By now you must know that we're in the midst of the largest corporate bankruptcy in U.S. history -- though it's only the largest if you ignore inflation. You probably also know that the company in question is Enron -- billed as America's seventh largest corporation, another convenient fiction to hype its importance. There are many other things you may know. President Bush and Enron Chairman Kenneth Lay were hot tub buddies who once had a campaign financial menage a trois with then-Texas Governor Ann Richards. Enron executives got rich while average workers stayed poor. Its auditing firm, Arthur Andersen, plans to change the final "e" to an "o" in an attempt to remain in business.
There's plenty of entertainment -- and some important lessons about greed, honesty, and the importance of maintaining a diverse investment portfolio -- buried in the shenanigans of the leading players, with more yet to come:
Enron was a gas company that morphed into, in the words of one prescient wag, "a hedge fund sitting on top of a pipeline." That is, instead of dealing with the mundane business of building plants, generating power, and delivering it to customers, Enron decided there was more money to be made in trading energy -- first natural gas and then electricity -- as a commodity. In doing so, it did some truly great things, such as replacing top-down, inefficient bureaucracy with competition. But it also caught New Economy dementia and started dealing in stuff as diverse as home videos and broadband.
And while it may have been an innovative company, it wasn't a forthcoming one. It set up several off-the-books financing companies, a common practice that allows a business to hide debt for large projects. Enron's innovation was that it didn't back them with any real assets -- like, say, a power plant -- but simply with Enron stock. Wall Street analysts admit to never really understanding how Enron made its money. "Enron's discussion of its finances reads like something written in German, translated to Chinese and back to English by way of Polish," cracked Forbes.com. Analysts didn't care, so long as the stock price stayed high. But when the bubble started to deflate, they started asking questions.
Enron turned out to be in a much weaker financial position than it claimed. On October 16, it reported a third-quarter loss of $618 million, announcing also that it would write down $1.01 billion in investments, including $35 million to a partnership. On November 9, it restated its earnings over four years, wiping out $586 million -- roughly 20 percent of what it claimed to have made. The losses were pegged to the partnerships. Investors and customers lost confidence in the company and it quickly collapsed, laying off 4,000 employees and putting Houston's art world in peril. On its way down, its executives put in calls to top Bush administration officials looking for help; so did its chief creditor, Clinton Treasury Secretary Robert Rubin. They didn't get any.
It's a scandal of first-rate proportions that's getting larger every day. But what kind of scandal is it? It's being covered out of D.C. Politicians with time on their hands due to the country's empty bank account are trampling each other in the rush to announce investigations. But it has yet to become a political scandal. The politicians are doing a great job distorting much of what we do know, even as they help us learn more.
Scandal-mongers will want to keep an eye on four central issues: the 401(k) wipe out, executive fraud, political influence, and energy policy influence. The categories aren't neatly distinct, and advocates combine and conflate them to make their points.
The tear-jerking tragedy (Venus) and fist-thumping, red-in-the face outrage (Mars) of the Enron collapse is the wipe-out of employee 401(k) balances, which were heavily invested in Enron stock. Way back in December, victims of the collapse traveled to Capitol Hill to testify about how they lost everything while executives walked away rich. CNN's Bill Press laid out the conventional wisdom in a December column. "The human impact is staggering," he wrote. "Those 11,000 employees whose 401(k) funds were invested exclusively in Enron -- and who were forbidden by Enron's own rules from diversifying -- today have no retirement plan at all."
This story is as phony as an Enron financial statement. Any retirees who lost everything committed two sins of investing: They put all their eggs in one basket and then didn't watch it. Outside of a 10-trading-day period from October 26 to November 12 when accounts were frozen so Enron could change plan administrators, all employees were free to sell any Enron stock they purchased for the 401(k) account. (Attorneys suing on behalf of investors say the freeze actually started on October 17.) Any employee over 50 -- which includes most retirees -- could have sold even the stock the company put in their accounts for free. There are no reports of any executive selling Enron stock after September 17, when retired CEO Jeff Skilling sold 500,000 shares. Chairman Kenneth Lay last sold shares on July 31. (Word is that he figured the stock would go back up and was waiting to get a better price.)
That's not to say employees don't have a legitimate beef. It just has nothing to do with their status as 401(k) investors and everything to do with their status as investors, period.
Start, I Mean Stop the Shredding
In its last few years of life, Enron lived as it died -- not by the sword, but by creative accounting. Start with the claim that Enron is America's seventh largest company. Enron had 19,000 employees. Citigroup, one of its most generous creditors, has 238,000; Phillip Morris employs 140,000; IBM 312,000. Andersen, its former auditor, employs 85,000, at least for now. You get the point. It was only the seventh largest company by revenues, and those revenues were not only mythical -- the company booked money long before it ever flowed in the front door -- but were mostly the product of an accounting loophole. According to Forbes.com, Enron booked the gross value of trades as revenue, while Wall Street firms book only their net take.
But this Texas-size tall tale, which serves the interests of the politicians and media, is benign compared to Enron's real accounting scandal. The question is not whether the books were cooked. They were, as Andersen's global managing partner testified before Congress in December. The question, to employ a scandal cliché, is who knew how fraudulent they were, and when they knew it. If executives such as Lay knew the company was teetering on top of nothing but hype yet continued to (1) sell stock for millions and then (2) talk the faltering stock up to investors and employees in order to keep the company from, well, crashing, they deserve, at the very least, a series of dates with Saddam Hussein in the next South Park movie.