Find It

It all began with Enron

By Kennedy Maize

At a pleasant Christmas dinner with friends last week, a smart diner posed a question: when should the government or the market have known that the U.S. (and the world’s, as it turns out) financial system was in life-threatening peril?

After pausing to scratch my head, I proffered an idea: it all began with Enron. Just a thought, a top-of-the-head proposition fueled by a glass of good wine, but worth contemplation.

My notion was not obvious, even to me, and I thought about it before I tossed it up for conversation. After further consideration, it’s an interesting proposition. I’m not sure of its explanatory efficacy, but I offer it for your consideration. It’s about market psychology.

Before Enron, many of us thought we understood financial markets, including trading in derivatives. It was all about the fundamentals: risk versus reward. Welcome to Vegas (where the bookies always have better market information than the punters). Package the risks and sell them to hedgers. Let the market sort out the winners and losers.

That approach to markets seemed to work well until 2001, when Enron’s market plays went south in a major way, just about the time terrorists struck New York and Washington. I described it at the time, borrowing from one of my favorite authors, Baltimore’s Edgar Allen Poe, as the “Fall of the House of Enron.” The analogy between Poe’s House of Usher and Enron was chilling. The houses fell beyond the comprehension of the observers of the day.

It turns out that Enron was engaged in multiple, complex derivative-based trades, meshed with deals for physical assets, so convoluted that even the geniuses at the Houston-based energy company couldn’t parse or value them. Enron, once a straight-forward gas pipeline company, became an energy and bandwidth trading conglomerate – much of it existing in the virtual world – too strange to comprehend.

The Enron folks were masters of the financial universe; they told us so repeatedly. The company had a greater percentage of employees with advanced degrees than any other major firm in the U.S. PhD’s and MBA’s abounded. Clerks had honors degrees in economics. Lawyers carried CEO Ken Lay’s briefcase. Lay had a doctorate in economics, as well as a pious self-image as a devout, practicing Christian. What a company!

The argument I posited last week over roast goose and gravy was that Enron opened our minds – the simplistic minds of some regulators, some investors, some reporters – to the notion that perhaps our financial institutions weren’t as transparent and straightforward as we believed. Maybe they were so complex that neither we, nor the Enron folks playing the markets, could really understand them. Maybe there was a need for real regulation?

After Enron crashed, investor faith in markets began to erode. Good thing, too. When the housing bubble burst in 2007 and 2008 and investigators started probing the derivatives game (as well as the role of short-selling in conventional markets), the resulting picture was frightening. Who knew that Wall Street brokers (and some significant streets in Washington) were packaging lousy mortgages (the term of art is “sub-prime”) with sound investments, slicing and dicing them (“securitizing” is the buzzword, which those who lived through electricity restructuring understand), and selling them to investors with no immediate interest in whether the debtors performed?

Sound mortgages and bad loans went into the same financial meat grinder, producing a sausage of debt-based derivatives that tasted just fine but were tainted with bad ingredients. No financial regulator – the equivalent of the now-discredited Food and Drug Administration – was able or willing to take the toxic products off the shelf. The market invented its own regulatory mechanism – credit default swaps – that quickly turned into another way to gamble on the markets.

Following my riff on how Enron started it all, I came across a fine column by Joseph Stiglitz, a Nobel laureate in economics and former Clinton administration advisor, writing in the January 2009 edition of Vanity Fair. Stiglitz noted that in the aftermath of the Enron and WorldCom failures, Congress passed the Sarbanes-Oxley Act, designed to pour more light into the convoluted financial transactions that led the telecom and energy companies to financial ashes.

Congress, Stiglitz observed, ducked a “fundamental, underlying problem” in the markets: stock options. Sarbanes-Oxley, as a result of heavy lobbying from the financial folk, didn’t regulate the use of options to price companies and reward executives. Options, Stiglitz argued, are a lousy way to value a company’s performance. They create perverse incentives for bad accounting: the need to pump up the companies’ performance overcomes the necessity to provide accurate information about the actual results of the firms. That means lies distorting the ability of investors and regulators (if such exist) to suss out the real profits and losses of the high-flying firms.

In the words of the late, great songwriter E.Y. “Yip” Harberg, “Say it’s only a paper moon, sailing over a cardboard sea. But it wouldn’t be make-believe if you believed in me.” In short, the market depended on belief, or a suspension of disbelief, on the part of investors that these investments could never go sour. That belief held for many years. Along came Enron.

