Enron in One Lesson
I recently finished reading The Smartest Guys in the Room, by Bethany McLean and Peter Elkind (senior writers for Fortune magazine). It tells in great detail -- 420 dense pages -- the story of Enron, the vehicle for what may have been the biggest fraud in history.
Here is my "short" version of the Enron mess. (With apologies for the inordinate length of this post.)
What did Enron's management actually do that was wrong? Mainly two things -- (1) outright lying to investors and (2) playing games with the books so that Enron's disclosures to the public made the company seem like something it wasn't. An example of transgression number 1 was when Jeff Skilling told stock analysts that Enron's broadband operation was up and running, when that wasn't even close to being true. Even a 10-year-old could see that that was wrong.
Transgression number 2 was much more devious. A piece of it was management's incorrect characterization of one-time gains as income from operations. In other words, Enron sold a productive asset (such as a power plant) and then made it appear as if the money from the sale was actually income from Enron's ongoing day-to-day business instead of a one-time thing. Another piece of transgression number 2 was shifting income from the proper time period to a different one, to give the appearance that Enron's day-to-day business made money steadily instead of by fits and starts with major ups and downs.
And a final (and huge) piece of transgression number 2 was using sleight of hand to make debts seem like income, so that Enron seemed to be making billions when it was actually borrowing billions. (This was the main purpose of those infamous off-balance-sheet partnerships.) Many of the top guys at Enron seem to have hoped and believed, against the odds, that the company would come up with a big, new, money-making idea before all the billions in loans came due. They were sadly mistaken.
What ethical lessons can we take away from the Enron debacle? The Enron scam lasted from 1996, when Skilling became Enron's president, until mid-to-late 2oo1, when the company finally imploded. Hundreds of people worked hard to maintain a massive illusion during that time. They were smart people from average backgrounds. How could they have done this?
Let's just look at the guys at the top. When it comes to business scams, I think there are basically two types of scammers: First are the guys who set out to rip others off. For whatever reason, they think that their own enrichment is more important than the harm they do to others. Second are the guys who do something wrong (like taking a little money out of the till) because they've convinced themselves that they will ultimately make things right. The end result, they think, will be a win-win; they're just committing a small wrong to stave off a big disaster. (See James Gould Cozzens's By Love Possessed for a fictional example.) But stealing becomes a habit, and ultimately they're so far in the hole that they drag their business and their creditors down with them.
I think Ken Lay (the chairman and CEO) and Skilling were primarily of the latter type. They believed that Enron had been a great business and would go on being a great business; it just needed a little help now and then in keeping up appearances until they hit the next jackpot. (Indeed, both men did have some good ideas early on that actually added value and made honest money.) But they became addicted to cheating; "now and then" quickly grew into "all the time." And in the process, they became blinded to the fact that they were deceiving people.
Andy Fastow, on the other hand (the chief financial officer, or CFO), was I think of the former type. He was basically an upscale con man. He saw Enron as just another way to separate investors and lenders from their money, by any means necessary. And he saw his off-balance-sheet partnerships as a way of separating Enron from its money.
Scammers like Lay and Skilling and Fastow have always existed and always will. What made Enron different was the scale of what they were able to pull off . . . for a time.
Thus, the main practical lesson from Enron is not new. It is simply that those of us who are investors (which nowadays means almost everyone in the U.S.) need to be vigilant about what we're investing in. The old saying is truer now than ever: don't invest in anything you can't understand. Too many people who should've known better -- especially analysts and credit-rating firms -- were bamboozled by Enron's purposely convoluted disclosures and assumed that the rosy picture painted by management was accurate. As we know now, it was a lie. It was fraud.
The larger life lesson, the moral lesson, is to be especially skeptical of hype when the hype is beneficial to us. There are countless ways in which the human mind can make something that's wrong seem right. (Remember that in Paradise Lost, one of the reasons why Adam agreed to eat the apple was that he felt sorry for Eve.) Just as we need to be on our guard against the fraudsters out in the world, we need to be on our guard against our own, inner sweet talk.
