Foxes guarding the chicken coop

President Bush's nominees to the agency that should have regulated Enron instead helped write the rules that let the company do whatever it wanted in the first place.

Topics: Enron,

Does anyone in the current administration even remember Enron? Judging by President Bush’s two nominees to the Commodity Futures Trading Commission (CFTC), who appeared at Senate hearings on Tuesday, the answer is no.

If there was one thing that could legitimately be hoped for after the biggest corporate bankruptcy of all time, it was that accounting rules would be tightened, and the rush to dismantle regulatory oversight over the kind of complicated financial games that Enron specialized in would be reversed. But instead, the people most responsible for loosening the rules are being put in charge.

The CFTC is the government agency that is supposed to be the watchdog over such advanced “financial instruments” as derivatives trading. But Bush’s nominees boast what critics call a laughable regulatory record. Walter Lukken is the drafter of a law passed in 2000 that gave Enron’s online trading arm the right to act without a shred of oversight. Sharon Brown-Hruska is a free-market economist and protigi of Wendy Gramm, the former CFTC commissioner who, after shepherding through a regulatory exemption for Enron, resigned from the commission and joined the company’s board of directors.

Enron’s implosion last fall and winter was declared at the time to be a watershed event, a Teapot Dome-like scandal that would lead to new legislation, increased oversight and greater degrees of financial transparency. Enron, the argument went, would be the spark that set ablaze a fire of reform.

If anything, the wave of corporate accounting scandals that dominated the business headlines all spring might have been expected to give even more fuel to the forces of reform. On June 23, Treasury Secretary Paul O’Neill declared that he and the Bush administration were “outraged” at the current rash of corporate malfeasance.

But little has actually changed, and the backgrounds of the new nominees to the CFTC — along with Congress’ rejection, earlier this spring, of a bill aiming to give the CFTC more responsibility for regulating energy traders — put the lie to O’Neill’s rhetoric. More than six months after Enron declared bankruptcy, the regulatory landscape is largely the same as it was before Enron’s problems became public. In fact, says Michael Greenberger, a law professor at the University of Maryland and the former director of trading and markets at the CFTC, “It’s not changed at all.”



“The mantra for not regulating is that these are isolated events,” says Greenberger. “But when you look across the spectrum, how can it be an isolated event with Enron, with Tyco, Arthur Andersen, Global Crossing, Adelphia, ImClone and all the others? What’s needed is a very dramatic reversal, almost to the kind Bush made with the Office of Homeland Security. And except for an accounting measure getting out of the Senate banking committee [which would create an independent board to oversee the industry], everything strong has failed.”

Enron proved, among other things, that lobbying and large donations are an excellent way to rewrite the corporate rulebook. The list of the company’s political victories is long and diverse. Electricity deregulation, the power to essentially veto appointments at the Federal Energy Regulatory Commission, passage of a law that exempted EnronOnline from all oversight — these are just a few of the perks that Enron claimed on its way up the Fortune 500 ladder.

But perhaps no single instance demonstrates Enron’s success better than its influence over the CFTC. The commission could have and should have been Enron’s key regulator. The CFTC is the agency most closely aligned what turned out to be one of Enron’s primary profit centers: derivatives trading.

The term “derivatives” is used to describe a class of financial contracts that are derived from another asset and priced according to that asset’s value. Also known as a form of “risk management,” over the past 20 years derivatives trading has become increasingly popular on Wall Street as a way to “hedge” risk, to protect yourself from an investment bet that goes sour or from swings in interest rates or currency prices. Enron, although once primarily a trader in actual physical commodities such as gas and electricity, rapidly developed in the late ’90s into a serious trader of derivatives based on a vast array of commodities.

The question of how to regulate derivatives has been at the heart of a vigorous, if abstruse, debate for the past 20 years between Wall Street and Washington. Enron has been in the middle of the battle, and until its demise, won every skirmish.

The first victory came in 1993. At that time, Enron’s primary business was selling actual energy but the Houston company wanted to get involved in selling energy derivatives. But rather than put up with the oversight requirements of the CFTC, Enron lobbied for an exemption — the right to trade energy derivatives without being subject to CFTC jurisdiction.

