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Enron's alchemy turns to lead for bankers

Enron for Dummies
New York Times, January 26, 2002

Enron is a new-economy company, a thinking-outside-the-box, paradigm-shifting, market-making company.
In fact, it ranked as the most innovative company in America four years in a row, as judged by envious corporate peers in the annual Fortune magazine poll.
It is also, at this point in time, a bankrupt company.

Eliternas sammansvärjning
(Percy Barnevik, Jacob Wallenberg, Carl Bildt m fl)
Anders Isaksson DI 2002-02-22


Financial Times Enron page: - Wall Street Journal Enron page

CNN about Enron -Time about Enron


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Infectious greed
FT, editorial. July 20 2002 5:00

For a man notorious for studied ambiguity, Alan Greenspan, chairman of the Federal Reserve, has a talent for the telling phrase. In 1996, he captured an era in two words: "irrational exuberance". This week came "infectious greed".

The root of the corporate governance breakdown in the US and, to a lesser extent, elsewhere was, in Mr Greenspan's words to Congress, "the rapid enlargement of stock market capitalisations in the latter part of the 1990s". This was not because people were greedier than at other times but because, in his words, there was "an outsized increase in opportunities for avarice".

Between the beginning of 1995 and its peak less than six years later, the capitalisation of the US stock market rose by $12,000bn. The irresistible force of huge opportunity met the movable object of shareholder vigilance. Only now, with the plunge in the markets, are the results being painfully revealed.

As the Fed chairman also said: "Lawyers, internal and external auditors, corporate boards, Wall Street security analysts, rating agencies and large institutional holders of stock all failed for one reason or another to detect and blow the whistle on those who breached the level of trust essential to well functioning markets."

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Testimony of Chairman Alan Greenspan
Federal Reserve Board's semiannual monetary policy report to the Congress Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate July 16, 2002
Lawyers, internal and external auditors, corporate boards, Wall Street security analysts, rating agencies, and large institutional holders of stock all failed for one reason or another to detect and blow the whistle on those who breached the level of trust essential to well-functioning markets.

In recent years, shareholders and potential investors would have been protected from widespread misinformation if any one of the many bulwarks safeguarding appropriate corporate evaluation had held. In too many cases, none did. Lawyers, internal and external auditors, corporate boards, Wall Street security analysts, rating agencies, and large institutional holders of stock all failed for one reason or another to detect and blow the whistle on those who breached the level of trust essential to well-functioning markets.

Why did corporate governance checks and balances that served us reasonably well in the past break down? At root was the rapid enlargement of stock market capitalizations in the latter part of the 1990s that arguably engendered an outsized increase in opportunities for avarice. An infectious greed seemed to grip much of our business community. Our historical guardians of financial information were overwhelmed. Too many corporate executives sought ways to "harvest" some of those stock market gains. As a result, the highly desirable spread of shareholding and options among business managers perversely created incentives to artificially inflate reported earnings in order to keep stock prices high and rising.

This outcome suggests that the options were poorly structured, and, consequently, they failed to properly align the long-term interests of shareholders and managers, the paradigm so essential for effective corporate governance. The incentives they created overcame the good judgment of too many corporate managers. It is not that humans have become any more greedy than in generations past. It is that the avenues to express greed had grown so enormously.

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Accounting concerns focus on GE
BBC 30 June, 2002

The industrial and financial giant General Electric is the latest big US corporation to be hit by worries about accounting practices. The company, nursed to near-legendary status by former chief executive Jack Welch, reportedly made $2.1bn (£1.4bn) in profits from its pension fund in 2000 and 1999 - despite the fact that the fund has been losing money thanks to sliding stock markets.

