Enron all over again

(Fortune Magazine) -- Start with the headlines about off-balance-sheet entities known as structured investment vehicles, or SIVs (or sieves, as some wags are calling them). As Gertrude Stein never said, an off-balance-sheet vehicle is an off-balance-sheet vehicle is an off-balance-sheet vehicle. Just as Enron's off-balance-sheet vehicles were propping up its stock price by camouflaging the company's real financial results, so SIVs were inflating the credit market by providing demand for the complex securities created out of mortgages and loans used to finance buyouts. Like Enron's off-balance-sheet vehicles, SIVs were invisible to those on the outside--and to many on the inside--until they weren't. When times were good, these creations made money for their sponsors, but when times changed, they became a problem for the rest of us. It's a little bit like "heads I win, tails you lose," which is pretty much how a former Enron executive described that company's off-balance-sheet vehicles.

In both cases, part of the problem was that the rating agencies, which are supposed to serve as watchdogs, were blindly optimistic, either through sheer incompetence or because of conflicts of interest. Just as Enron's investment-grade rating--which it kept until four days before its bankruptcy--turned out to be an illusion, so did the investment-grade ratings on many mortgage-backed securities. "Structured finance," as the Street calls the black art of making one thing look like something else, couldn't transform Enron from a money-losing company into a moneymaking one, and it couldn't make subprime mortgages into investment-grade debt. Now the rating agencies are scrambling to explain why it isn't a problem that they are paid by the very people they're supposed to rate, and Congress is holding hearings. That's exactly what happened six years ago.

Just as with Enron, the messy truth here is that some of the victims are also the villains. Buyers of these complex mortgage-backed securities didn't understand what they were getting, just as buyers of Enron's stock didn't understand its accounting. But no one wants to remember two simple rules--some things are too good to be true, and be wary of Wall Streeters bearing gifts--when everyone seems to be making so much money. And the collateral damage always hits the true innocents, such as gas pipeline workers and homeowners.

While Marx may be right that history repeats itself, it rarely does so exactly. One of the biggest enablers of the Enron mess was the accounting firm Arthur Andersen. Today it appears that the accountants have gotten some backbone. In early October the Center for Audit Quality--which has the backing of the Final Four accounting firms--issued a paper saying that firms could not employ wishful thinking in valuing the complex securities on their books. And that just might explain the mammoth losses that firms are suddenly declaring.