I'm reading Kurt Eichenwald's book on Enron entitled CONSPIRACY OF FOOLS. What I feared would be a dry and technical story is anything but. Highly fascinating; highly recommended. And you'll come away with opinions about selected members of the cast of characters that you may not have otherwise formed.

You're assuming the conclusion. Ribstein and Kirkendall would agree that if Enron agreed to assume the risk that no third party would buy the barges, then there is fraud. The problem is that, if Enron didn't agree to assume that risk, and merely gave, as Fastow told the prosecutors, a high level of assurance that a third-party buyer could be found, then substantial economic risk was shifted from the seller, and the transaction is completely legal. Unseemly, perhaps, but legal, and it was entirely commonplace in the timeframe in question for this sort of time-shifting of income realization to happen. To criminalize it retroactively and bring the hammer of the law down on third parties who had no reason to believe they were doing anything illegal is Kafkaesque, to say the least. The complaint Kirkendall and Ribstein make is that the prosecution didn't focus on the critical question of risk-shifting, but rather on smearing the legal transaction as illegal, while at the same time suppressing evidence that the transaction was legal. The jury was not even instructed that the transaction could be legal! Finally, though there were several people on the call where the alleged illegal agreement was made, including at least one cooperating government witness, the government did not call a single one of them to the stand.

I'm not assuming the conclusion, Ted, I'm drawing a conclusion based on the facts that I know. The evidence suggests, to me, that Fastow promised to buy back the barges, that Merrill Lynch expected him to buy back the barges and did the deal based on that representation, and that Fastow (through LJM) in fact bought back the barges. The phone call is not the only piece of evidence.

I noticed, for example, that one of Merrill's memos noted "reputational risk" as a risk factor in the deal. You don't do that with a plain vanilla financing.

Now, this may not add up to a criminal conviction. I have a lot of sympathy for the defendants here -- drawing the line between planning and fraud is hard. If I were on the jury, I might vote to acquit, and the 5th Circuit has a tough case. But we should not pretend that the transaction was perfectly legal or run of the mill. It wasn't, even in the pre-2001 era.

Thanks Tim. I have been meaning to get to the Eichenwald book. I found the Enron documentary a little disappointing, so I'm looking forward to a new take on it.

My problem with Tom's post is the repeated use of the phrase standard structured finance transaction or some such thing. Sales of assets in return for notes are standard finance transactions. So are lease-buybacks. So are leveraged leases. But lease-buybacks accounted for as true sales are not standard. They are fraudulent.

I was a structured finance attorney -- in Houston -- for Enron. Depending on how the deal was presented to me, I cannot imagine giving an opinion on this deal. I completely agree with Larry Ribstein about the overcriminalization of agency losses, but this is the criminalization of fraud, which has always been a crime. The fraud here is breaking FASB rules on what is a "true sale." Believe me, I have drilled into my brain what is a true sale and what is not and what is a gray area. If an outside attorney had even sensed a whiff of lease-buyback, hopefully they would have red-flagged it. This was an end-of-the-year deal. Corporations (especially Enron) loved to call outside lawyers at the end-of-the-year and tell them to paper these deals. As far as I can tell, no outside lawyers were called. (If someone can tell me differently, I would love to know.)

Also note that the barge was a power plant barge. The barge had a power plant on it. It was not a ship, or a yacht. It was a power plant, built to be mobile in case of political upheaval. Why would Merrill Lynch buy a power plant, with a loan from Enron, for this wacky price?

I am a criminologist. My primary research interest is "control fraud." These are frauds in which the person who controls a firm (typically the CEO) or a nation ("kleptocracy") uses the apparent legitimacy and power of the firm or nation to defraud customers, creditors, investors, and/or citizens. I was a senior regulator during the S&L debacle. I have a recently published book about control fraud and the debacle (The Best Way to Rob a Bank is to Own One. UTexas Press 2005) and am working on a book on the current wave of control frauds. I am the Executive Director of the Institute for Fraud Prevention. I have four comments about Larry's post and your response.

First, Larry is consistent. We had a discussion roughly 12 years ago, when I was still a regulator and he was with GMU, about the S&L debacle. I had written a proposal to study why the control frauds were overwhelmingly real estate developers and recent entrants to the industry. Larry said, "We don't need to study that; we know what caused the debacle." He went on to give the (in my view, erroneous) conventional economic wisdom about deposit insurance disabling private market discipline and combining with mass insolvency to produce widespread, severe moral hazard. I responded that one problem with that explanation was that it overpredicted fraud and "gambling for resurrection" -- over 3000 S&Ls were insolvent by mid-1982 but only about 300 S&Ls (the "high fliers") engaged in control fraud. (None of them engaged in honest "gambling for resurrection. See my "endnote" below for brief details, and our research (Black, Calavita & Pontell (1995); National Commission on Financial Institution Reform, Recovery and Enforcement (1993); Akerlof & Romer (1993) for support; Black (2005).)

Larry responded with the look reserved for the dullest of undergraduates and asked: "Did it ever occur to you that the others were just stupid?" I replied that we did entertain that hypothesis, but since every "high flier" failed and the great majority of the putatively "stupid" managers of traditional S&Ls survived we rejected the hypothesis. He was not pleased! But this is the reductio ad absurdum of a branch of law & economics: if you have an economic incentive to engage in control fraud but you do not do so you are not moral; you are "stupid."

