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Wednesday, August 7, 2013

Transcript: Enron Lives, GDP changes, Galbraith Comments

James Galbraith from Pula Croatia.  More on his take later in the podcast.

Also: Enron Lives at JP Morgan, not just Goldman Sachs and Morgan Stanley
Listen to this episode
but first, we noted the revisions to the benchmark GDP numbers by the BEA last week pushed historic GDP up across the board, and particularly in 2012.  We have long argued that GDP numbers ought to be revised down for the destruction of the environment and to account for the health care sector by output rather than inputs, never mind that GDP conflates the production of bads with goods.

What were the major changes in the treatment of economic events that caused the improvement in numbers?
  • Expenditures by business, government, and nonprofit institutions serving households (NPISH) for research and development (R&D) are recognized as fixed investment. The new treatment improves BEA’s measures of fixed investment and allows users to better measure the effects of innovation and intangible assets on the economy.
  • Similarly, expenditures by private enterprises for the creation of entertainment, literary, and artistic originals are recognized as fixed investment, further expanding BEA’s measures of intangible assets.
  • In the NIPA fixed investment tables, a new category of investment, "intellectual property products," consists of research and development; entertainment, literary, and artistic originals; and software.
We leave you to ponder whether R&D is really fixed investment, or whether a new TV show is an investment.

Now.  Enron lives!

No sooner had I relayed the Senate hearing with Senator Elizabeth Warren and Professor Saule Omarova in a colloquy on whether the Enron business model had moved to big Wall Street houses like Morgan Stanley and Goldman Sachs, than the next day we get word that it is also at JP Morgan Chase.

Quoting from Reuters

July 30, 2013

(Reuters) - JPMorgan Chase agreed on Tuesday to pay $410 million to settle allegations of power market manipulation in California and the Midwest, the latest in a series of high-profile inquiries by U.S. federal energy regulators.

The settlement, announced by the Federal Energy Regulatory Commission (FERC), will allow Chief Executive Jamie Dimon to close the books on one of several costly run-ins with regulators over the past year. It came days after the bank said it was quitting the physical commodities business.

JPMorgan Ventures Energy Corp, the commodity trading unit that became one of the biggest U.S. electricity traders with the 2008 acquisition of Bear Stearns, agreed to pay a civil penalty of $285 million and disgorge $125 million for "manipulative bidding strategies" from September 2010 through November 2012.

It is the second largest penalty in FERC history, and comes as the once-quiet government regulator steps up its pursuit of market malfeasance after gaining expanded powers from Congress in 2005, part of efforts to crack down on market manipulation after Enron Corp's spectacular collapse.

JPMorgan spokesman Brian Marchiony said the settlement would "not have a material impact on our earnings" because the bank had previously set aside reserves.

FERC said JPMorgan admitted the facts in the agreement, but "did not admit or deny the violations."

From Forbes

JPMorgan Chase agreed to pay $410 million to settle charges with the Federal Energy Regulatory Commission (FERC) for manipulating electricity prices in the same markets Enron used to play its dirty tricks.  Under the supervision of Wall Street power woman Blythe Masters, who was reportedly under scrutiny but escaped sanction, a unit inherited by Bear Sterns designed bidding strategies to trick electronic systems and obtain massive compensation payments sometimes doubling market prices in California and Michigan.  The settlement comes as JPMorgan announced plans to get rid of its commodities unit, five years after Masters built it back up again, and also a few days after media reports suggested Goldman Sachs, JPMorgan, Morgan Stanley and others were manipulation key commodity markets including aluminum and copper.

As is usual in these types of cases, JPMorgan admitted its JP Morgan Ventures Energy Corporation (JPMVEC) developed 12 “manipulative bidding strategies designed to make profits from power plants that were usually out of the money in the marketplace,” but neither admits nor denies any wrongdoing.  Asked about why FERC agreed to this seeming contradiction, a spokesman for the Commission declined to comment.

After buying the failing Bear Stearns in the heat of the financial crisis in 2008, the bank run by Jamie Dimon inherited the rights to control the output of several antiquated power plants, some of them built in the 1950s and ‘60s which were inefficient to the point where they were out of the money, FERC explained.
These came under the purview of Blythe Masters, JPMorgan’s global head of commodities and one of the bank’s top executives.  The specific management of these landed in Francis Dunleavy’s lap, a former Bear Stearns employee, who supervised former Bear man Andrew Kittell and John Bartholomew who was familiar with the California market due to previous experience at SCE, a utility in the area.

Saddled with loss producing assets, the team at the Houston-based principle investments unit developed several bidding strategies which turned out some juicy profits.  Reporting directly to Masters, Dunleavy and his team showed how “asset optimization strateg[ies]” managed to  turn out tens of millions of dollars in profits from units that lost millions at market rates.

Said strategies were devised specifically to obtain above-market payments through bids that falsely appear economic to automated systems, sending low priced bids for wholesale energy and triggering compensation systems that resulted in higher electricity prices for rate payers and nice profits for JPMorgan.  Many of the plants were operated by the California Independent System Operator Corporation (CAISO), the same types of units being manipulated by Enron in the early 2000s.

JPMorgan has agreed to pay a civil penalty worth $285 million, and return $125 million in “unjust profits” which will go to ratepayers in California and Michigan, and to make annual reports to the commission for three years.  The settlement follows a string of victories by FERC which extracted payments from Deutsche Bank and Barclays recently.  The bank also managed to avoid personal sanction to its employees, including Masters, who was reported to be in their scope.  William Scherman, who represented Dunleavy, Kittell, and Bartholomew, noted his clients cooperated with authorities, adding they were prepared to defend their conduct in court.

FERC declined to comment on how Masters, who was said to have made “false and misleading statements under oath” by the New York Times, escaped personal penalties.  While JPMorgan wasn’t immediately available for comment, documents reportedly suggested Masters, who helped develop many of the exotic derivatives and instruments used ahead of the financial crisis, “falsely testified that she did not understand how the scheme made money, beyond a generic understanding that it was designed to maximize all sources of revenue.”

Tuesday’s settlement is the second big hit to Masters over the past few days, after JPMorgan announced plans to “explore strategic alternatives for its physical commodities business.”  Masters is credited with having built JPMorgan’s commodities business over the past five years.  Years before, Danny Masters, Blythe’s ex-husband, had been head of the global commodity business, which the company shut down between 1998 and 1999, according to ReutersForbes reached out to JPMorgan to inquire about the future of Ms. Masters, but hadn’t received a response at the time of publication.

Who is Blythe Masters? Quoting now from Wikipedia:

Responsible for the structuring and distribution of credit derivative products at J.P. Morgan, Masters became a managing director at 28, the youngest woman to achieve that status in the firm's history.[5] She is widely credited with creating the modern credit default swap.  In 1994, J.P. Morgan had extended a $4.8 billion credit line to Exxon, which faced the threat of $5 billion in punitive damages for the Exxon Valdez oil spill. A team of J.P. Morgan bankers led by Masters then sold the credit risk from the credit line to the European Bank of Reconstruction and Development in order to cut the reserves which J.P. Morgan was required to hold against Exxon's default, thus improving its own balance sheet. J.P. Morgan later bundled together packages of these loans and offered them to market as BISTRO, for Broad Index Secured Trust Offering, and these new financial instruments were quickly adopted by other banking institutions.

When derivatives played a role in the 2008 financial crisis, Masters was described by the UK newspaper The Guardian as "the woman who invented financial weapons of mass destruction".  

In 2006 she was named J.P. Morgan's head of Global Commodities. She has frequently represented the industry in Washington D.C. on everything from potential curbs on commodities trading to the financial regulatory overhaul.