Derivatives and Evil at a West End theater in London
February 22, 2010
This past Monday my new employer, the London School of Economics, took me to see “Enron” to a theater. (As nice a perk as it gets for a financial sociologist like myself). For three hours, co-blogger Yuval Millo, myself and other colleagues watched with amusement the story of the company that symbolized the marriage of finance and fraud. Or derivatives and evil.
Although unexceptional as a play, the performance is a masterpiece at financial communication. “Enron” the play is no highbrow drama, but it sets the standard for how derivatives can be communicated to the public.
The plot is the well-known tragic story of three flawed but remarkable men. Ken Lay, Jeff Skilling and Andrew Fastow set out to conquer the world with an equal-part cocktail of financial innovation, free-market ideology and hard lobbying (Rebecca Mark also appears, but eventually is sidelined). Their story is eaten up by investors, and Enron becomes the darling of the world’s capital markets. Reality (profits, production, revenues) struggles to catch up. And their managers decide to close the gap through fraudulent financial engineering, enabled by minionic accountants, lawyers and bankers. See the Financial Times here if you want more of the actual company story. It’s gripping.
In the end, of course, no amount of social construction could keep the numbers at bay. Journalists ask difficult questions. Skilling breaks down. The firm collapses. Employees and investors are ruined. Fin. (The anti-performativity bloggers at OrgTheory will smile at this breakdown of the construction)
Sounds simplistic? It is, unfortunately. There is little “character development” through the play. The playwright, 28 year old Lucy Prebble, did not include a hint of the reflectiveness that makes, say the character of Edmund so compelling in Shakespeare’s King Lear. None of Hamlet’s self-doubt. No single positive aspect of Skilling worth reporting.
And yet I think the play is an absolute triumph. Its goal, as I see it, is not complexifying the simple but rather simplifying the complex. In effect, Enron is a masterpiece at communication. It tells how derivatives and financial engineering can enable fraud with the directness of a Spanish baroque painting.
Indeed, Enron reaches climax when Andrew Fastow proposes LJM, the off-balance sheet vehicle that would buy toxic Enron-generated assets. This allowed the company to falsely mark its derivatives positions at a profit. The initiative would normally be illegal, as the law requires that the firms that buy such debt be independent from the management of the company that sells it. But Fastow found a loophole. Enron could own three percent of the independent company. And that company could itself be three percent owned by another one. And so on, such that Fastow could create a pyramid structure that controlled a seemingly-independent company.
This point was amazingly well made in the play using a device of boxes-within-boxes. A single small box could hold a bigger one, which in turn could hold a bigger one. As Fastow made this point, he vividly grabbed the smallest box, and it suddenly became illuminated with a red LED light. Waving the light like a magician, he conveyed his idea to Skilling, who proceeded to make Fastow chief financial officer. As this happened, the spectator sitting on my left (a professor of human resource management) uttered “aha!”. He was having an epiphany. Nine years after the event, he had finally understood Enron’s fraud.
Or take the “raptors,” the financial vehicles that “followed” Enron and ate up the debt that it created. These were represented as man-sized dinosaurs, clad in a suit and with red eyes. They opened up suitcases full of dollar bills and ate them up, often chocking on them. Again, brilliant, effective, memorable.
Enron, in short, is exemplary in starting a course that many should follow. Bridging the gap between the few who understand derivatives, and the many who suffer their consequences. It also opens up many questions about the nature of communications when derivatives are involved: are banks handling well their communications? are politicians explaining well their macroeconomic policies? are hedge funds wise to keep mum about themselves and let the public stereotype them?