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Loopholes or illegality?

In yesterday's New York Times news analysis entitled "A Powerful, Flawed Witness Against Enron", it concluded, "Moreover, many traders, Mr. Belden included, seem to have thought that such manipulations were simply clever methods of taking advantage of poor rules, rather than illegality."

This is an interesting debate. According to my economist friend, individuals act to serve their self-interests and incentives. One of these is to find loopholes in the rules and take advantage of them. If the people who make the rules are not smart enough to spot the loopholes, could the individual be blamed for exploiting the loopholes?

Many academics have found that electricity markets are very susceptible to gaming. "Gaming" refers to the economic phenomenon of maximising value whenever there are more than two people transacting with each other. I defined it in my report years ago, "Gaming is the act of exercising market power to reap large profits. Gaming differs from arbitrage in that the former arises from persistent opportunities rather than a temporary advantage created by inefficiencies in the market. "

So if the rules aren't good enough, and individuals, as rational decision makers, identify the loopholes and "game" the system to make profit for themselves, could this be wrong?

Similarly, if a trader's mission is to make as much money for himself and the company, he will find and exercise trading strategies to do so. If an electricity trader follows company rules and market rules, making lots of money, but causing blackouts in the State of California, is he to blame?

21 October 2002 Monday

Enron links

Energy articles

Power pools - market power and gaming

Reaction from my economist friend to this entry:

I agree, though one must consider whether the strategies employed really were profit maximizing for the firm. Among many contributing factors, Enron may have suffered from a bad set of principal/agent problems. Their agents (traders) may have had incentives that were at odds with the principal's (Enron's) interests. At the very least, the time horizons may have been badly out of whack. So, you should take your question/analysis one step further -- can we blame the traders if Enron set up a stupid internal incentive structure?

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