Wendy Gramm, chairwoman of the CFTC from February 1988 to January 1993, agreed. She shepherded the exemption through, and in April of 1993 — after Gramm quit the CFTC and took a seat on Enron’s board of directors — the CFTC approved the policy Enron favored.

Enron took its exemption to the bank. Its derivatives business grew enormously over the next few years. Eventually, however, the exemption came up once again for debate. By the end of 1997, derivatives contracts of all kinds represented more than $25 trillion in real assets, and many in Congress — and at the CFTC — wanted to know more about their effects. Brooksley Born, a Clinton appointee who became the head of the CFTC in 1996, called for oversight.

“In late 1997 and early 1998, she said the emperor has no clothes,” says Greenberger. “She said that derivatives are futures contracts and that the CFTC had jurisdiction.”

But once again, Enron carried the day. A handful of legislators, including Sen. Phil Gramm, R-Texas (husband of Wendy Gramm), defeated the forces of regulation, with no small help from the U.S. Treasury Department, the Federal Reserve and the Securities and Exchange Commission. All three government agencies, though headed by Born’s fellow Clinton appointees, scorned her new CFTC proposal. They even issued a rare joint statement declaring, “We have grave concerns about this action and its possible consequences. We seriously question the scope of the CFTC’s jurisdiction in this area.”

After a report favoring less regulation rather than more reached both houses, Congress acted. In December 2000, the Commodities Futures Modernization Act (CFMA) became law. The CFMA essentially established derivatives as a new, unregulated form of finance.

“The CFMA made it clear that this kind of trading would be exempted,” Greenberger says. “Only a handful of congressmen and senators probably realized that they were enacting this deregulatory provision.”

For those working under the law, however, the CFMA has proven hard to ignore. Thomas Erickson, a Clinton-appointed commissioner, says that the law has severely undermined the agency’s ability to keep track of the economy. Not only does the law let companies deal in derivatives without maintaining established levels of capital (to protect against overextended investing), as banks are required to do; the law also protects companies from having to disclose information about their derivatives business.

“It’s a black hole of information,” says Erickson. “It’s off our radar completely.”

Ultimately, he adds, the law makes it much harder for the CFTC to do its job — to hold companies accountable.

“It’s a real challenge,” Erickson says. “We’ve got so many built-in hurdles to an investigation that you have the possibility of having your jurisdiction questioned at every stage. Where we are today, I believe that we would be hard pressed to be able to reach the same kinds of settlements as we did before the CFMA, like with Sumitomo, a case where the commission earned a $150 million settlement for the manipulation of copper prices.”

Immediately after Enron’s bankruptcy, Sen. Dianne Feinstein, D-Calif., drafted legislation that aimed to close the loophole in the CFMA that allows energy trading to be exempt from regulatory oversight. The law would have put electronic energy exchanges like Enron’s EnronOnline under CFTC jurisdiction: Companies would have to disclose information on trading volumes, players, profits and losses while also keeping capital reserves.

There is no guarantee that CFTC oversight could have prevented Enron’s collapse. But experts argue that it would have made Enron’s troubles more visible. Regulators have learned only recently that Enron controlled about 25 percent of all U.S. wholesale energy trades during its peak, and that during the California energy crisis, the company — according to its own internal documents — used its market power to manipulate the market. Feinstein maintains that her proposal, which would have put energy and metal trades under CFTC jurisdiction, would prevent a similar scenario from occurring elsewhere.

“In terms of energy derivatives, there seems to have been real gaming of the market, so it’s clear that there needs to be some basic oversight,” says Howard Gantman, a Feinstein spokesman. “It existed in the past — until the CFMA — and we’d like it to be returned.”

But in order to achieve this goal, Feinstein has been forced to go up against many of the same forces that kept the CFTC impotent for much of the ’90s. So far, she’s lost. Her attempt to tie the legislation to the Senate energy bill failed in April by two votes.

