Homeland, Honor, & Candor

Never doubt that a small group of dedicated individuals can change the world. Indeed, it is the only thing that ever has (Margaret Mead).

Sunday, May 07, 2006

Enron: the smartest guys in the room


Enron was pride, but then it became arrogance, intolerance and greed.

Bethany McLean, a co-author of this book, once said "in reality, Enron was a human tragedy". It had taken Enron 16 years to go from $10 billion of assets to 65 billion of assets, and took them only 24 days to go bankrupt. Actually, America's largest corporate bankruptcy-Enron was a house of cards. What happened? Who was responsible for it happening? What can we do to prevent this sort of thing from happening again?

"Government is not the solution to our problem. Government is the problem. The society, which have achieved the most spectacular broad-based economic progress in the shortest period of time, are not the most tightly controlled, not necessarily the biggest in size, or the wealthiest in natural resources. No, what unites them all is their willingness to believe in the magic of the marketplace" (Ronald Reagan).

The magic power of deregulation pushed Kenneth Lay (former CEO and Chairman) to found Enron in 1985. Through a merger of vast networks of natural gas pipelines, Lay thought Enron would be poised to take advantage of the government's decision to let gas prices float with the currents of the market. He had a view of deregulation from the standpoint of all the money that he thought could be made. He was not alone. A couple of Texas oilmen (including Bush family) shared his views on how to get government out of the energy business. Early on, George Bush senior helped secure billions in government subsidies for Enron International, and he helped promote Lay as deregulation's ambassador-at-large.

In 1987, two oil traders of Enron Oil (its president was Louis Borget) made bets from Enron, on whether the price of oil would rise or fall. Oil trading is like gambling. Sometimes you win, sometimes you lose. However, Enron Oil always seemed to win and have a steady high profits.
BUT... There were offshore accounts, phony books, and a trail that led from the company's treasurer Tom Mastroeni to a mysterious Lebanese speculator no one could find M. Yass (like My Ass).

Borget and Mastroeni presented falsified bank records to Enron, then they had admitted they diverted company's profit to personal accounts. Borget and his traders manipulated Enron's earnings and destroyed daily trading records, but Ken Lay did not fired and even disciplined them. In other words, Lay encouraged 2 rogue traders to gamble Enron reserves more, instead of avoiding risk. Then he needed to find a man with good idea. The man was Jeffrey Skilling, a graduate of Harvard Business School.

Jeff Skilling's biggest single new idea was to find a new way to deliver energy rather than be bound by the physical flow of the pipeline. Enron would become a kind of stock market for natural gas. It was a magical new idea: Transform Energy into Financial Instruments that could be traded like stocks and bonds.

Skilling saw the opportunity to build an industry new, and to start a business from scratch, but he had one specific condition, that had to be met before he had joined Enron. And it was that he'd be allowed to use a certain kind of accounting known as MARK-to-MARKET.
Arthur Andersen signed off and the SEC approved it. Mark-to-market accounting (Hypothetical Future Value Accounting) allowed Enron to book potential future profits on the very day a deal was signed. No matter how little cash actually came in the door, to the outside world, Enron's profits could be whatever said they were.

While Enron's stocks kept rising, its businesses kept losing money (Examples include their India, California, Blockbuster and Broadband projects). They could bury their debt and losses with Andrew Fastow's (former CFO) help. Finally, Enron bankrupted because frankness, truth, forthrightness and ingenousness always win.

Enron's Bankruptcy Facts:
* 20,000 employees had lost their jobs & medical insurance
* Average severance pay $4,500
* Top executives were paid bonuses totaling $65 million.

In 2001:
* Employees lost $1.2 billion in retirement funds
* Retirees lost $2 billion in pension funds
* Enron's top executives cashed in $116 million in stock

Criminal Charges:
* Guilty pleas-15, Convictions-6, Acquittals-1, Pending Cases-11
* 3 California traders pled guilty to wire fraud
* 4 Merrill Lynch executives convicted of fraud in the Nigerian Barge case
* Ken Lay & Jeff Skilling's trial was held in Jan 2006.

Sources: Documentary movie "Enron: The smartest guys in the room", Bethany McLean, Peter Elkind "The smartest guys in the room: The amazing rise and scandalous fall of Enron"

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