Enron’s collapse made belief in financial markets far tougher. As the sub-prime mortgages surfaced and defaults accumulated in 2007, the market kicked into cascading disbelief and cynicism. Credit cramped up across the board. The result of Sarbanes-Oxley in the real world was less transparency and more financial constipation, the exact opposite of the law’s intentions.

Enron’s destruction in 2001 didn’t trigger the financial collapse of 2007-2008. But Enron lifted a veil on the malignant machinations of the market-makers that came to light last year, creating a climate of distrust of all markets and all market dynamics. We will see how this plays out in the next four years of the Obama administration.

I’d love to hear from readers with their thoughts on this very crucial and difficult subject.

Obama, Cabinet government, and John Holdren

By Kennedy Maize

Some of my friends on the left have been lamenting the Cabinet choices of president-elect Barack Obama. One of them wrote in an email recently, “As the new government was put together, brick by brick, a disturbing pattern emerged. Time and again, those who had braved the perils of the Clinton… threat were passed over for those who came quite late to the party. Only Obama’s Illinois base prospered among his early supporters. The result: with the exception of Clinton, a bland and generally faceless cabinet.”

I don’t buy it. I don’t put much stock in Cabinet government. The Cabinet hasn’t been a major force in policymaking going back to the Johnson administration. Maybe it was in Kennedy and Ike, although the record isn’t very clear.

Cabinet secretaries and agency heads are mostly figureheads, unless they have some special relationship with the president. I suspect the same will be the case with Obama. “Bland and faceless” is par for the course. Probably desirable. Robert Reich, neither bland nor faceless, was not a successful Secretary of Labor.
I’d focus on who plays pickup hoops with Obama, more than who sits at the Cabinet table. A solid 15-foot jumper will count for a lot with this White House. And that’s fine, as the president should rely on his own crowd, while taking seriously what his agencies tell him. Ultimately, the choices are Obama’s, not those of the agencies.

Take the Department of Energy (please). Steve Chu, with a Nobel in physics, has scientific cred (although DOE’s credibility as a science agency is vastly suspect). Bush’s final DOE appointment, Sam Bodman, also had some scientific credibility; look what it got him.

I’m not aware of any personal connection of Chu to Obama. The appointment is a look-good, feel-good choice (unless Chu has a really good cross-over dribble). Energy policy gets cooked in the White House political oven, not the DOE microwave.

Look at Colorado Sen. Ken Salazar for the Department of Interior, a good choice. Has Obama ever demonstrated any significant interest in what Interior does? I’m not aware of it.

EPA? Ditto.

When it comes to the formal White House staff, the situation is similar. White House Council on Environmental Quality? Nancy Sutley is a friend and an exceptionally-competent individual. She won’t be calling policy shots, but supporting them. She will be a technician, not a policymaker.

The same pertains with White House environmental and energy advisor Carol Browner (mistakenly labeled, shudder, “energy czar”), and White House science advisor John Holdren of Harvard’s Kennedy School of government.

Holdren, to my mind, is a classic science policy fraud, who has mind-melded the Obama folks by his learned, bearded credentials. I wholly share — after some 30 years of interactions with Holdren — the judgment of John Tierney of the New York Times [http://tierneylab.blogs.nytimes.com/2008/12/19/flawed-science-advice-for-obama/].

Tierney, the best science columnist now writing, said of Holdren on Dec. 19: “Does being spectacularly wrong about a major issue in your field of expertise hurt your chances of becoming the presidential science advisor? Apparently not, judging by reports from DotEarth <http://dotearth.blogs.nytimes.com/2008/12/18/a-strong-voice-on-co2-as-science-adviser/> and ScienceInsider <http://blogs.sciencemag.org/scienceinsider/2008/12/sources-john-ho.html> that Barack Obama will name John P. Holdren as his science advisor on Saturday. [UPDATE: Mr. Obama did indeed pick Dr. Holdren. <http://www.nytimes.com/2008/12/21/us/politics/21science.html?ref=science>]“

I doubt that Holdren will be more than a nod by the administration to the current notion that that Bush administration censored “sound science” in favor of “political science.”’ I suspect Holdren will recommend a retreat from the Bush administration’s anti-scientific views on subjects such as stem cell research. That’s good.

On energy issues, Holdren represents “scientific correctness,” a totally repulsive notion when it comes to energy policy and climate science. But I suspect the science from the White House will clash head-on with the science from coal interests in Congress. The result: a fundamental stalemate, papered-over with unworkable schemes involving cap-and-trade prestigitation.