“At present, there is no constituency for reform in the derivatives world, and there won’t be until a major financial institution collapses — which will happen,” says Mayer, author of “The Fed” and more than a dozen other finance books. “Until then, the Fed, the SEC, the CFTC, the Treasury, Congress and the White House will all accept the industry’s lunatic claim that the tightening of links between markets, the elimination of friction and the loss of redundancy improves the reported profits of derivatives transactions and stabilizes the system.”

Bush’s nominations to the CFTC add insult to injury for critics looking for real reform.

Brown-Hruska started her career as an economist whose Ph.D. thesis argued that markets self-correct against price manipulation — no regulation or disclosure required. In 2001 she co-wrote an article for Barron’s that argued against an SEC proposal that would force brokers to reveal how much they paid for exclusive market information.

She also served as chief economist at the CFTC from 1990 to 1995 under then-chairwoman Wendy Gramm. She now works as an assistant professor of finance at George Mason University’s Mercatus Center — a free-market think tank headed by Gramm, and which has received $50,000 from Enron since 1996.

Given the degree of outrage over Enron, says Greenberger, “the idea that a protigi of Wendy Gramm could be placed on the commission that will investigate this issue is mind boggling.”

Lukken’s record is similarly tainted. A former legislative assistant to Sen. Richard Lugar, R-Ind., Lukken has one major piece of legislation associated with him: the CFMA, a law which current CFTC commissioner Erickson describes as “Swiss cheese,” meaning “there are so many holes that let you get out of the block.”

“[Lukken and Brown-Hruska] don’t represent any new thinking that will provide a remedy,” says Randall Dodd, director of the Derivatives Study Center. “What needs to be done is broad rethinking of where the system has failed, and how to come up with new solutions. These people have never supported a government regulation in their life. And at this juncture, that’s not the type of narrow-minded thinking that’s needed.”

Brown-Hruska declined to comment on her appropriateness for appointment to the CFTC.

Seth Boffelli, a spokesman for Sen. Tom Harkin, D-Iowa, who is chairing the hearings on the pair of Bush nominees, said only that “I’m sure there will be some tough questions asked and depending on what they say, we’ll go from there.”

To critics, Bush’s nomination of two people who are the epitome of the deregulatory thinking that allowed Enron to get away with financial murder is a clear indication that no substantive changes can be expected from the current administration. But some potential critics are holding fire.

“I haven’t seen significant change yet, but I think the jury is still out,” says Brooksley Born, now in private practice. “Congress is still working on a number of things, and the administration itself is also in the process of working out some issues. So we have to wait and see.”

But some critics argue that we are waiting and seeing our way into a continued financial meltdown. The signs are obvious, they say: The energy industry has been battered in the stock market; the NASDAQ is at lows not seen since Sept. 11.

“There’s a crisis of confidence in the market, in energy in particular,” says Erickson. “The participants no longer trust each other or have confidence in each other. I’m as interested as anyone else in seeing the markets grow and I think there are a few simple things that you can attach that instill confidence — transparency, disclosure requirements. Those are the kinds of things that are the cornerstones of markets.”

Robert Shiller, author of “Irrational Exuberance,” agrees. “In the long run, business people are better off if we have good strong regulations in place to prevent shenanigans from happening,” he says. “If people are getting upset, we need to take measures that have some teeth. The mood is souring; we need to do something.”

Damien Cave is an associate editor at Rolling Stone and a contributing writer at Salon.

Featured Slide Shows

  • Share on Twitter
  • Share on Facebook
  • 1 of 7
  • Close
  • Fullscreen
  • Thumbnails
    AP/Jae C. Hong

    Your summer in extreme weather

    California drought

    Since May, California has faced a historic drought, resulting in the loss of 63 trillion gallons of water. 95.4 percent of the state is now experiencing "severe" drought conditions, which is only a marginal improvement from 97.5 percent last week.

    A recent study published in the journal Science found that the Earth has actually risen about 0.16 inches in the past 18 months because of the extreme loss of groundwater. The drought is particularly devastating for California's enormous agriculture industry and will cost the state $2.2 billion this year, cutting over 17,000 jobs in the process.

       

    Meteorologists blame the drought on a large zone (almost 4 miles high and 2,000 miles long) of high pressure in the atmosphere off the West Coast which blocks Pacific winter storms from reaching land. High pressure zones come and go, but this one has been stationary since December 2012.

