Arnold Kling  

Two Tyler Retweets

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Toggling Without a Switch... How Toggling Works (I Think)...

The sole purpose of this post is to retweet two of Tyler Cowen's assorted links.

1. How to tell when a CEO is lying. I was expecting to click through and read, "His lips are moving," but in fact it is a serious and interesting article.

2. Robert Bradley on Enron.

I once watched the DVD of "The Smartest Guys in the Room," and that is everything I know about Enron. (Which is not to say I thought that the movie was accurate.) My sense is that when things got desperate, Enron generated profits by writing put options on their stock--not literally, but some of their special-purpose entities amounted to that. So when the stock started to go down, they incurred losses on the put options, which drove the stock down further, which increased the losses on the put options, and so on, with the result that they went from apparent soundness to bankruptcy very quickly.

The problem with sophisticated finance is that the geeks figure out fancy new ways to create out-of-the-money options and next thing you know some suit thinks that selling those options is an way to make easy money. Hence, Enron. Hence, AIG.

What the Bradley interview brings out is how tight the Enron folks were with government, which was really part of their business model. It is my view that the big-time finance that emerged over the past few decades also involved a high degree of entanglement with government--in saying that, I do not wish to infringe on any Simon Johnson or James Kwak trademarks. On the entanglement issue, I see the "financial reform" as making the problem even worse, which means that I am more despondent and cynical than Johnson and Kwak.



COMMENTS (4 to date)
Joel Johnson writes:

Is this geeks-suits dynamic caused by stupid government regulations? If so, what would the effective reform package look like?

I like the "an/a" typo in the post because it shows Arnold's understanding that there's an important difference between "an easy way to make money" and "a way to make easy money."

Lori writes:

My guess was that Enron's claim to fame was making a business model out of opacity. They replaced the standard M.O. of dummy corporations with a new twist we'll call dummy partnerships, engineered, not surprisingly by Arthur Anderson, the world's largest partnership, at least at the time.

Since the M.O. is the generation of vast amounts of disinformation and noise. I'm sure to some extent they were gaming the tax system, or the SEC rules, but they were also gaming the market itself. The logic seems to be that if you bury the liabilities under enough layers of dummy partnerships, the investing public won't be able to see them.

John Fast writes:
Enron generated profits by writing put options on their stock. So when the stock started to go down, they incurred losses on the put options, which drove the stock down further, and so on, with the result that they went from apparent soundness to bankruptcy very quickly.

If I understand correctly, the smarter thing would have been to write call options on their own stock, so when the stock went down they would at least make money on the call options, thus mitigating the loss.

Placing put options was like playing double-or-nothing, which is usually just a good way to go broke. (I love Edwin Silberstang's discussion of why this is a bad system in Vegas.)

Rob Bradley writes:

The full interview with me, which is almost three times longer and covers not only Enron but also my development as a free-market energy specialist, has been posted here:

http://www.ethicsandentrepreneurship.org/20100924/interview-with-robert-bradley-jr/

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