In Washington, everything is political, including science, law, accounting, history, medicine, and auto mechanics. I once told a coal industry group in a speech at a convention, when they were lamenting about the junk science involved with acid rain, “In Washington, you can have all the science you can buy.”

Enough of my rambling about the odious Holdren. Back to my major point. Appointments generally don’t matter. Obama will pay attention to folks he knows and trusts, and draw on his staff (including his cabinet) to cover his back. Most of Obama’s closest advisors won’t be Senate-confirmed officials, but White House insiders — David Axelrod, Rahm Emanuel, Valerie Jarrett, and the like.

Call me cynical. But that’s the Washington I know.

Another downside to wind power

By Kennedy Maize

Here’s an interesting new wrinkle on wind power, from a researcher at the University of Illinois. According to Somnath Baidya Roy, turbulence from large wind farms can harm growth of crops in the local countryside.

Baidya Roy notes that in recent years, wind power has moved from small, isolated turbines to large farms containing a large array of turbines connected to the electric grid. In northwest Iowa, he observes, a wind farm has more than 600 wind machines, sending some power to more than 140,000 homes.

If wind is going to make a greater contribution to national generating capacity, the wind farms must be far larger, he says. “If wind is to be a major player in global electrical production,” says Baidya Roy, “we have to think in terms of even larger scales – of say, thousands of turbines per wind farm. Such a wind farm could replace 10 coal-fired power plants, but with so many turbines, turbulence could generate huge problems.”

Turbulence creates two environmental externalities for wind generation, says Baidya Roy. First, turbulence can interfere with the windmills, reducing their efficiency. On top of that, turbulence from the turbine rotors can also mess up local ground temperature and moisture levels. “Turbulence creates stronger mixing of heat and moisture,” he says, “which causes the land surface to become warmer and drier. This change in local hydrometeorological conditions can affect growth of crops within the wind farm.”

What to do? Baidya Roy suggests greater understanding of land use planning, looking for places to site wind farms where wind flows freely, without obstructions such as trees and mountains. That means wind developers should avoid tops of mountain ranges, where the wind resources are plentiful, but the surface friction is high. Baidya Roy says “frictional dissipation” is the enemy of efficient wind projects. He is using a 25-year collection of data from surface weather stations, radiosonds and satellites to map wind’s frictional dissipation around the world.

Where are the wind wonderlands? According to Baidya Roy’s mapping project, eastern and central Africa, western Australia, eastern China, south Argentina and Chile, northern Amazonia, the northeastern U.S., and Greenland are the best hosts for low-impact wind farms.

Obama to make energy and environment picks

By Kennedy Maize

The Obama administration has picked Steven Chu, currently the director of the Department of Energy’s Lawrence Berkeley National Laboratory, to be secretary of energy. The selection was quite a surprise, as Chu’s name had not surfaced in any of the rumors circulating in Washington. Indeed, he’s not well know in Washington political circles.

Chu is a respected scientist, having won the Nobel Prize in physics in 1997 for work on laser trapping of atoms. He’s also on record as concerned about global warming and how to combat climate change. He told the Washington Post in a 2007 interview, “I was following it just as a citizen and getting increasingly alarmed. Many of our best basic scientists realize that this is getting down to a crisis situation.” Chu would be the first scientist to head DOE, one of the two largest science agencies in the federal government (the other is the National Institutes of Health).

Chu comes from a well-educated Chinese family. His father emigrated to the U.S. In 1943 to pursue advanced studies in chemical engineering at MIT. His mother followed two years later to study advanced economics, according to his Nobel biography. He was born in 1948.

Chu’s undergraduate degrees were in physics and mathematics from the University of Rochester. His Ph.D. is in physics from the University of California at Berkeley. He became head of LBL in 2004, and also holds a faculty position at Stanford University.

His nomination would be a tacit acknowledgment that energy policy will not be set at the Department of Energy (it never really has been), but at the White House. Further support for that analysis: President-elect Obama is said to be naming former Clinton administration Environmental Protection Agency administrator Carol Browner as White House energy “czar.” What that means in specific terms is unclear, but it clearly signals that the White House will be calling policy shots on energy and environment. Browner was a key aide to Vice President Al Gore, who wore the White House policy hat on energy and environment in the Clinton years.

