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Scoundrels, economists, the game theory and moral hazard theory

Raśl Escalante writes: "I read the Game Theory and Enron emails in reverse order and could not figure out where Game Theory came into the picture. Game theory does have a role in the economics that study phenomena such as frauds, but it is a secondary one. [Well, the tiddlewinks I saw being used to train young bankers were obviously to teach them how to play the market in places like Latin America.RH].

The branch of economics that would predict the Enron debacle is Moral Hazard Theory. Among other tools, Moral Hazard models occasionally use game simulations and game mathematical modelling to predict the probable outcome of different situations in which a person's moral integrity is put to the test (to put it simply). I have never seen people playing tiddlywinks to learn game theory, but would have probably appreciated it when studying for my Bachelor's. My own thesis involved game modelling of moral hazard situations in credit/savings cooperatives.

The practical applications of Moral Hazard Theory are usually the design of systems and processes in which the interests of someone who "owns" a resource (called the "principal") are not well aligned with those of the person who manages that resource (called the "agent"), or in which one person in a transaction has more information than others (information assymetry). These systems and processes sometimes fail to protect the principals from the agents' voracity and lack of scruple, for which they should be rigorously punished (the "agents", of course). Ritual castration should be considered, although that would probably not be sanctioned by human rights groups and would not be a solution for female "agents". As far as I know, MHT is not used to predict the future.

The Economist published a very interesting article on the moral hazard implications of Audit firms selling consulting and other services. The conclusions basically state that a far closer look should be taken into the rules that apply to auditors in order to prevent Enron style scams, which I am sure we'd all agree on".

Bob Crow says: "One should be careful about terms like "no intrinsic" value in referring to derivatives -- or anything for that matter. Derivatives have an important and legitimate role in managing risk. In fact, one of the major contributors to the California electricity debacle was that the Public Utility Commission did not allow a derivatives market. Thus, purchasers could not lock in prices over the intermediate to long run and we were at the mercy of spot markets and the ability to manipulate them".

My comment: My understanding is that if you own stock or bonds (not shares), you own part of the company, and therefore intrinsic value. As for the California electricity debacle, Philip Huyck spoke about that at the WAIS globalization conference. Perhaps he will share with us his expert opinion. A major issue in the Enron scandal is the use of offshore tax havens. Let us see if the world community succeeds in its efforts to solve that problem. There are also conflicting legal systems. Let us see if that community can agree on international codes. It all adds up to a very big order. On the US political scene, one storm cloud looms: the resistance of the White House to disclose the dealings of top officials with Enron.

Ronald Hilton - 1/29/02