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Enronhärvan växer
DN 2002-04-08

På måndagen utvidgades en tidigare stämning så att en rad stora banker och Wall Street-firmor nu anklagas för att ha deltagit i en sammansvärjning för att bedra investerare och fordringsägare.
En rad guldkantade namn utpekas som medbrottslingar. På listan återfinns JP Morgan Chase, Citigroup, Merrill Lynch, Lehman Brothers, Bank of America samt tyska Deutsche Bank och brittiska Barclays Bank.
Dessutom inkluderas de två stora advokatbyråerna Vinson & Elkins och Kirlkand & Ellis plus ett antal höga chefer på den nu sönderfallande revisionsbyrån Arthur Andersen, inklusive dess avgångne vd Joseph Berardino. ........ mer


Look and learn from Enron
John Kay , Financial Times, Apr 08 2002

Readers of this column will know that good lists contain seven items. Here are seven lessons from Enron:

Market value isn't a measure of the size of a company It has been said that an unprecedented proportion of the world's largest companies are newcomers. It's true, if you measure size by market capitalisation. On this basis, Enron became number seven in the world, and Cisco, briefly, number one................... more


A manager's real responsibility
Martin Wolf
Financial Times Jan 30 2002


PAUL KRUGMAN
How many more Enrons are out there?


The Real Enron Scandal
by the Editors of
The New Republic

The scandal is that conservatives in Washington systematically rejected a series of safeguards that would have alleviated the damage from Enron's collapse, or even prevented it altogether.

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The day of reckoning
Financial Times, editorial comment, January 21 2002

It is difficult to overstate the damage done to the profession by the bankruptcy of Enron. The energy company's peak stock market valuation of $66bn, in September 2000, was partly based on inflated profits and a balance sheet that excluded crucial liabilities. Andersen, one of the "Big Five" firms, not only gave the auditors' stamp of approval to misleading accounts, but also scurried to shred evidence.

Andersen has fatally undermined the argument that the profession is bound to maintain high standards because it cannot afford to compromise its reputation. Based on this theory of enlightened self-interest, accountancy firms have enjoyed the freedom to sell more and more services to their audit clients, while continuing - in the US - to regulate themselves. Andersen is not the first to let down the users of accounts, notably shareholders. But the size of this collapse, its location in the sophisticated US market and the paucity of excuses make this scandal a turning point.

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Andersen recovers missing Enron files
The Times, 2002-01-19

A System Corrupted
By PAUL KRUGMAN

Especially Republicans
By George F. Will
Washington Post, January 15, 2002

The androids’ nightmare
The Economist
Jan 18th 2002

Enron's Sins
Wall Street Journal editorial 2002-01-18

Enron and the role of the banks
Financial Times editorial, January 16 2002


Andersen recovers missing Enron files
The Times, 2002-01-19

ANDERSEN, the accountancy firm caught in the Enron scandal, has recovered thousands of electronic files relating to the Enron audit.

The recovery of back-up files - including e-mails and duplicates of paper documents that were shredded - will help the investigation into the collapse of the Houston-based energy trading group. Andersen admitted on January 10 that individuals in the firm had disposed of a "significant but undetermined" number of electronic and paper documents relating to Enron.

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Enron and the role of the banks
Financial Times editorial, January 16 2002

The more that is learnt about the collapse of Enron, the wider the ramifications become. Failures in the audit process and the vulnerability of many employees' pensions have now been joined by concerns over the actions of the banks. The Enron debacle has highlighted fundamental weaknesses in the US system of financial regulation, which has failed to keep pace with changes in the industry.

The latest concern centres on the role of JP Morgan Chase, one of Enron's two main bankers. It was involved in an offshore company used by the energy trader to move risk off its balance sheet. The disclosure of the existence of such off-balance-sheet arrangements accelerated the downward

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The description of the Fed as the "lender of last resort" is accurate without being informative.
Lender to whom? For what purposes? Last resort before what?
Did the bank "lend" $29 billion to Bear Stearns, or did it, in effect, buy some of the most problematic securities owned by Bear?
George F. Will New York Post 21/4 2008

The Fed has no mandate to be the dealmaker for Wall Street socialism. The Fed's mission is to preserve the currency as a store of value by preventing inflation. Its duty is not to avoid a recession at all costs; the way to get a big recession is to engage in frenzied improvisations because a small recession (aka, a correction) is deemed intolerable. The Fed should not try to produce this or that rate of economic growth or unemployment.