Second, the criminology literature discusses "neutralization" techniques. These are measures perpetrators and their defenders use to try to reduce any psychological discomfort they might otherwise feel from harming others. Larry, is a classic example, but by no means an outlier among those who share similar ideological views on government. Dr. Mankiw, for example, after hearing Akerlof & Romer present their "Looting" paper at Brookings in 1993, criticized them, arguing that it would have been “irrational … not to loot” and that it “was only prudent … to loot” (in Akerlof & Romer 1993: 65). "Criminalization of agency costs" joins a long, sad line of rationalizations by economists for why crimes by elites aren't "really" crimes. Effective neutralization, unfortunately, leads to increased crime.

Third, the fraudulent "sale" technique Enron used with commercial and investment bankers was also used extensively in the debacle. It fooled Fischel, for example, into opining that Lincoln Savings and CenTrust were exceptionally profitable and well managed and posed no risk to the FSLIC. It did not fool experienced regulators in the field. Fischel opined that they were ignorant of economics and that their views added no value. The fake sales also deceived the markets successfully (and this was not due to deposit insurance or "regulatory accounting" -- these were GAAP financial statements and they deceived "at risk" voluntary participants, e.g., subordinated debt holders and shareholders and those who purchased participations from fraudulent S&L lead lenders).

The claim that these fake sales should be treated as real because they bear the risk that the co-conspirator may renege on the oral repurchase agreement (in circumstances where the deal is kept oral for the purpose of preventing the auditors, investors and/or regulators from learning of it) is a wonderful example of chutzpah! Talk about turning a (further) vice into virtue.

Fourth, like most white-collar criminologists I rarely use the word "evil," because it is so subjective a phrase and generally adds little value to the discussion. I wonder, however, why you were so quick to agree that the senior insiders, including Fastow, who destroyed Enron were NOT "evil." How can any of you know this? And what is your conception of "evil"? You seem to (implicitly) reject the concept that it could be banal. Fastow has confessed to actions that you know from your reading involved scores, probably hundreds, of acts of deceit in order to get even more wealthy. He betrayed everyone he had a duty to protect. He had no need to do so.

Skilling and Lay set up a compensation system that had two key elements: those who produced high "profits" would get the bulk of the bonuses and it did not matter that those "profits" were fictional and actually produced enormous, fatal losses. The CEO does not have to bring the SVPs and EVPs into the room and say: I want you to engage in massive accounting fraud. Economists believe that financial incentive structures largely determine behavior. Skilling and Lay embraced that view. Why is it so hard to believe that they intended the logical consequences of the compensation system they put in place? (An aside from Criminology: economic models overpredict control fraud because the most effective constraints on such frauds are often non-financial.) As I said, I don't know what "evil" means to others and I have no lens that lets me evaluate their souls, so I don't know whether Fastow, Lay, and Skilling, etc. were "evil." Larry cannot bring himself to see fellow elites as "real" criminals (though he, like Fischel in Payback, is very willing to see prosecutors as evil). But why are you so willing in the face of Larry's angry response to agree with him that they are not "evil"? Yes, the journalist you rely on sees Lay as wonderful -- so wonderful that he implies he was a great supporter of the (semi) whistle blower. In fact, Lay began researching whether he could fire her as soon as she (semi) blew the whistle.

{An endnote about the conventional wisdom about the debacle: Neither the high fliers nor the "traditional" S&Ls engaged in the form of "gambling for resurrection" that conventional finance theorists predicted. (I.e., none of them maximized the "put" option. Virtually all "traditional" S&Ls "gambled for resurrection" in the sense that they maintained substantial (but REDUCED -- not increased) exposure to interest rate risk -- but they WON those bets and greatly reduced the ultimate cost of the debacle. None of the high fliers acted in a manner consistent with HONEST gambling for resurrection. They were all control frauds, they all failed, and they followed characteristic business practices that were rational for frauds and irrational for honest gamblers.)}

Best,
Bill

William K. Black
Executive Director, Institute for Fraud Prevention

Mr. Black: You have attributed to me statements that I don't remember making. Alas, I'm sorry I don't even remember meeting you, though this meeting seems to have been a major event in your life. Although I don't remember the statements, my guess is that if we did have the conversation you're reporting, you're either mischaracterizing my statements or taking them out of context. But other than these minor quibbles, I agree with what I think was the point of your convoluted rehashing of the s & l prosecutions: That criminalization of fraud has been completely ineffective. That was your point, wasn't it?

Larry,

Yes, we've met. And yes, your tone in the meeting I described was the same as the tone of your current post. You made no substantive response to my analysis then or now. The tenor, context and content of your remarks to me about the S&L debacle is conveyed accurately in my post.

No, my meetings with the Keating Five, Speaker Wright, and Mr. Keating were "major events in my life." But self parody cannot be topped, so your comments stuck with me.

Your substantive position (apparently) is a belief that fraud should not be a crime. I do not agree and do not accept your bare assertion that making fraud a crime has been "completely ineffective." If you wish to try to demonstrate the accuracy of your conclusion I will be interested in your analysis.

Best,
Bill

William K. Black
Executive Director, Institute for Fraud Prevention

305457: Hey, does anyone know where I can find a list of gas stations with low prices in my area?