Gas Pains

Enron's failure shows a market success

Critics of capitalism are always gleeful when a big business fails: The fallen giant is a perfect place to grind their axes. Enron, which just collapsed before the country's eyes—taking much of the accumulated 401(k) savings of its employees with it—is the latest sharpener.

"Enron was the peerless darling of the all those who believed that free markets were the acme of existence," writes Thomas Frank, editor of The Baffler and author of One Market Under God (2000), in Salon.com. "Its wreckage is as good a place as any to sit down and take stock of the deregulated, privatized state into which we've been so rudely hustled over the last decade. And here is what it looks like: Top management walking off with hundreds of millions of dollars while employees lose their jobs, investors lose millions and customers get to look forward to more rolling blackouts. Profiteering. Bought politicians. Stock market bubbles that inevitably burst. Workers thrown out on the streets. Left to its own devices, this is what the free market does."

That's one way to view Enron's descent from America's seventh largest corporation to a shriveled ward of a bankruptcy court. Here's another: Enron's demise shows that markets work and work well, even if they do fall short of utopia.

Enron, founded in 1985 as a gas pipeline company, had a tradition of innovation. It took advantage of changes in the law to create markets in energy, even as it pushed for more deregulation. "Enron created markets where none existed, and replaced monopoly with competition, reducing the need for regulation and thereby lowering the cost of energy for consumers and businesses," economist Irwin Stelzer writes in The Weekly Standard. In recent years, Enron transformed itself from an energy company into a trading house that made markets in products from electricity to broadband. Its business was complex, and even professional analysts weren't sure how it made its money.

It turns out it was making its money with smoke and mirrors—and was making significantly less than it claimed. Executives set up captive but off-the-books partnerships to take on debt and kick off revenue for Enron. This inflated Enron's revenues while keeping bond-rating agencies happy. Whether executives actually lied will be determined in a court of law, but it's clear they didn't believe in full disclosure. "If you don't ask the absolute right question, you don't get the right answer," a Wall Street analyst told The Wall Street Journal. Company executives bullied analysts who questioned where the money came from. This lack of disclosure proved fatal. When investors lost confidence in Enron, they fled.

This is precisely how markets, which are complex webs of information based on trust, are supposed to work. Once the trust is gone, investors flee and enterprises fail. (If only the same could be said of governmental organizations, such as the Departments of Energy and Education.)

Markets, be they for groceries or microchips, are wonderfully resilient. Failure for one firm provides opportunities for others. Just as the failure of Safeway would not cause anyone to starve for lack of access to food, the failure of Enron has not caused a single factory, office building, or house to lose power. Other companies have already moved in on Enron's profitable business lines. Enron was once one of America's largest corporations. But it won't be gone but a few months, and everyone save its former employees, its large investors, business historians, and the real estate agent trying to lease its former office space will have forgotten it ever existed.

So who will ultimately bear the cost of Enron's collapse? The exact two groups who ought to: investors and employees. The first, because they took the risk freely in hopes of future rewards. Those rewards came in the past, and investors were handsomely rewarded. Markets are imperfect, and Enron was certainly another case of analysts failing to do their jobs. Up until mid-October, 14 of 18 analysts had a strong buy recommendation on Enron. Yet the company's collapse wasn't unheralded. Jim Chanos, of Kynikos Associates, pointed out in early 2001 that Enron didn't make much money. One of his colleagues characterized the company this way: "A giant hedge fund sitting on top of a pipeline." A March 5 story in Fortune called the company's stock price and business dealings into question.

The second group is more troubling, since no one wants to see people thrown out of work. This is worse in Enron's case since, at the end of 2000, 62 percent of employees' 401(k) account balances were in Enron stock. With the stock collapse, so too did many workers' retirement plans.

But here too we have established systems, most notably unemployment insurance, to deal with the transition. (I will write about the 401(k) issue next week.) And employees are in the best position to have actual knowledge about how a company actually operates and its general health.

So there's another way to look at what the free market produces. A company fails to come clean with investors, possibly crossing the line into illegal behavior. Investors flee, the company collapses, and executives face civil lawsuits and criminal investigations. Other companies move immediately into the vacated market. No one loses service, and the price of the product is not affected. Meanwhile, yes, thousands of employees lose their jobs, and those who heavily invested in company stock lose a lot of their retirement savings.

It's certainly far from perfect. But it beats all the available alternatives.