins once, and at 61, he would probably be willing to sell if the premium was significantly rich, argues one New York based banker. Another adds that Lay will probably wait for the share price to recover before he would even consider talking to bidders.

Bankers argue that potential bidders would be unwilling to ride roughshod over Lay's wishes through a hostile bid as most of Enron's value is tied up in intellectual capital.

Hostile bidders run the risk that senior staff will jump ship, argues a London banker. Another obstacle to any bid is concern that Enron may have additional skeletons in its financial closet. Last week's stock market sell off was prompted by Enron unexpectedly writing off some $1.2 billion in equity resulting from the termination of contracts with a special purpose vehicle linked to Peter Fastow, CFO. Analysts fear that Enron may have to terminate similar contracts over the next quarters.

Author:EyeforEnergy Newsdesk

Original article

The follow up:

S.E.C. Opens Investigation Into Enron

Enron takes a hit from S&P

If Shipman is correct they should be able to weather the storm.

Outsourcing is a grotesque misapplication of JIT theory.

Default swaps are currently quoted at 17.5 percent--indicating that the market estimates that they have a 17.5 pct chance to default. I'd say that's about right--4 to 1 odds; in contrast, Williams and Dynegy def swaps are trading at 2 pct. Given the size of their positions, an additional $1 bn line of credit doesn't seem all that big to me, especially since they had to post their best pipeline assets as collateral in the event that they have to draw down the line. There is still a lot that could happen. The SEC upgraded the status of its investigation--and turned it over from the Ft. Worth locals to the DC big boys. Who knows what they'll find when they start turning over rocks? In all honesty, I don't think they have the ability to take another big hit. If things turn worse in India, or if they have to take another big writeoff . . . . They have very little margin for error.

Dynegy Says It Is in Talks to Buy Enron

The End Game. How does an informed person view this? In particular what does this mean

"Enron could be forced to issue tens of millions of shares of stock to cover off-balance sheet debts that it has guaranteed"

given that it's stock price is falling precipitously?

I'm sure glad I turned down the job offer I received from Enron last month. Whew!!!! Dodged that bullet.

Lucky Man!

Might be a nice acquisition for Shell; better hang on to those shares.

Rival to Buy Energy Trader After Dizzying Financial Fall

The end.

"The deal is an extraordinary turnabout for Enron, a Houston-based company that had been a driving force behind electricity deregulation nationwide"

What does this mean exactly?

"The pain of the stock's 90 percent plunge this year will not be equally shared. Some Enron employees have held onto their shares and seen their retirement accounts eviscerated. Meanwhile, Mr. Lay, Mr. Skilling and other former and current executives sold hundreds of millions of dollars in Enron stock in 2000 and this year"

Is there anything to this other than the obvious conclusion that the executives made better investment decisions than the employees? Or is the implication of unfair, insider trading to be believed?

Regulators Struggle With a Marketplace Created by Enron

Smaller Rival to Acquire Teetering Enron

1. Things went pretty much like I conjectured a couple of weeks back--once Enron's customers started to back off, the company was in a death spiral and was either going to fold or have to find somebody to bail them out (just like Warren Buffet bailed out Salomon in 91).

2. The statement about Enron's role in deregulation essentially means that the company was one of the most stalwart activists for deregulating wholesale and retail electricity markets. The firm had a vision of scrapping the old vertically integrated utility model (in which a single firm generated the power, transmitted it over "big wires" and then distributed it and sold it to residential and commercial customers) and replacing it with an unintegrated model in which independent generators competed to sell power in wholesale and retail markets. To make this vision work, it is necessary to create some "rules of the road" governing access to the transmission grid. Enron was a leader in advocating the creation of "RTOs"--regional transmission organizations--that would run the grid on a non-discriminatory basis. Enron was extensively involved in lobbying congress, federal regulators (FERC), and state regulators to make this vision a reality.

3. I believe that the movement towards an open grid is on the whole beneficial. Unfortunately, the tenor of the remark that you quoted, and which I have seen echoed elsewhere, suggests that foes of deregulation are going to use Enron's debacle to denigrate the vision the company was promoting. This is the crudest sort of ad hominem (or should it be "ad corporatum"?) "reasoning." Moreover, if anything, Enron failed not because it didn't know about its core business markets--power and gas--but because it ventured beyond those areas in an effort to sustain its rapid growth. Enron's problems had nothing to do with its understanding of energy markets--quite the reverse.

4. The remark regarding the profits of the executives do suggest that Lay, Skilling, et al did profit from insider trading. It is indeed the case that these individuals sold substantial quantities of shares at the same time they were telling the public that the shares were undervalued. I find that there is blame to go around, however--analysts didn't respond to the eventual revelation of these sales with the proper skepticism. If they had, the problems may have been detected sooner when they could have been corrected without putting the company in extremis.

Thought you might find this interesting

Volume 79 Number 219 November 12, 2001

DYNEGY AGREES TO BUY TROUBLED ENRON FOR $7.8-BIL

New York-Troubled energy giant Enron agreed late Nov 9 to be taken over by smaller rival Dynegy in a $7.8-bil stock-swap, with assumption of at least $12-bil of Enron debt.

The deal includes an immediate "asset-backed" infusion of $1.5-bil from Dynegy's 26.6% owner ChevronTexaco, to shore-up Enron's cash-strained trading operations, with another $1-bil of new equity from ChevronTexaco when the merger closes.

