Enron: What matters and what doesn

1
EnronWhat matters and what doesnt

• Robert J. Michaels
• California State University, Fullerton
• and
• Tabors, Caramanis Associates, Cambridge MA
• rmichaels_at_tca-us.com
• 
  Western Farm Credit Bank
• Annual Shareholders Meeting
• 
  Dana Point,
  California
• 
  
  Mar. 12, 2002

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What was Enron?

• Began with regulated pipelines
• Seized deregulated market opportunities
• In electricity and gas
• Structured commodity and financial trades
• Venture capitalist
• Investor in hard assets
• Political actor

3
Why the collapse doesnt matter

• Newly competitive markets offer alternatives to
  Enron
• No pricing or deliverability crises with
  bankruptcy
• The irony Enrons political activities were
  instrumental in bringing the markets
• Enron was both a political and economic
  competitor
• Matched against experienced opponents

4
The dangers of the collapse

• An invitation to shortsighted legislation and
  regulations
• Cut competitive opportunities for business
• Eliminate choices by customers (reregulation)
• Eliminate other choices (retirements)
• Hinder development of useful financial tools
• Encourage questionable shareholder suits

5
Enrons Business Model

• Basically a trading company
• A hedge fund sitting on top of a pipeline
• Domestic asset light philosophy
• And some heavy investments abroad
• Light assets can be OK for a trader
• But traders cant usually justify P/E like
  Enrons
• So Enron needed to grow earnings, steadily

6
Special-Purpose Entities

• SPEs valuable to access capital, manage risk
• Leasebacks, securitizations, funding acquisitions
• FASB rules
• Enron SPEs removed balance sheet problems
• Allowed revaluations and resales, income growth
• Funding by transactions with employees
• 3 and other standards violated
• Triggers on Enron share and debt status

7
Accounting and standard-setting

• Enron practices the dark side of disclosure
• FASB 133 -- marking derivatives to market
• Intended to force reporting of losses
• Enron uses it to inflate earnings
• Forward curves from internal data
• Balance sheets not released with earnings
• Consequences of FASB haste to revise

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Directors and managers

• Weakness of Enrons Board of Directors
• Need for managerial autonomy
• Led to successes like EnronOnline
• Strength of Enrons internal controls
• CRO the board tends to be vague on risk
• An increasingly important problem in firms with
  large risk exposures

9
Auditors and analysts

• Role of Andersen in collapse uncertain
• Andersen defense Enron didnt tell us
• Enron defense Andersen said it was OK
• No clear ways to change audit regulations
• Some analysts saw Enron problems early
• Accounting details, credit risk derivatives
• Conflict of interest and recommendations
• Inherent uncertainty in valuing company
• Accountings long-standing crisis

10
Enron and wholesale credit

• Two different lessons of Enron
• The rise and the bankruptcy
• New good Enrons from deregulation and
  globalization
• The plight of mutuals, publics, and nonprofits
• Taking risk management seriously

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The future of risk

• Investor insistence on seeing downsides
• Coping with technical complexity of risk analysis
• Third-party risk analysis the emerging solution
• Enrons full statement of trading book risk
• Risks investors and management must know
• The emerging duty to hedge

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What was Enron again

• The makings of a drama
• A vision of risk measurement
• The limits of financial companies
• Management is more than risk management