Tuesday, July 28, 2009

Trading: "Was Enron Right?"

Martin Hutchinson was UPI's Business and Economics editor. He's pretty sharp and this piece had a line that caught my eye.
From Prudent Bear:

The mammoth profits reported by Goldman Sachs and the investment banking end of JP Morgan Chase last week surprised markets and demonstrated once again the power of trading operations to earn spectacular returns, for their protagonists and even occasionally for investors. It was of course the theory of Jeff Skilling and the late lamented Enron that in the new wired world, business would increasingly be done from trading platforms to the great benefit of all. So was Enron not an obviously malevolent scam that deserved to get its top official a 25-year jail term, but a noble misunderstood pioneer of 21st century business?

The Enron thesis was an attractive one at first blush. Commodity and energy distribution is an expensive business, but the advent of Internet technology and efficient communications enabled costs to be taken out of it by making each stage of the distribution process tradable, with price discovery through open bidding rather than by wholesalers negotiating individually with utilities. Similarly, financial services could be made more efficient by taking loans off balance sheets through securitization, enabling home mortgages to be traded in bulk across New York trading desks and packaged to investors in Dusseldorf. Removing all those middlemen and shining the light of the market into obscure local operations should both normalize prices and reduce costs.

It all sounded very plausible when I heard Jeff Skilling expound it at a conference in April 2001, even as Enron's stock prices had gone into unexpected freefall. Whatever the man's failings, he gave a hell of a presentation.

We now know the fate of Enron and the home mortgage securitization market, which suggests there had to have been a flaw in Skilling's glossy presentation, whether applied to energy or financial markets. Nevertheless, Goldman's, JP Morgan's and indeed Bank of America's most recent earnings (the latter of which rested largely on good results at Merrill Lynch) suggest that 25-year jail sentences are not the inevitable outcome of practicing this theory; great wealth may also eventuate, at least for traders.

Trading is among the most intellectually opaque of all ways of making money. Modest analysis can uncover the secrets of profitability at almost all businesses, at least post facto, but not those of trading. Traders seem no cleverer than the rest of us, and rather less endowed with charm, although they clearly have excellent nerves. They are also unable to explain how they make money, or at least extremely unwilling to do so. Even books such as the excellent if annoyingly arrogant best-sellers of successful ex-traders such as Nassim Nicholas Taleb offer little further enlightenment beyond massive helpings of rather dubious philosophy.

One can understand "buy low and sell high." But if it were as easy as that, why couldn't everybody do it? Furthermore, why are the most successful traders almost all concentrated in the same houses? There appears to the naked eye very little difference between a trader at Goldman Sachs and a trader at a second-tier European bank, yet only the Goldman guy is likely to become seriously rich.

There are two major secrets to success as a trader....MORE