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Posts Tagged ‘credit crunch

Dissecting the crunch – Bethany McLean on the lessons of Enron

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In “Don’t Get Fooled Again“, I look at the rise and fall of Enron, whose management sought to inflate the company’s share price by hiding bad debts amid a fiendishly complex internal accounting structure.

Bethany McLean, the journalist credited with being the first to raise serious questions about the company, has just written a fascinating piece highlighting parallels between the Enron scandal and the current financial crisis triggered by the “credit crunch”:

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…

…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.

Written by Richard Wilson

October 4, 2008 at 1:40 pm

“Don’t Get Fooled Again” reviewed in The Hindu

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By D. Murali, Chennai

Be it in love or in business, we have an amazing capacity to deceive ourselves and also be deceived by others.

Aha, you may not like to believe that, but alas, that’s a fact, bemoans Richard Wilson in ‘Don’t Get Fooled Again: The Sceptic’s Guide to Life’ (

“Being human involves an odd dichotomy: we need to delude ourselves that we are exceptional, even if we aren’t, in order to make the most of whatever potential we do have,” Wilson observes. “We thrive on being told how great we are, and we gravitate towards people who are willing to indulge that need.”

When we allow ourselves too much self-delusion, we are in danger of becoming fantasists, wide open to exploitation, he cautions. “And if we are too blind to the flaws of our heroes and idols – and too trusting of those we perceive to be figures of authority – we risk becoming complicit in the actions of criminals or, at the very least, making idiots of ourselves.”

Quite reassuringly, however, we all have the capacity to be sceptics, says Wilson. He explains how the antidotes to delusion are logic and evidence, preferably evidence from multiple sources. “We tend to delude ourselves least about the things that are easiest to measure objectively.”

Where possible, compare information from alternative sources and look for inconsistencies and contradictions, the author guides. This is not the same thing as being a cynic, he distinguishes. “Cynics like to assume the worst of people and things. Sceptics try to make as few assumptions as possible.”

A chapter titled ‘the emperor’s new paradigm’ studies how businesses thrive on a culture where creative thinking has acquired a near-mystical status, and where the gap between rhetoric and reality can be perilously thin.

Wilson is horrified that some organisations pay enormous sums of money “to those promising to help them ‘think outside the box,’ ‘challenge the orthodoxy,’ ‘push the envelope,’ ‘take a blue sky approach,’ ‘drive through change’ or bring about a ‘paradigm shift.’”

In a market where concepts have become a commodity, Wilson warns that it’s possible to make money not only from brilliant new ideas, but also from mediocre ideas cleverly packaged in brilliant-sounding expressions. Watch out, therefore!

Also let us be careful not to demonise ‘all those idiots who get bamboozled by the nonsense, and congratulate ourselves that we would never fall for anything so stupid,’ because if we do that, then we’re much more likely to get fooled ourselves, Wilson advises. For, “The delusion that human nature operates differently for ‘those idiots’ than for us is perhaps the most dangerous one of all.”

We all need a bit of wishful thinking from time to time, he observes, “to get ourselves to sleep at night or out of bed in the morning, or to psych ourselves up for some ghastly public speaking engagement.” His wise counsel is that it is most important to know which stones we are choosing to leave unturned, and to know that this choice is benefiting us rather than leaving us open to exploitation.

To those who are prodded by the politicians and the media to be ever-frightened, the author’s prescription is laughter. “By mocking our fear-mongering political class and their torture-tainted nightmare tales, we not only bring some small measure of accountability to the political process – we can also help to counteract the anxiety culture that threatens both our health and our freedom,” he suggests.

Prescribed read for the hype-harassed and panic-pumped.

Written by Richard Wilson

September 16, 2008 at 1:01 am