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Bank of England tar krafttag för att rädda den brittiska ekonomin. Den brittiska riksbanken pumpade på måndagen in motsvarande 600 miljarder kronor i banksystemet
- en summa som kan dubblas om försöket att avvärja en kollaps på bostadsmarknaden misslyckas.
Dagens Nyheter Ekonomi

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Moral Hazard

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Especially Republicans
By George F. Will
Washington Post, January 15, 2002

Enron will remind everyone -- some conservatives, painfully -- that a mature capitalist economy is a government project. A properly functioning free market system does not spring spontaneously from society's soil as dandelions spring from suburban lawns. Rather, it is a complex creation of laws and mores that guarantee, among much else, transparency, meaning a sufficient stream -- torrent, really -- of reliable information about the condition and conduct of corporations.

Off and on over the years, a few capitalists have done more to delegitimize capitalism than America's impotent socialist critics ever did or today's moribund left could hope to. It is the Republicans' special responsibility to punish such capitalists.

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A System Corrupted
By PAUL KRUGMAN

New Yorkt Times January 18, 2002

The Enron debacle is not just the story of a company that failed; it is the story of a system that failed. And the system didn't fail through carelessness or laziness; it was corrupted.

We usually take the viability of the modern corporation, in which professional managers look after the interests of shareholders, for granted. But as economists since Adam Smith have warned, a separation between ownership and management opens the possibility of insider abuse. Indeed, Smith thought that such a separation was a bad idea, except in a handful of businesses.

But you can't run a modern economy with family-owned companies and partnerships. So capitalism as we know it depends on a set of institutions — many of them provided by the government — that limit the potential for insider abuse. These institutions include modern accounting rules, independent auditors, securities and financial market regulation, and prohibitions against insider trading.

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The androids’ nightmare
The Economist
Jan 18th 2002

The aftershocks from the collapse of Enron, a Texan energy-trading firm, in history’s biggest corporate bankruptcy, may yet destroy the firm’s auditors, Andersen, reducing the Big Five of global accountancy to the Big Four. The survivors might find themselves facing a harsher regulatory climate. About time too.

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Enron's Sins
Wall Street Journal editorial 2002-01-18

A reformed German Communist named Willi Schlamm once said that the "problem with capitalism is capitalists; the problem with socialism is socialism." We've been thinking about that distinction as we try to make sense of Enron's self-immolation.

The price for Enron's financial shenanigans won't be paid only by its shareholders, auditors and creditors. Politicians will seize on its sins as another excuse to meddle in financial markets, which is all the more reason for market believers to be ruthless in cleaning out our own closets.

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A manager's real responsibility
Martin Wolf
Financial Times Jan 30 2002

Businesses fail. As Joseph Schumpeter, the great Austrian economist, pointed out almost a century ago, such "creative destruction" lies at the heart of the market economy's dynamism. Coming at the end of an era of rapid growth, swift technological change and widespread euphoria, a big corporate failure, such as Enron's, cannot be that surprising. There could be many more. Yet the Enron case also sheds intriguing light on conflicts of interest inherent in corporate capitalism.

The private corporation is the most remarkable institutional innovation of the past two centuries. Today's economy would be unimaginable without its dynamism and flexibility. But the corporation is a hybrid institution, both hierarchical and embedded in markets. Before the modern corporation, commerce was largely for individual merchants, while big hierarchical institutions, both civil and military, were the province of rulers.

Alfred Chandler of Harvard University argued in his classic book, The Visible Hand, Harvard University Press 1977 that the modern multi-unit business enterprise emerged in the 1840s. This was the point at which technological advance combined with an enlarging economy "to make administrative co-ordination more productive and, therefore, more profitable than market co-ordination".

