Constellation brought the near-collapse on itself

The Baltimore Sun

Would Constellation Energy's near-collapse and emergency sale have been necessary if the General Assembly hadn't resisted and ultimately quashed its planned merger with Florida's FPL Group two years ago?

That's the buzz in the wake of news yesterday that MidAmerican Energy Holdings would rescue Constellation by buying it for a paltry $26.50 per share.

If regulators and politicians had just gotten out of Constellation's way, the thinking goes, this week's credit crisis wouldn't have threatened the company with bankruptcy. FPL's size and steady earnings, according to this argument, could have backstopped Constellation and prevented the loss of confidence that caused yesterday's deal.

"I agree with that," said Constellation Chairman and CEO Mayo Shattuck, when I put the proposition to him yesterday. An FPL merger, he said, was supposed to "diversify the earnings base of the company" so it wouldn't be so dependent on Constellation's trading operation - the one that threatened the whole enterprise this week.

Nice try, but scapegoating Annapolis won't work. A CEO's job is to take no more risk than his company's balance sheet can handle. Whatever its size.

Shattuck demonstrably failed to do that.

The credit crisis threatening Constellation and numerous other companies seemed a one-in-10,000 chance a few months ago. Its speed, breadth and depth have stunned everybody. There might have been concerted efforts to send Constellation into a tailspin by driving down its stock and sowing doubts about its credit.

It's a jungle out there. But that's why Shattuck and his colleagues get paid very, very well to protect shareholders against even long-shot threats.

In an interview, Shattuck distinguished between the ordinary "economic" risks that Constellation faces every day and the extraordinary menace of the past few days.

"Economic risks have been managed as they've always been and are in sound shape," he said.

But credit risks are economic risks. Just ask Constellation shareholders, whose stock is worth less than half what it was a week ago.

The General Assembly didn't cause Constellation's problems. Constellation did, first by betting on energy trends with buckets of borrowed money, then by misstating what would happen if the credit ratings it needed to borrow that money were ever downgraded.

Downgrades would have compelled the company to post hundreds of millions - in some cases, more than a billion - of dollars more than had previously been disclosed.

That goof, revealed a month ago, was "a disclosure error of some magnitude," Shattuck admits. "In normal circumstances, an issue like that in any market in history could be rectified within several weeks. In this environment, it has consequences that extended obviously into a perfect storm" of financiers going under or seeking help.

The market could see that huge collateral calls might push Constellation to bankruptcy if it got caught in the storm. That made lenders reluctant to lend, which increased chances of a downgrade, which boosted chances of a collateral call. When Standard & Poor's revealed Wednesday that it was considering a downgrade, things snowballed, and Constellation had to find a partner.

Not everybody's in trouble, though.

Notice that Warren Buffett, the canny owner of MidAmerican through the Berkshire Hathaway conglomerate, not only isn't in distress but has plenty of cash to buy fire-sale assets such as Constellation.

With billions in insurance and other financial assets, Buffett could have easily bet the farm in the manner of Constellation or American International Group, the insurance behemoth seized by the government this week.

But he didn't. He kept his powder dry and was happy with the notion that steady, prudent growth generates the best returns. What a concept. Don't be surprised if the wheeling and dealing on Constellation's trading desk diminishes under the new proprietors.

The General Assembly resisted Constellation's marriage with FPL, owner of Florida Power & Light, because of concern about the merger's effect on BGE, Constellation's subsidiary. Legislators also wanted to hold the merger ransom in return for a payoff to BGE residential customers.

But even if authorities had approved the deal, the combined company would have underwritten the same kind of bets on electricity, coal and natural gas prices that got Constellation into trouble. Who's to say that, given the greater financial backing, the wagers wouldn't have been larger and just as dangerous for its future?

The financial theme of 2008, for home buyers or Wall Street tycoons, is borrowing more money than you can handle if things go bad.

It's hard to blame overzealous regulators and business-hating politicians for that.

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