Enron is still driving the world crazy.
Enron inflated the paper worth of its assets to borrow against them– this theoretical value was the driver of their ability to keep growing and borrowing money.
Post their crash — the regulators and accountants got much tougher on valuation standards and created a tougher concept of “mark to market”. Here is a snapshot definition of this accounting treatment which is partially responsible for the turmoil in the markets today.
For a real world look–imagine this concept– your mother in law owns a home– it is 30 years old– when she bought it –newly constructed– the cost was $ 1 million. She got a $800,000 mortgage. The mortgage–interest and principle have all been paid off now and she owns the home outright–with no debt against it.
She owns the home outright and on her personal net worth statement she has valued the home conservatively at $ 2 million.
Theoretically– she could borrow 50 percent of the home value –or $ 1 million –from a bank on a credit line.
Let us say that she did that– and now she is paying interest on the $ 1 million loan. She has used the $1 million for her grand children’s college–and for vacations and for cash for a rainy day. Plus– to pay off the interest on the credit line.
Now let us say that 6 of her neighbors listed their homes for sale and none of them sold– conceptually– the homes now have ZERO value– and her home is worth zero on a mark to market basis– a snapshot right at this time of the theoretical value of her home.
Theoretically– she should mark her home to zero on her personal net worth statement and the banks could come and say– “give us back the $ 1 million we loaned you” because your home has zero value.
I know this is simplistic–but it kind of outlines what is happening in many cases as to what something is worth and how to value it.
We live in interesting times.
I hope not. With the fall of Enron, its employees lost their pensions, health insurance, and all financial security by investing in their company and, in turn, led to the slaughter. Deregulation of the banking and securities industry, with the help of Senator Phil Graham, allowed for it to happen. That same deregulation has lead to our current crises by allowing for, in part, the selling and packaging of sub-prime loans as bonds in the securities industry. The lines of banking and investing merged and as a result, the Financial Services Industry, curently the largestst US Idustry, is about to be taken under the government’s wing as a socialized institution. Government must learn from the abuses of Enron, and put the consumer first, but me thinks not.
while I have total respect for your opinion, this is such an inaccurate example; mark-to-market – like expensing stock options
– simply requires transparent, truthful disclosure; no more, no less
It was just a massive Ponzi scheme. Problem is the Fed is going to bail out the banks unlike Enron. Leaving tax payers and the middle class’ investments (401K) holding the bag.
The people who made out so big were the brokers. They just rubber stamped bad loans which were bought in bulk within a couple years. They didn’t care if the loans started to default because they would most likely be sold within a couple years. My loan was sold to another company within a year and I am sure it will end up selling again.