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Non-Tech : The ENRON Scandal -- Ignore unavailable to you. Want to Upgrade?

To: Dr. Peter E. Pflaum who wrote (924)	1/21/2002 7:49:51 AM
From: Baldur Fjvlnisson	Respond to of 5185

Derivatives and Volatility: The Holy Grail of Finance If a stock's price and beta have become the dominant force in individual stock investing, a more sophisticated variation of this theme dominates the institutional markets. On Wall Street, volatility has become the bible and the Holy Grail of finance. Volatility has become the be-all-and-end-all of today’s financial world. It is what drives institutional trading through financial instruments called derivatives. These complex financial instruments dominate modern finance. They were originally developed as a means to hedge against risk. They began to take on a different role as the result of a formula that was developed in the 1970’s. That formula enabled investors to determine what a call option is worth at any given moment in time. The formula is known in the financial world as The Black-Scholes Option-Pricing Formula. The formula began to mutate with probability theory. In the minds of financial engineers, it was now possible to isolate risk, price that risk, and then develop trading models around it. Around the globe, complex computer models have been developed to take advantage of every permutation and possibility of every financial instrument and market. The world of derivatives has grown in size to a market that now approaches $100 trillion with seven U.S. banks accounting for over 50% of that total. They have been used to power the markets with energy, but they can also cause destruction when they are used for speculation. Originally they were used to hedge against interest rate and currency risk. Today, the majority of derivatives are used for just this purpose. However, they are also used for speculation because derivatives take leverage to the nth degree. A small proportion of capital can control a large amount of assets. In the case of Long Term Capital Management, the firm had $4 billion in equity, nearly $140 billion in debt, and controlled a derivative book totalling $1.25 trillion. Small movements in financial instruments turned nickels into billions in profits. Today J.P. Morgan Chase has $42 billion in equity and controls $30.4 trillion in derivatives, a leverage factor of 725:1. However, leverage is a two-edged sword that can quickly turn profits into losses and just as quickly into bankruptcy. 1 Derivatives have become the atomic bombs of modern finance. When they explode, as they did with Orange County, LTCM and now Enron, they create a swathe of destruction across the financial markets. Because they involve a high degree of leverage, they can produce high returns when they go right and catastrophe when they go wrong. It is unfortunate that the degree of risk they involve isn’t properly measured. The models are based on probability theory and measuring volatility. Those models don’t measure leverage and balance sheet risk. As was the case with LTCM and Enron, that leverage proved fatal. This is one reason why the markets are so frequently surprised by the sudden disasters that unfold. financialsense.com

To: Dr. Peter E. Pflaum who wrote (924)	1/21/2002 3:03:11 PM
From: Karen Lawrence	Respond to of 5185

Even the one third who live in privileged suburban reserves and gated communities are hurt by the crimes of capitalism, they may wake up to their collective responsibilities besides killing foreigners. . Yours is a great post.

To: Dr. Peter E. Pflaum who wrote (924)	1/21/2002 4:39:21 PM
From: Sir Auric Goldfinger	Respond to of 5185

Funny thing about the point made in that NYT article is that there are plenty of warning signs on these kinds of companies (as Gretchen Morgensen pointed out yesterday), but the "investors" don't care. They only care when they get clocked over the head with a BK. And thus they get what they deserve for being lazy and/or ignoring the truth. It is the employees who really get screwed here, very sad.

To: Dr. Peter E. Pflaum who wrote (924)	1/22/2002 12:46:50 AM
From: Mephisto	Respond to of 5185

"American strategic advantage, upon which is built all our wealth and power, is freedom of innovation and capitalization of new enterprise. " Certainly, our technological edge has helped us wage the war in Afghanistan. I was amazed at the various gadgets the military use. And, our technology, pushed us ahead in the 90s. On the other hand, Knneth Lay has misused technology. He sends e-mail to employees to urge them to buy Enron stock when the company is in trouble. He claims Enron is an innovative company. Unfortunately, the press, Wall Street, his employees and investors believed his hype! I worry about the future. The Bush administration backs old and environmentally unfriendly companies. I read that Cheney's old company Halliburton may be in trouble as well! Thanks for the post!

