Friday, May 26, 2006

Ken Lay's Revenge

Ken Lay and Jeffrey Skilling are likely to have a lot of time on their hands to contemplate their legacy. The press will undoubtedly depict their convictions yesterday as the hallmark of an era of rampant corruption and speculative excess, but ultimately they will have the last laugh.

Enron, the company that a jury of their peers has now found was driven into bankruptcy by the fraud of Mssrs. Lay and Skilling, is generally credited with at least inventing and certainly mainstreaming and refining the idea of trading electricity futures and derivatives of those futures instruments. There is nothing intrinsically different in this than in the trading of commodities futures that farmers and others have engaged in for centuries. It helps everyone – electricity producers and consumers alike – who already bears or for a fee is willing to bear exposure to risk to benefit from a more efficient allocation of that risk. A farmer has a huge amount of risk tied up in whether that year's crop succeeds or fails, and because of the vagaries of weather not just where he is but elsewhere this is to some extent beyond his control. Professional “speculators” will make it their business (literally) to try to amass information about the global outlook for corn, which will determine its market price, and if the risk-averse farmer is willing to pay the less risk-averse farmer to accept delivery at a guaranteed (if potentially lower) price on a guaranteed date, the farmer benefits from eliminating the risk and the speculator benefits from expected profits, which may or may not pan out. The speculator performs the further service of more efficiently matching up those who make corn to those various parties who may need it in the future – what economics textbooks call “widening the market.” And so too with electricity futures. (Just as with corn futures, fraudulent trading in electricity futures does not promote efficiency, and hence is obviously to be discouraged, by criminal sanction if necessary.)

And while Enron is now essentially dead, a tiny shell of its former self in the process of liquidating its remaining operations, the innovation it pioneered lived on. Numerous other companies trade electricity actively, and the practice has even spread to many countries in Europe. These exchanges sprout because they mutually benefit the participants. And whether they know it or not, they benefit others, e.g. electricyt buyers, who never get near them.

I was always surprised by the amount of attention the Enron collapse got. The story broke less than two weeks after the U.S. launched its attack on Afghanistan, when the fate of that venture was still uncertain and the wounds of Sept. 11 were still raw. And yet Enron managed to push that story below the fold of the major newspapers; yesterday’s conviction drew four columns of all-caps headlines in The New York Times.

And that is undoubtedly mostly because of the power of Enron as archetype for an era. It symbolized the speculative excesses of the high-tech 1990s, and the too-clever marketization of everything by unregulated Masters of the Universe. In combination with the 2000-1 California electricity fiasco (itself caused mostly by the inability of its electricity generators to ration electricity by passing on higher costs to consumers), it served to delegitimize market forces at a time when in the view of many they were due for a comeuppance. Despite the fact that Enron and Tyco and Worldcom were a tiny fraction of the thousands of companies traded on the U.S. stock exchanges, the meme of “corporate corruption” took hold, as deceit and fraud were increasingly assumed to be the norm in corporate America. For an eminently representative post-verdict specimen of this crabbed view see here. Howard Fineman of Newsweek blames the episode on some amorphous villain called the Texas business culture. And the shame attached to Enron in particular endures above all; every fall for the last few years the University of Missouri (where Mr. Lay went to school) has solicited applications for the Kenneth H. Lay endowed chair of economics, and every year they have to run the ad again, presumably because it goes unfilled.

Ultimately Enron was symbolic of almost nothing except a few venal individuals. The innovations that spurred it will live on, no matter what the anti-corporate crusaders say, because they make it easier for people to pursue the goals they wish to pursue. That is what all markets do, and ultimately whatever its sins and the pain it has inflicted on those who bought into it Enron has ultimately given more to humanity than it has taken.


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