Sunday, April 13, 2008

Too Big To Fail

On Thursday I was scanning the second part of the interview with the anonymous hedge fund manager in n+1 (It's a very fun read, if you have the time). An exchnage between the despondent manager and the interviewer about the collapse of Bear Stearns really caught my eye:

n+1: Wouldn’t it have been better to let them go bankrupt?

HFM: And let their counterparties face the music? Maybe, but the parlous condition of the financial system as a whole I think persuaded the Fed that this is not the time to experiment and see how interconnected the system has become.

With this passage I finally realised what has been bugging me about this financial rescue effort. Why didn't this happen to Enron?

Now I'm going to go through a few differences and similarities, and before I do that I'm going to make myself very clear: there has been no evidence of any criminal wrongdoing at Bear Stearns, and I believe that there was plenty at Enron.

I'm more curious about how much the two meant to their respective industries, and I want to make a stab at what the likely effects of Enron's collapse were on the wider economy.

You will recall that when Enron was going bust, caught in a vicious cycle of pulled liquidity lines, ratings downgrades, and yes, financial results that finally reflected reality, there was no talk whatsoever of bailing them out. Not from friend of management George W. Bush, not from energy regulators, not from futures regulators. It's always been a difficult detail to square with the caricature of an administration in thrall to the energy industry.

But Enron was pretty essential to the then-nascent businesses of gas and electricity trading, It was pretty-much single-handedly making markets in electricity trading, for good or for bad, as the poor residents of California discovered, when their electricity bills were at the mercy of Enron's Houston-based power traders.

The sums of money involved in electricity trading were pretty inconsequential, but Enron's bankruptcy, combined with the reckless over-building of power plants, ratings agency clampdown on industry participants, and pushback from local utilities, set back the deregulation of the power industry in the US permanently. It also led to billions in losses at banks that were involved in the sector, and at shareholders in Enron and its clones.

With Bear Stearns, certainly, the sums involved were much larger. But Bear was not the only actor in the markets in which it operated, and its misfortunes seem to echo those of Enron, in that its inability to access liquidity was a big factor in its collapse.

The cynic in me says that one big difference between Bear and Enron was the presence of Hank Paulson in the cabinet, a former investment banker with an outsized faith in the importance of the financial services industry. Moreover, when even the New York Times has an in-house investment banking apologist, public opinion can be swung behind a rescue quickly. Enron's followers included such mainstream publications as Platt's Global Power Report and Argus.

I guess deep down I know that the criminality and the California power crisis probably doomed Enron. Bear Stearns was a group of good old Wall Street boys playing crazy leverage games with other people's money. But if we want to look at the intersection of public policy and business failures, Enron's collapse, while more the case of the dog that didn't bark, was probably more interesting.


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