To: Dr. Peter E. Pflaum who wrote (924)	1/22/2002 12:17:12 PM
From: Mephisto	Read Replies (1) \| Respond to of 5185

"The destruction of trust and faith in capital markets would be the most serious threat to our culture, welfare and security I can imagine - more than terrorist, more than federal deficits, more than corrupt politicians, a capital market melt down is possible but not likely." As a further comment to my other post, I hope Krugman is correct although others have pointed out that there are likely other companies that used "creative accounting practices" similar to Enron's - Mephisto

To: Dr. Peter E. Pflaum who wrote (924)	1/22/2002 11:30:17 PM
From: Mephisto	Respond to of 5185

Sen. Kerry to Offer Alternative to Bush Energy Proposal By Dana Milbank "Old thinking passed through the doors of 1600 Pennsylvania Avenue far more often and easily than new thinking," according to the draft remarks. "Exxon Mobil, Enron or Chevron enjoyed an access bonanza at the expense of consumers and state-of-the-art environmental technology manufacturers. The process and its results stand as a monument to the difficulty of forcing industry and institutional change." Washington Post Staff Writer Tuesday, January 22, 2002; Page A03 The leading Senate foe of the Bush administration's energy plan, Sen. John F. Kerry (D-Mass.), will propose a Democratic alternative today based on higher fuel efficiency standards, tax incentives for new energy sources and a target of 20 percent reliance on alternative and renewable fuels by the year 2020. Kerry, a likely presidential candidate in 2004, will seek to tie the administration's energy proposal to the disgraced Enron Corp., according to an advance draft of Kerry's remarks, scheduled for delivery to the Center for National Policy today. The administration has said executives from ENRON, now in bankruptcy proceedings, had six meetings with the White House energy task force. "Old thinking passed through the doors of 1600 Pennsylvania Avenue far more often and easily than new thinking," according to the draft remarks. "Exxon Mobil, Enron orChevron enjoyed an access bonanza at the expense of consumers and state-of-the-art environmental technology manufacturers. The process and its results stand as a monument to the difficulty of forcing industry and institutional change." Kerry has threatened to keep Bush's proposal, particularly a provision calling for drilling in the Arctic National Wildlife Refuge in Alaska, from coming to a vote in the Senate. The plan, drafted by Vice President Cheney's energy task force, has already been approved by the House. Bush is expected to mention his energy proposal as he travels today to Charleston, W.Va., to speak at a machinery company. "A comprehensive energy plan, as the president proposed last spring, and the House passed in a bipartisan fashion, is important to our national security and job creation," said Taylor Gross, a White House spokesman. "We are pleased that others now recognize the importance of what the president previously proposed." Kerry argues that "if we enact the entire Bush energy plan, we will find ourselves 20 years from now more dependent on foreign oil than we are today." He proposes a variety of tax credits and incentives to increase domestic alternative and renewable energy sources such as wind, solar and geothermal to 20 percent of production in 18 years. Kerry also will call for raising corporate average fuel economy requirements for auto manufacturers "as far and fast as we can," but does not mention a specific target. The senator also favors tax incentives to speed production of hybrid-fuel engines and to develop hydrogen fuel cells. Kerry will call for "reinvesting" in public transit and rail and promoting biofuels and ethanol as oil alternatives. Ethanol support is a crucial political issue in Iowa, which holds the first caucus during the presidential primary season. Kerry also will suggest "significantly increased" tax incentives for business and home energy efficiency, beyond those now contemplated. He shares the Bush administration interest in making a cleaner form of coal, and he supports federal assistance for a natural gas pipeline from Alaska to the Midwest. Kerry, who sits on the Senate Finance Committee, will introduce legislation within two months that consists mainly of tax cuts, a spokesman said. © 2002 The Washington Post Company