Inserting complex hierarchies into the market required the merging of two distinct forms of social organisation and value systems. The merchant is individualistic. The administrator is a follower of orders. Management theory's absurdities derive in part from the uncomfortable fusion of these conflicting patterns of behaviour.

The corporation is decidedly not above the market. Believing that was a mistake made by many observers in the middle decades of the past century. Changes in market conditions, including technology, will alter the boundaries of the corporation, with painful results for those used to things as they were.

Corporations exist because hierarchical relationships can be more efficient than market transactions. Where this is so, the terms of the contracts cannot be fully specified. In an administrative hierarchy, the bargain is between the obedience of the subordinate and the sense of responsibility of the superior. The same bargain lies at the heart of a corporation. It rests on the capacity to form relationships of trust. Only in societies where this is possible do large institutions, including corporations, work well.

The corporation is a wonderful institution. But it contains inherent drawbacks, at the core of which are conflicts of interest. Control over the company's resources is vested in the hands of top managers who may rationally pursue their interests at the expense of all others. Economists call this the "principal-agent" problem. In the modern economy, where shares are held by fund managers, there is not just one set of principal-agent relations but a long chain of them.

The principal-agent problem is exacerbated by two others: asymmetric information and obstacles to collective action. Corporate managers know more about what is going on in the business than anybody else and have an interest in keeping at least some of this information to themselves. Equally, dispersed shareholders have a weak incentive to act, because they would share the gains with others but bear much of the cost themselves.

The upshot is the chronic vulnerability of the corporation to managerial incompetence, self-seeking, deceit or downright malfeasance. In practice, there are five (interconnected) ways of reducing these risks.

The first is market discipline, since failure will ultimately find managers out. The second is internal checks, with independent directors or requirements for voting by institutional shareholders. The third is regulation covering the composition of boards, structure of businesses and reporting requirements. The fourth is transparency, including accounting standards and independent audits. The last is simply values of honest dealing.

Economists are very uncomfortable with the notion of morality. Yet it seems to have rather a clear meaning in the business context. It consists of acting honestly even when the opposite may be to one's advantage. Such morality is essential for all trustee relationships. Without it, costs of supervision and control become exorbitant. At the limit, a range of transactions and long-term relationships becomes impossible and society remains impoverished.

Corporate managers are trustees. So are fund managers. The more they view themselves (and are viewed) as such, the less they are likely to exploit opportunities created by the conflicts of interest within the business.

What has all this to do with Enron? The answer is that the checks failed. The conflicts of interest of those responsible for transparency (the auditors) were huge and rules governing accounting proved inadequate. Because information was insufficient, the company was able to pursue its bets well beyond a sensible limit. The vast personal wealth available to top management also created big incentives for such behaviour.

None of this is unique to Enron. It was merely an egregious case. In what will surely come to be called the US bubble era, top managers were allowed to do many things that made little sense for anybody but themselves. Lavish share options that failed to align their interests with those of shareholders were just one example.

The response will be to tighten up on regulation. Some of this is necessary, particularly over the role of auditors and the probity of accounts. Yet care must be taken. Any system guaranteed to prevent bankruptcies would damage the risk- taking essential to economic dynamism.

Why not look at the moral claims of business leaders as well? Many of them now spout on about promoting sustainable development and other global causes. More to the point is an emphasis on the core values of management. Outside checks and balances are essential. But so is managerial morality.

The more managers prate of social responsibility, while feathering their own nests, the less likely they are to ensure the loyalty of their staff and the long-term health of their organisations. They have positions of trust in their businesses. Acting accordingly is their prime moral responsibility.

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"An awful lot of people are not managing their own money,"
"In old-style 19th Century capitalism, I owned my company, I made a mistake, I bore the consequences."
Joseph Stiglitz, Columbia University professor and Nobel laureate CNBC 19/1 2010



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