Urban Dictionary defines “Cluster Fuck” as follows: A completely unorganized gathering of people, usually involving a task that all the people must complete.
Here’s a good example of a Cluster Fuck:
“Existing law provides for the furnishing of utility services, including residential electrical, gas, heat, and water services, by privately owned public utilities subject to the jurisdiction and control of the Public Utilities Commission and similar services by publicly owned public utilities including municipal corporations subject to their governing bodies and municipal utility districts and public utility districts subject to their boards and directors. The bill would amend the Public Utilities Act to require that the commission undertake various actions, including the facilitation of the efforts of the state’s electrical corporations to develop and obtain authorization of the Federal Energy Regulatory Commission for…”
Don’t read that. It will make your fucking head hurt. Here’s the translation: The State of California will henceforth colossally fuck up electricity. I mean, electricity is hard enough to understand. What the fuck is an ohm? Fuck if I know. But despite over 125 years of all that shit working just fine, in 1996 California passed AB1890 to unorganize the fuck out of electricity by deregulating its power markets. They did this for a lot of reasons, but mainly because the power utilities got kinda tired of making consistent, government-guaranteed profits. That’s no way to live. So to sex things up, they lobbied the politicians to separate power generation from power distribution. The idea was to leave the boring-ass power making business to the government and create sexy-ass new companies, in a free and open retail electricity market, to delight their customers with an amazing, low-cost energy experience.
Meanwhile back in Houston, Kenneth Lay is building Enron Corporation into the darling of Wall Street. Enron started in the natural gas business in the mid-80’s, but by the late 90’s they had grown like mad through acquisition and now played all over the fucking place, among which was the trading of deregulated commodities and energy. In 1999, Jeff Skilling is named President and CEO of Enron Corporation. Skilling joined Enron in 1990 to head up the trading business and as California and other states deregulated power, Skilling staffs up and goes big into the power trading.
Which was like taking candy from a baby because the newly deregulated state power market was amateur shit, and Enron didn’t fuck around. Under Skilling’s leadership, Enron Energy Services (EES) is out buying cheap power distribution rights from knuckleheaded state regulators while Skilling is building up a formidable energy trading desk.
One such distribution right, what is known as Path 26, was the primary power artery between Northern and Southern California. This is kinda important, because if Path 26 if unavailable, there is really only one other viable route for electricity to get from the power generators in Socal to the power consumers in Norcal. That is backup Path 15. So Enron is like, fuck man, this is crazy, let’s just buy majority distribution rights on Path 15 as well, and then Cali is our bitch. And so they do. And their traders order up their energy distribution guys to clog the main path to jack prices on the main path and then clog the backup path to turn off the lights. And the result is rolling blackouts and total price control. Fucking madness.
But fuck, Enron owned similar rights in a bunch of Western states, and they soon realized they could do shit like buy overpriced power from Cali at $250, sell it to Arizona for $1200 and then resell it back to California for $12,000.
And the shit gets crazier. With power prices going ape-shit, businesses started to freak out because their profits were predicated on predictable energy costs and 20X spike could totally fuck them. But hey, Enron had a solution for that as well. They had another desk that sold contracts on energy futures, allowing businesses to lock in prices at todays inflated rates. It’s a fucking hell of a hustle.
But while the trading desks are balling, Enron was also into some pretty fucking capital intensive shit like laying pipelines and trenching fiber optic cables. And despite the collective hard-ons they were causing on Wall Street, a very few people started to wonder, hmmm… Enron is into shitloads of businesses, some of which are pretty old school and maybe not so profitable. But what the fuck, they are trading at 70X earnings (I shit you not) and 6X book value. What are they, exactly? A power company? A telecommunications company? A fucking hedge fund?
One such person was James Chanos. Chanos was running a short-only investment fund and he had a knack for asking questions. When shit seems too good to be true, it probably isn’t and 70X earnings and 6X book value this shit was too good to be true. So one day, his homie, another hedge fund guy from Houston, calls him and asks if he saw a “Heard on the Street” article in the Houston edition of the WSJ. He hadn’t but he was curious so he looked into it and ‘the fuck, shit was not right. Chanos is a researcher at heart. He knows the answers are the answers, and they are there for the taking despite the bullshit. He digs in, pulling the 1999 10K’s and 10Q’s and he sees that they have all these funky offshore entities, with names like JLM II and Raptor, that they use to funnel money to and from Enron. The gains from these entities were often booked as revenue but the losses were written off deep in the financials (they took the profits, but didn’t take the losses). And what is stranger, these entities were often ran by Enron officers, which is fucking weird. A dude can barely chew gum and walk, how the fuck are they running both Enron and JLM II or some such shit in the Bahamas? He then clicks into their accounting and sees that their results are calculated using “mark-to-market” and “mark-to-model” accounting methods to book “gain-on-sale” returns of future energy contracts as current profits. This is maybe more complex than electricity, but in essence, Enron was selling long-term energy contracts to their sucker customers in California and elsewhere, and booking the contracts as current revenue, based on “optimistic” prices in a highly elastic energy market. They are manufacturing profits out of thin air. So net net: he calculates that Enrons return-on-capital is in the range of 6–7% (fucking low) and with tractors and power plants and shit, their costs are almost certainly greater than that. They are losing money and the books are a fucking sham.
So by late 2000, Chanos goes short and between November 2000 and December 2001 Enron’s stock goes from the mid-70’s to zero.
I fucking love the shorts. Computers can trade a trend but shorting is still a human game (for now). It may be hella frightening when a computer beats a grandmaster at Go, but put that motherfucking machine on a high-stakes poker table and let’s see who’s boss. In a short so much can go wrong. Go long and at worst, you lost all your money. But go short and the losses are theoretically unlimited. You can be 1000% right on the fundamentals but get the timing wrong and lose big. You are in the fucking wilderness when you bet against the trend. Markets love nothing more than the smell of a short squeeze in the morning.
Chanos is a stud and this is an amazing short. They say his firm made $500M, which is cool, but to call bullshit on fucking Enron at the height of the bullshit cycle, fuck yeah.
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