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Talks by Mr. Stephen Young, Global Executive Director of the Caux Round Table 1.

Rise and Fall of Enron and Wall Street, 30th Jan12 2. The Agency Problem, 31th Jan12 Rise and Fall of Enron and Wall Street http://www.cauxroundtable.org/ Problem of intellect and value Intellectual model fail Rational market (theres a book by Justin Fox) http://blogs.hbr.org/fox/ http://www.yale.edu/polisci/people/jfox.html Causes of the fall; Intellectual arrogant <1> rationality of markets <2> accuracy of valuations <3> minimization of risk The only chart to know why financial collapse in US Eg: total credit market debt (all sectors) as % of US GDP

http://economicrot.blogspot.com/2009/02/national-debt-chart.html Moral arrogance lose sense of connection with other people Paradigm of failure: Asset Bubble - Value of company assets mis-priced as too high for long run eventualities - Value of company then accepted by markets at unrealistic long-term amount - When markets learn the truth, asset price collapses, company goes bankrupt ENRON - In reality a Ponzi Scheme http://en.wikipedia.org/wiki/Ponzi_scheme Fraud on the financial markets Use borrowed money to substitute for real earnings Actual cash flows not impressive Mark to Market Accounting Value assets at trading price Assumes market price is real price What can we sell for this for? Ted OConnell anecdote - $20 Mil present value of multiyear contract valued at $90 by ENRON trading desk. Blockbuster Video contract; ENRON value at $100 Mil net present value, while Blockbuster Video at $0

- Special Purpose Entity Sell assets along with segregated debt Book profit reported as net income and lower debt shown on ENRON balance sheet - Pretty Picture!! From 1996 to 2000 ENRONs reported revenues rose 750%-65% a year-unheard of success! - But; Special Purpose Vehicles capitalized with ENRON stock (3% ownership of entity) and some investor s equity. Accounting rules then permit Entity to be separate business not show up on ENRON books. Special Purpose Entity then borrow money from ENRON to buy ENRON Assets. If price of ENRON stock.. - Special sales of energy; ENRON would sell qty of energy to bank book money received as reportable income. BUT Separately ENRON would agree to buy back same amount of energy in 6 months at much higher price Implicit.. - Energy trading ENRON arranged to buy energy with no down payment for resale: pledge its stock to secure loan of energy Wall Street - Cycle of Asset Bubble Low interest rates and liquidity (recycled Chinese reserves) encourage Americans to buy houses; house prices rise and rise. Investors buy mortgages on US houses as secure investment; add more liquidity to mortgage market Mortgage brokers and local banks take fees up front to write mortgages Mortgages sold to big banks and Wall Street firms like Bear and Lehman Big Banks put small mortgages together in big groups and sell to institutional investors (securitized mortgages) Brokers and local banks and finance co like to make more money and have no liability if mortgages default (moral hazard) So give mortgages to anyone no controls on likely-hood of repayment (no doc loans Securitized mortgages bought by Wall Street firms through special purpose entities Entities borrow money to buy securitized mortgages Entities then sell securities (CDPs) which are a claim to part of the income from mortgagees received and the paid out by entities Institutional investors buy CDOs, adding more liquidity to the flow of funds into home mortgages Rating agency ie: Moodys play role. Rating agencies are corrupted. Inaccurate and biased ratings. Ie: pay small, get poor rating, pay more, get excellent rating.

- New business model Wall Street firms make fees on selling CDOs and trading securitized mortgages and CDOs Wall Street firms make money by borrowing money Old partnership go public; no longer partners money at risk; partner become staff; profit from bonuses and fees Making profits on trading generates most profit Borrow money, buy securities, sell securities at a profit, repay borrowed money Use complicated algorithms to predict risk, avoid loss, find arbitrage opportunities to profit, high frequency trading by computers Use academic theory of rational markets, efficient markets, reliable predictability of prices Ie: facebook projects out future valuation etc BUT Borrow money overnight to buy stocks (repo loans); pledge securities purchased for repayment Loans must be rolled over next day If price of securities drops, more collateral demanded by lenders or loans not rolled over trading firm hits a wall Bear and Lehman hit the wall and died Bear was bought; Lehman went bankrupt = death of Wall Street Govt had to rescue private markets failure of free market capitalism If US govt did not step in with guarantees, loans etc in Oct 2008

CITIBANK, AIG, Goldman Sachs and maybe Bank of America would also have failed Karl Marx had predicted free market capitalism would failed Collapse Avoided Elsewhere - Asset bubble not universal - Australian banks - Canadian banks - Thai banks - Different approach to valuation of sub-prime. Inherent weakness in riding a bubble; <1> too much debt <2> future profits uncertain quality of earnings low <3> compensation practices increased moral hazard short term gain chosen over long term risk <4> boards of directors supine enablers of managements stupidity Quranic principles; assumptions <1> Quran is addressed openly to all who can read or hear the message <2> Quran guidance of universal application Khalifa: leadership <1> thoughts, actions, are to meet standard of stewardship <2> responsibility to others, to the future, is our duty <3> money, power Amanah; <1> power, wealth, position given to us in trust to be used widely <2> consistent with khalifa stewardship .. Emotions (greed) and rationalization (illusion)