Man Without Qualities

Friday, June 21, 2002

Enron Arbitrage

In a prior post the Man Without Qualities wrote:

[T]wo memos from Enron’s attorneys Stoel Rives ... and Brobeck have caused some fuss .... The Man Without Qualities has not commented on these memos (or the earlier story about a request by an employee of ISO, the State-created energy network, to Enron that it hike prices in at least one case in order to deny profits to a third party), because I have simply not been able to take the fuss seriously. For example, as Arnold Kling has pointed out, any sensible person ... who actually reads the memos should be left with the belief that the memos describe almost nothing but ordinary arbitrage moves decorated with silly names (Death Star, Fat Boy, etc). I agree with Mr. Kling. ... ...[E]ven the Stoel memo – described as the worst kind of “smoking gun" by Enron’s critics, such as Paul Krugman - quotes one Enron trader as describing one strategy as the “oldest game in the book” and then goes on to observe that “interestingly, this strategy appears to benefit the reliability of the ISO grid!” Does that sound like a "smoking gun?" The Brobeck memo is much more sophisticated and does much to explain why the Enron tactics did not amount to serious infractions. As Matt Miller put it: “[E]xperts parsing the details [of the “shocking memos] in court will show these practices are largely legal and common, they'll never work as a basis for getting California's money back.”

Since that earlier post, some very smart people with a lot of understanding of arbitrage economics have been studying Enron's activities, and some of them have posted the results of those studies on the internet, including Jonathan Falk, whose very interesting paper is summarized as follows on his web site:

In this paper the author critically examines the strategies cited as distorting the electricity market in California. Far from distorting the market, Mr. Falk finds that the majority of these strategies actually corrected potential distortions in complicated interrelated markets. He further concludes that to the extent that some of these strategies exploited market flaws to bring some of these markets out of alignment, there were obvious corrections available that policymakers should focus on rather than the futile, or at least unproductive, search for scapegoats.

The paper itself concludes:

[O]f the ten trading strategies cited by the memo, six increased market efficiency. There is no hint in any of the political invective that consumers and producers are clearly better off for the existence of the strategies named “Fat Boy” and “Get Shorty”. Other strategies, e.g. “Death Star,” had no impact on market efficiency at all. On balance, there is no evidence that Enron’s activities in California had any deleterious impact on electricity markets.

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