A former Browner aide, Lisa Jackson, is set to be the EPA nominee. Most recently, she’s been chief of staff to New Jersey Democratic Gov. John Corzine, and was Garden State environmental chief under Corzine before that. In keeping with Obama’s diversity agenda, Jackson is black and grew up in the Ninth Ward of New Orleans. Jackson, 46, is a chemical engineer from Princeton. She was a key Browner aide during the Clinton administration. Again, the White House, not the EPA, will be calling environmental policy choices. Cabinet officers don’t make decisions in Washington; they implement them.

At the White House Council on Environmental Quality, Obama appears ready to name Nancy Sutley to head the group. Sutley, a white woman and lesbian activist, has been deputy mayor for energy and environment to Los Angeles Mayor Antonio Villaraigosa. Sutley has an undergradute degree from Cornell University and a masters from Harvard’s Kennedy School.

Sutley worked as a policy analyst in Washington for a lobbying group representing non-utility electric generators in the early 1990s. In 1993, she joined the EPA as an advisor to Browner. From there, she moved to an EPA slot in California, to the administration of former Democratic Gov. Gray Davis, and then into the state Water Resources Board and the Los Angeles city government. She has a reputation as being very smart and quite pragmatic. She originally was a Hillary Clinton supporter for the Democratic presidential nomination.

It’s the name game at DOE

By Kennedy Maize
It’s time for the latest round of the name game, this time focusing on who President Elect Obama will pick to head the Department of Energy. Clearly, the the DOE pick is a second-level decision, after economics and national security.

In fact, DOE really doesn’t have much to do with energy. Around 20% of DOE’s $20+ billion budget goes for “energy,” and much of that is basic science that used to be part of NSF. DOE has almost nothing to do with electricity.
The Federal Energy Regulatory Commission and the Department of Agriculture’s Rural Utilities Service have far more to say about electric energy in the US than DOE. Interior has far more to say about coal, oil, and gas. What they all have to say isn’t always to my taste, but they are players. Bodmanland is not.
Let’s start a contest. Who is going to to be the next energy secretary? Here are my top-three entries. Feel free to add your own, and we will see who got it right when the announcements are made.
These picks are not based on my wishes, but my sussing out of the scene. If I could name the choice, it would be Al Franken. A comedian would fit in nicely at Forrestal.
Maize’s No. 1 pick: Phil Sharp, the absolutely correct choice from a political standpoint. PhD (this seems to be important in Obamastan). Former important House player from Indiana and House Energy and Commerce subcommittee chairman, former Kennedy School academic, currently major domo at a major think tank (Resources for the Future, in Washington). Phil’s a moderate pragmatist in the Obama mold, and has, to my knowledge, no important enemies.

No. 2: Ernie Moniz of the MIT physics department (a long-time ally of John Deutch of MIT’s chemistry department and Carter and Clinton-era principal). Moniz energy undersecretary in Clinton’s DOE, and in the White House science policy office for Clinton before that. He’s smart, knows the territory, and also has no significant enemies that I’m aware of. The fact that he actually knows something about energy is not necessarily disqualifying. Expertise has never been a prerequisite at DOE (Charles Duncan, James Edwards, John Herrington, Bill Richardson, Federico Pena, Spence Abraham, to name a few). Nor has it been a guarantor of success: Jim Schlesinger, Don Hodel, Hazel O’Leary, Sam Bodman.

No. 3: John Bryson, former CEO of Edison International (Southern California Edison), former member of the California Public Utilities Commission, and a founder of NRDC. He’s smart, wiley, and ingratiating. He’s got some of the attributes of the Cheshire Cat. I wouldn’t pick him for anything, but I’m not part of the Obama administration.

Dark horse longshot: Betsy Moler of Exelon (ComEd and PECO). Moler is a former deputy energy secretary who should have won the job when Bill Richardson stepped down. She’s also a former FERC chair, former Senate Energy Committee key aide, and put herself through law school while working as a Senate clerk. Her rabbi is John Rowe, who has solid Obama contacts in Chicago. The downside is that she’s making wheelbarrows of money after years of comfortable but limited income in government. Also, Moler’s a bit tarred with the ludicrous Clinton administration (Richardson) pursuit of the baseless Wen Ho Lee spying charges.

Feel free to weigh in with your choices or observations or critiques of my choices. Why not have fun when the new folks come to town?

About

Find It

Recently Written

Archives

It all began with Enron

Obama, Cabinet government, and John Holdren

Another downside to wind power

Obama to make energy and environment picks

It’s the name game at DOE

Subscribe to POWERnews