    Darin Epperly

    Your summer in extreme weather

    Great Plains tornadoes

    From June 16-18 this year, the Midwest was slammed by a series of four tornadoes, all ranking as category EF4--meaning the winds reached up to 200 miles per hour. An unlucky town called Pilger in Nebraska was hit especially hard, suffering through twin tornadoes, an extreme event that may only occur every few decades. The two that swept through the town killed two people, injured 16 and demolished as many as 50 homes.   

    "It was terribly wide," local resident Marianne Pesotta said to CNN affiliate KETV-TV. "I drove east [to escape]. I could see how bad it was. I had to get out of there."   

    But atmospheric scientist Jeff Weber cautions against connecting these events with climate change. "This is not a climate signal," he said in an interview with NBC News. "This is a meteorological signal."

    AP/Detroit News, David Coates

    Your summer in extreme weather

    Michigan flooding

    On Aug. 11, Detroit's wettest day in 89 years -- with rainfall at 4.57 inches -- resulted in the flooding of at least five major freeways, leading to three deaths, more than 1,000 cars being abandoned on the road and thousands of ruined basements. Gov. Rick Snyder declared it a disaster. It took officials two full days to clear the roads. Weeks later, FEMA is finally set to begin assessing damage.   

    Heavy rainfall events are becoming more and more common, and some scientists have attributed the trend to climate change, since the atmosphere can hold more moisture at higher temperatures. Mashable's Andrew Freedman wrote on the increasing incidence of this type of weather: "This means that storms, from localized thunderstorms to massive hurricanes, have more energy to work with, and are able to wring out greater amounts of rain or snow in heavy bursts. In general, more precipitation is now coming in shorter, heavier bursts compared to a few decades ago, and this is putting strain on urban infrastructure such as sewer systems that are unable to handle such sudden influxes of water."

    AP/The Fresno Bee, Eric Paul Zamora

    Your summer in extreme weather

    Yosemite wildfires

    An extreme wildfire burning near Yosemite National Park forced authorities to evacuate 13,000 nearby residents, while the Madera County sheriff declared a local emergency. The summer has been marked by several wildfires due to California's extreme drought, which causes vegetation to become perfect kindling.   

    Surprisingly, however, firefighters have done an admirable job containing the blazes. According to the L.A. Times, firefighters with the state's Department of Forestry and Fire Protection have fought over 4,000 fires so far in 2014 -- an increase of over 500 fires from the same time in 2013.

    Reuters/Eugene Tanner

    Your summer in extreme weather

    Hawaii hurricanes

    Hurricane Iselle was set to be the first hurricane to make landfall in Hawaii in 22 years. It was downgraded to a tropical storm and didn't end up being nearly as disastrous as it could have been, but it still managed to essentially shut down the entire state for a day, as businesses and residents hunkered down in preparation, with many boarding up their windows to guard against strong gusts. The storm resulted in downed trees, 21,000 people out of power and a number of damaged homes.

    Debbie Arita, a local from the Big Island described her experience: "We could hear the wind howling through the doors. The light poles in the parking lot were bobbing up and down with all the wind and rain."

    Reuters/NASA

    Your summer in extreme weather

    Florida red tide

    A major red tide bloom can reach more than 100 miles along the coast and around 30 miles offshore. Although you can't really see it in the above photo, the effects are devastating for wildlife. This summer, Florida was hit by an enormous, lingering red tide, also known as a harmful algae bloom (HAB), which occurs when algae grow out of control. HABs are toxic to fish, crabs, octopuses and other sea creatures, and this one resulted in the death of thousands of fish. When the HAB gets close enough to shore, it can also have an effect on air quality, making it harder for people to breathe.   

    The HAB is currently closest to land near Pinellas County in the Gulf of Mexico, where it is 5-10 miles offshore.

  • Recent Slide Shows

Comments

0 Comments

Comment Preview

Your name will appear as username ( settings | log out )

You may use these HTML tags and attributes: <a href=""> <b> <em> <strong> <i> <blockquote>