Dynegy will offer 0.2685 of its shares for each Enron share, giving Dynegy holders 64% of the combined company. At Dynegy's closing price Nov 9 of $38.76/share, that equates to $10.41/share for Enron, which has seen its stock plummet from more than $90 barely a year ago to a recent low of $7 before rebounding on Dynegy bailout rumors. Enron closed Nov 9 at $8.63/share.

The merged company will be named Dynegy Inc and be headed by Dynegy CEO Chuck Watson. The only Enron executive moving to a senior position will be new president Greg Whalley, who will be an executive vice-president and part of a new "office of the chairman" at Dynegy. Enron will get to name three of 14 directors, which could include CEO Ken Lay. ChevronTexaco will maintain its three director seats.

ChevronTexaco will make its investment in the form of $1.5-bil of Dynegy convertible preferred shares, with warrants to buy another $1.5-bil of Dynegy stock over three years. Dynegy will invest the initial ChevronTexaco cash in Enron in return for preferred stock and "other rights" in Enron's crown-jewel Northern Natural Gas pipeline unit. If the Dynegy-Enron deal fails to close, Dynegy can acquire Northern and ChevronTexaco can redeem its preferred at cost or convert it to common for 36% ownership of Dynegy.

Dynegy said the deal should be "strongly accretive" to earnings in the first year. Merger savings are expected to be $400- to $500-mil a year, from exiting "non-core" businesses, eliminating overlap and lower interest costs. The deal, which will need shareholder and regulatory approval, is not likely to be consummated until the third quarter of next year. But it is by no means a sure thing.

Vocal opponents are already emerging to the possible enlargement of Enron's huge trading operations. Among them: crusty Raymond Plank, CEO of US E&P independent Apache. Plank blames electronic over-the-counter systems such as those run by Enron and Dynegy for much of the volatility that has whipsawed natural gas and power markets over the past year.

Plank says this volatility is wreaking havoc on producers' capital spending plans and the creditworthiness of small upstream companies. Not to mention the disaster that hit California, PG&E and SoCalEd.

Plank extends his opprobrium to the New York Mercantile Exchange, which he views as another venue for moving prices up and down to generate volatility.

Of course, volatility is not senseless to public trading companies using mark-to-market accounting. Under US GAAP, traders run through their income statements the theoretical mark-to-market profits being made on even far-out futures and derivatives positions. And under standard option pricing models, volatility is the key variable in calculating their present value.

With enough volatility, and a long enough contract, any trader can persuade his accountants even the most far-fetched option position can have current mark-to-market value. The only test is the "reasonableness" of the assumed forward price curve, which Enron can tweek daily with its postings on EnronOnline. Both Enron and Dynegy employ Arthur Andersen as auditors and consultants.

Indeed, Enron, Dynegy, El Paso, Duke, Aquila, Williams and any number of other trading houses make no bones about their affinity for volatility. On its last earnings conference call (the one that sparked Wall Street rage over CEO Ken Lay's disclosure of a looming $1.2-bil accounting nightmare), Enron whined its European earnings were a little light due to "not as much volatility as we'd have liked" in power markets there.

"They acknowledge the don't make money off price (differentials)," gripes Plank: "They make their money off volatility."

Helping drive volatility on these electronic exchanges is the ability to move prices with very small trades, since only Enron or Dynegy see the volumes involved on their EnronOnline and Dynegy Direct systems. As some traders have pointed out to Platts, this can allow a market manipulator to gradually start an upward price stampede that can snowball into a short squeeze, spilling over onto the NYMEX futures and cash markets.

Such may have been the case with last winter's irrational run-up in gas prices to some $10/Mcf. Did Enron cause it? Probably not. Would it have been able to see it developing and position itself accordingly? Without question.

An added beauty of these electronic systems is the trading goes on with little or no margin deposits by the players. Even with its recent credit-ratings collapse, Enron has been able to make counter-parties rely on its own balance sheet as collateral for trades. And customers who qualify for EnronOnline can simply play off their own net worth without tying up much cash.

Compare that to the roughly 10% margin required by NYMEX. Or better yet, the 50% margin required on stock trading.

One quick but painful fix for the volatility problem, Plank notes, would be to make futures and options players abide by the same leverage rules stock traders have faced since 1929. If Enron and Dynegy had to post 50% margin, Plank quips, "They'd go home to their wives at night." In other words, they'd return to their historic pipeline business and quit spending so much time in the options pits.

Enron is not keen for that, and has spent a lot of time and money lobbying to avoid such regulation. It may have been the company's best investment ever: legislation last year exempts electronic trading systems from oversight by the Commodity Futures Trading Commission, notes energy consultant Philip Verleger. Among the key backers of that law was Sen. Phil Gramm, Republican-Texas, whose wife and former CFTC commissioner Wendy Gramm is an Enron director.

It all sounds chillingly similar to what happened to the unregulated "junk" bond market and its principal architect, Drexel Burnham Lambert's Michael Milken. Drexel disappeared in a cloud of government investigations. Milken went to prison.-James Norman

Thanks to all for this discussion. I am not well enough informed to join in, but please know you are helping alot of ordinary folks to understand this issue. You folks obviously are NOT ORDINARY!