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January 26, 2002

Enron for Dummies

By BILL KELLER

I  saw this week that President Bush is `outraged' by the Enron scandal,
and I know I should be too, but there's a lot I still don't get. For
starters, what kind of company is  Enron, exactly?

Enron is a new-economy company, a thinking-outside-the-box,
paradigm-shifting, market-making company. In fact, it ranked as the most
innovative company in America four years in a row, as judged by envious
corporate peers in the annual Fortune magazine poll. It is also, at this
point in time, a bankrupt company.

I meant, what does Enron do?

"Do?" Ah, a quaint old-economy question. You're probably one of those
people who like the new no-cell- phone cars on Amtrak. Enron does a lot
of things, but mainly it buys and sells energy.

What's so innovative about that?

When Enron got started, natural gas and electricity were produced,
transmitted and sold by state-regulated monopolies. They were often
plodding and inefficient. Enron used Wall Street magic to transform
energy supplies into financial instruments that could be traded online
like stocks and bonds. These contracts guaranteed customers a steady
supply at a predictable price. This may be a good place to pause for an
Enron Lesson. The company did stupid and venal things, but introducing
the laws of supply and demand into the energy system was smart business
and is, by and large, good for customers. One sad side effect of this
scandal is that some good ideas may be discredited by association with
Enron.

So where did Enron go wrong?

As often happens with buccaneering entrepreneurs, it got a case of
hubris. It figured if it could trade energy, it could trade anything,
anywhere, in the new virtual marketplace. Newsprint. Television
advertising time. Insurance risk. High- speed data transmission. All of
these were converted into contracts — called derivatives — that were
sold to investors. Enron poured billions into these trading ventures,
and some failed. It turned out Enron was good at inventing businesses,
but terrible at the tedious work of running them, judging by some
appalling internal management audits discovered by The Times's Kurt
Eichenwald. For a time, Enron swept its failures into creative hiding
places, but ultimately the truth came out, confidence in the company
collapsed and you now have a feeding frenzy.

How did it hide its mistakes?

To keep its mystique alive and its stock price growing, it set up
partnerships where it could bury its losses, or generate imaginary
revenues. Here's one of the more audacious examples, pieced together by
The Wall Street Journal: Enron invested a bunch of money in a joint
venture with Blockbuster to rent out movies online. The deal flopped
eight months later. But in the meantime Enron had secretly set up a
partnership with a Canadian bank. The bank essentially lent Enron $115
million in exchange for Enron's profits from the movie venture over its
first 10 years. The Blockbuster deal never made a penny, but Enron
counted the Canadian loan as a nice, fat profit.

Um, I'm not sure I follow that . . .

Neither did the Canadian bank, which now holds a lot of worthless Enron
i.o.u.'s. Enron also seems to have baffled the accountants at Arthur
Andersen, the bankers at J. P. Morgan, the Wall Street geniuses who
touted Enron stock, and those C.E.O.'s who kept voting Kenneth Lay, now
abruptly retired, the mastermind of the year. Also (with some
exceptions) the business press.

Did Enron break the rules?

Whether it broke the law is yet to be determined. Various prosecutors
are undoubtedly reviewing the statutes on accounting fraud, insider
trading and illegal destruction of documents, among other crimes. But
rules were for sissies. These were invincible innovators, who sneered at
rules. In that respect, they were the quintessential 90's company.

What's that supposed to mean?

The company embodied the get- obscenely-rich-quick cult that grew up
around the intersection of digital technology, deregulation and
globalization. It rode the zeitgeist of speed, hype, novelty and
swagger. Petroleum was hopelessly uncool; derivatives were hot.
Companies were advised to unload the baggage of hard assets, like
factories or oilfields, which hold you back in the digital long jump,
and concentrate on buzz and brand. Accountants who tried to impose the
traditional discipline of the balance sheet were dismissed as
"bean-counters," stuck in the old metrics. Wall Street looked to new
metrics, new ways of measuring the intangible genius of innovation, and
the most important metrics were the daily flickers of your stock price.
Above all, everyone was looking for the killer app.

