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Mark-to-Fantasy Becomes an Ugly Reality with the Impact of (S&P) 500 Enrons
Throughout most of the history of America, assets were valued by either the amount of money they made you or the amount of money someone would buy them for. Not too long ago, the smartest guys in the room came up with an idea to value things by what we want them to be versus what they really were. Believe it or not, that is why we are never going to get a significant rate increase in the US, unless it is forced upon us by the markets… and when that rate increase does occur - BAM! Let me explain in more detail.
Enron was a diversified energy company and at it's demise was the largest corporate bankruptcy in American history. In the beginning, Enron's natural gas business was substantial and its accounting had been straightforward, ie. the cost to supply gas was matched with the revenues to delivering gas to customers in plain vanilla, discrete time periods (ex. quarters). Then this financial engineer named Ken Skilling joined the company and changed all of that. Now, the energy trading business used mark-to-model accounting, with the reasoning that such accounting represented "true economic value". Enron became the first non-financial company to use the method to account for its complex long-term contracts, although it's arguable that the contracts were financial in nature.
The Enron mark-to-model accounting requires that once a long-term contract was signed, income is estimated as the present value of net future cash flow. You see, the problem with that is that there aren’t too many of us that can predict the future very accurately, thus measuring future cash flows now is akin to counting ass hairs on a pink unicorn. Alas… I digress. Enron proceeded with this methodology anyway, and as you may have guessed, dramatically misleading results ensued (misleading to investors and shareholders, that is).
Modeled accounting DCF income would be recorded from these projects, but actual cash never arrived. In order for Enron to show rising earnings, they had to juice up the assumptions in the models, thus more accounting income was booked, but there was no cash to back it up. Never fear, the SEC approved the accounting method for Enron in its trading of natural gas futures contracts on January 30, 1992. Not being enough paper income for Enron, further boldened by the ruling and apparent support of the SEC, it then extrapolated its mark to model accounting methods and fictitious earnings methodology to other areas in the company. Why? Because Wall Street demands increasing accounting earnings over increasing economic value, so Enron simply used its models to help Wall Street realize its wishes. It was during this time that Enron actually emboldened the financial sector to get model-creative. After all they were getting away with it, weren't they?
In July 2000 (yeah, right about dot.com bubble burst time), Enron and that other well known energy sector company - Blockbuster Video (why didn’t anyone ask???) - signed a 20-year contract to introduce on-demand entertainment to various U.S. cities by year-end (you know, something like today’s Netflix streaming service). It only took a few pilot projects for Enron to recognize estimated profits of more than $110 million from the deal. When the network failed to work (as you knew it would when an energy company with shady accounting practices gets into the media distribution business), Blockbuster withdrew from the contract. Despite Blockbuster’s exit, Enron continued to book future (modeled) profits on a deal that actually and at the present resulted in a loss. Eventually, the Ponzi scheme collapsed, along with everything attached to it. Enron’s execs got into a lot of trouble, but the banking industry and many other industries took note and said, “Hey it may not too wise to push fake broadband, but the SEC and FASB ok’d the mark to fantasy thing. This was 2000. The rest is simply history.
In reviewing the chart below, be aware of the following facts:
- The data is taken from the Federal Reserve... Don't shoot the messenger!
- The primary input variable in most mark to model contraptions is the prevailing risk free interest rate - the same (not so) risk free rate that the world's central banks (including the Fed) are trying to so hard to synthetically suppress.
- The world's banks (and the US banks in particular) are responsible for funding companies, both through whole loans and through securities markets. If those banks' shrivel (ahem, Deustche Bank), then the loans and securitizations shrivel as well. That's why the ECB has spent hundreds of billions of EUR to prevent it and the Fed and the BOJ are well into the trillions. You know how that has turned out, right? If not, reference "ECB's Own Data Shows QE Program As Utter Failure, Largest Banks Dwindle, Depositor's Capital Eyed for Bail-Ins"
- If banks hit a cyclical and/or structural downturn, or if rates spike, or if regulators decide to outlaw lying about what's on the books... Watch out below...
Next up, I will show all how Veritaseum was designed to enable individuals and companies to sidestep much if not most of this nonsense. You see, Veritaseum allows zero trust transactions while enabling all to retain full control, custody, possession and ownership of your assets. You can't mark to model, or mark to fantasy, because the reality is always there in your face all to see.
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yep.. Reggie shouldn't let the details get in the way of a good story
Reggie, great to see you back on here.
Thumbs up for ........ass hairs on a pink unicorn.
So what are we thinking....? The trend is your friend? Run away? Keep Stacking PM's? Thoughts.... Disclaimers are assumed...
" Ken Skilling "?
Kenneth Lay = dead mofo
Jeffrey Skilling = prisoner in white collar institution with no bars.
Funny how I saw Ken Lay sipping umbrella drinks in Fiji a few years ago...
Speaking of Enron....look at Abengoa, they look like the FNM of green energy finance, which was not viable @ $100/ barrel oil (they're less viable now).
http://www.bloomberg.com/research/stocks/people/relationship.asp?personI...
Nobody wants to buy green electrons, they cost 400% more than non-green electrons and act exactly the same, you just feel 400% as smug buying them.
Reggie! longtime, no relevance, bud.
I'm always surprised to see you paid for you taking a swing so far behind the curve ball.
Nice article.
Good review of the debasement of GAAP.
500 Enrons; very good, very clear, very scary.
I was tracking Reggie on the subject of Enron untiil the Veritaseum thing then slowly drifted back to ass hairs on a pink unicorn.
Quality matters Reggie.
More so than Quantity.
Especially on such important matters as Accounting Debasement.
Wrecking Accounting to Hide Price Discovery is a pivotal part of the Bernanke fiction that has become the US Economy.
Would be nice if the chart expanded, only a pink unicorn can read that thing.
Reggie, you're one of my favorite commentators but for goodness sakes, have someone proofread your writings before they hit the wire.
"the amount of money someone would by them for. "
"measuring future cash flows now is akin to counting ass haird on a pink unicorn. "
I can see how possibly spell-check would miss "by them for," but "ass haird on a pink unicorn?"
Hairs, Reggie, Hairs!
Aren't you splitting hairs ?
Amen! add to that . . . "or the amount of money someone would by them for. . ."
Regulators will definitely not decide to outlaw lying.
Regulatory capture guarantees this.
Thus piss ant arrogant frat boys the likes of Ken Lay (though I think Ken is in hell now) and Jeff Skilling will continue to ass rape this world until they discover a new one.
Then they will ass rape it too.
There is no justice.
"Former Enron CEO Jeffrey Skilling succeeded in getting his prison sentence reduced by 10 years as part of a court-ordered reduction. U.S. District Judge Sim Lake of the Southern District of Texas announced at a hearing in Houston today that Skilling will serve 14 years. His original conviction called for him to serve 24 years in connection with the collapse of the once high-flying energy trading firm. Under the agreement with federal prosecutors, Skilling could be released as early as 2017."
Isn't that a punch in the nut sack!
Reality is for the weak, so take the blue pill and shitcan the red one.....
No Demand = Today = No Demand = Today etc.