I recently finished reading The Smartest Guys in the Room, by Bethany McLean and Peter Elkind (senior writers for Fortune magazine). It tells in great detail -- 420 dense pages -- the story of Enron, the vehicle for what may have been the biggest fraud in history.
Here is my "short" version of the Enron mess. (With apologies for the inordinate length of this post.)
What did Enron's management actually do that was wrong? Mainly two things -- (1) outright lying to investors and (2) playing games with the books so that Enron's disclosures to the public made the company seem like something it wasn't. An example of transgression number 1 was when Jeff Skilling told stock analysts that Enron's broadband operation was up and running, when that wasn't even close to being true. Even a 10-year-old could see that that was wrong.
Transgression number 2 was much more devious. A piece of it was management's incorrect characterization of one-time gains as income from operations. In other words, Enron sold a productive asset (such as a power plant) and then made it appear as if the money from the sale was actually income from Enron's ongoing day-to-day business instead of a one-time thing. Another piece of transgression number 2 was shifting income from the proper time period to a different one, to give the appearance that Enron's day-to-day business made money steadily instead of by fits and starts with major ups and downs.
And a final (and huge) piece of transgression number 2 was using sleight of hand to make debts seem like income, so that Enron seemed to be making billions when it was actually borrowing billions. (This was the main purpose of those infamous off-balance-sheet partnerships.) Many of the top guys at Enron seem to have hoped and believed, against the odds, that the company would come up with a big, new, money-making idea before all the billions in loans came due. They were sadly mistaken.
What ethical lessons can we take away from the Enron debacle? The Enron scam lasted from 1996, when Skilling became Enron's president, until mid-to-late 2oo1, when the company finally imploded. Hundreds of people worked hard to maintain a massive illusion during that time. They were smart people from average backgrounds. How could they have done this?
Let's just look at the guys at the top. When it comes to business scams, I think there are basically two types of scammers: First are the guys who set out to rip others off. For whatever reason, they think that their own enrichment is more important than the harm they do to others. Second are the guys who do something wrong (like taking a little money out of the till) because they've convinced themselves that they will ultimately make things right. The end result, they think, will be a win-win; they're just committing a small wrong to stave off a big disaster. (See James Gould Cozzens's By Love Possessed for a fictional example.) But stealing becomes a habit, and ultimately they're so far in the hole that they drag their business and their creditors down with them.
I think Ken Lay (the chairman and CEO) and Skilling were primarily of the latter type. They believed that Enron had been a great business and would go on being a great business; it just needed a little help now and then in keeping up appearances until they hit the next jackpot. (Indeed, both men did have some good ideas early on that actually added value and made honest money.) But they became addicted to cheating; "now and then" quickly grew into "all the time." And in the process, they became blinded to the fact that they were deceiving people.
Andy Fastow, on the other hand (the chief financial officer, or CFO), was I think of the former type. He was basically an upscale con man. He saw Enron as just another way to separate investors and lenders from their money, by any means necessary. And he saw his off-balance-sheet partnerships as a way of separating Enron from its money.
Scammers like Lay and Skilling and Fastow have always existed and always will. What made Enron different was the scale of what they were able to pull off . . . for a time.
Thus, the main practical lesson from Enron is not new. It is simply that those of us who are investors (which nowadays means almost everyone in the U.S.) need to be vigilant about what we're investing in. The old saying is truer now than ever: don't invest in anything you can't understand. Too many people who should've known better -- especially analysts and credit-rating firms -- were bamboozled by Enron's purposely convoluted disclosures and assumed that the rosy picture painted by management was accurate. As we know now, it was a lie. It was fraud.
The larger life lesson, the moral lesson, is to be especially skeptical of hype when the hype is beneficial to us. There are countless ways in which the human mind can make something that's wrong seem right. (Remember that in Paradise Lost, one of the reasons why Adam agreed to eat the apple was that he felt sorry for Eve.) Just as we need to be on our guard against the fraudsters out in the world, we need to be on our guard against our own, inner sweet talk.
posted by iohannes | 12:31 PM