Killer app?"

You are clueless. The killer application was the world-beating
opportunity. (Mr. Lay called that Blockbuster deal "the killer app for
the entertainment industry.") As often as not, the killer app was not a
new product or service, but a beautiful loophole. In the new- economy
best seller "Unleashing the Killer App," the first example is a guy who
realizes that gas stations in Germany are exempt from the country's
rigid early-closing laws for most stores. Voila! German gas stations
become virtual shopping malls. By the way, in the 90's, expressions like
"killer app" were widely believed to have an aphrodisiac effect.

So it was about sex, after all?

Oh, absolutely. Wall Street was the new Hollywood, risk was the new
testosterone, Lou Dobbs was Leonardo DiCaprio. Accountants called
themselves consultants and bought Miata convertibles. And how cool was
Enron? About two years ago a Fortune magazine writer likened utilities
and energy companies to "a bunch of old fogies and their wives shuffling
around halfheartedly to the not-so-stirring sounds of Guy Lombardo. . .
. Suddenly young Elvis comes crashing through the skylight." In this
metaphor, the guy in the skin-tight gold-lamé suit was Enron. The writer
left out the part where Elvis eats himself to death.

That reminds me, is it true what they say about the name "Enron"?

Mr. Lay wanted to call it Enteron, until they realized that was a
biology term for the digestive tract. In hindsight, Enteron seems right
for a company of such ungoverned appetites. Though I prefer my wife's
name for the company: End Run.

Did Enron buy political influence?

Please. That's not the way things work in Washington. Enron bought
access. Money just got it in the door to make its case. (The case it
made probably went something like this: If the government does things
Enron's way a lot of people will get very rich and they will be very,
very grateful to the wise leaders who made it all possible.) If you're
asking whether the Bush administration did favors for Enron, sure it did
— and so, by the way, did the Clinton administration, and both parties
in Congress. Attention has focused on a number of fascinating loopholes
lawmakers and regulators secretly customized for Enron. But — and here's
another Enron Lesson — most of what Washington contributed to the glory
of Enron it did in plain sight. Politicians demonized government
regulation, and methodically dismantled the safeguards set up in
previous downturns to protect little investors. They promoted the cult
of stock-market speculation, even calling for Social Security funds to
be fed to Wall Street. They cut taxes and all but stopped auditing tax
returns. I'd say Enron's campaign donations, about $6 million over the
past dozen years, paid off better than most of its other investments.

Isn't that what free markets are all about — getting government out of
the way?

Yes and no. Free-marketers believe in reducing regulation. Enron
believed in reducing regulation of Enron. Enron was perfectly capable of
lobbying for the federal government to take over the electric power grid
from the states — hardly a free-market position, but one that would have
made life easier for Enron. It lobbied for tighter regulation of air
pollution, because it had figured a way to make money trading emission
credits. And at the end Enron sure seemed to be fishing for a bailout.
More important, a central tenet of capitalism is that people who run
companies are subject to the discipline of the marketplace, as meted out
by the shareholders. That can't work if the shareholders are lied to
about the condition of the company. Another Enron Lesson: The louder
someone yells "free markets!" the closer you want to look at his files
(assuming they have not been shredded).

But the administration didn't bail out Enron at the end, right?

No, the administration declined to climb aboard that sinking ship. A
final Enron Lesson: When business and politics meet, Kenny Boy, it's not
a relationship, it's a transaction.

What happens now?

A witch hunt, of course. In the end, with any luck, Congress will stop
some of the money sloshing around the political system, and restore a
bit of law and order to the wild frontier. But first, a few burnings at
the stake. My wise friend Floyd Norris says there's a basic law of the
market: When you get rich, it's because you're smart. When you get poor,
it's because somebody cheated you. Just as Enron embodied the
stock-market delirium on the way up, it will, now that the euphoria is
over, be the scapegoat for all those smooth talkers who convinced us
dummies that we could be rich.