Enron Explained
Cutting through the hype.
By Ramesh Ponnuru, NR Senior Editor
From the February 25, 2002, issue of National Review.
It's now clear that this company was never as big as it seemed. It was, to a large extent, an illusion built on hype, accounting tricks, and outright fraud. Our eyes have now been opened.
Or have they? The generally accepted story of Enron's demise — the scandal of Enron — is almost equally overblown. Like the company itself, the scandal is largely built on hype, accounting tricks, and fraud.
No amount of hyperbole is being spared in discussions of the impact of Enron's fall. David Broder says that almost everyone is worrying about his pension now. Paul Krugman writes that it's a bigger deal than September 11 because it "told us things about ourselves that we...had managed not to see." Jonathan Alter calls Enron "a cancer on capitalism." Even the normally unflappable George Will sees a "systemic crisis of capitalism."
Reforms are said to be necessary "to keep this from happening again." It's almost always left unclear what "this" is that can't be allowed to recur. Presumably it's not that an energy company went bankrupt in the middle of a recession and a downdraft in energy prices.
True, it wasn't just any bankruptcy: Enron was the seventh-largest company in the country, and was found to be cooking its books. But it was the book-cooking that made it look so large in the first place. Michael Lynch of Reason, one of the few reporters on the Enron beat not to have succumbed to hysteria, notes that the company that was auditing Enron, Arthur Andersen, had more employees. Nobody lost electrical power. Kmart's bankruptcy was more consequential economically.
Or maybe the evil that must never be repeated is what happened to Enron workers' 401(k)s. It's estimated that 62 percent of their pensions were in Enron stock, which is now worthless. Ted Kennedy writes in the Boston Globe: "As Enron stock fell from a high of over $90 to less than $1 a share, the company prevented workers from selling their Enron stock at every turn." Worse, top executives were selling their own stock at the same time.
It sounds pretty bad. But let's keep a few things in mind. First, employees did not have to buy Enron stock. And contrary to Kennedy's assertion, they were free to sell it at any time if they did buy it (except for one brief period, which we'll get to in a minute). Enron contributed company stock to employees' 401(k) plans: For every two dollars an employee contributed, he got one dollar of company stock. He could not sell that stock until age 50.
Assume a worker didn't buy Enron stock on his own. At the outset, a third of the assets in his 401(k) plan were Enron stock (because of the company contribution). That proportion rose as Enron's stock skyrocketed in value in the late 1990s. When the stock crashed, his plan lost much of its value — but mostly because that value was wildly inflated in the first place. He would have been better off if the company had raised his wage instead of giving him stock. But nobody forced him to work for a firm with that compensation package.
Our employee's plight, by the way, was not affected by his boss's stock sales. Former employees complain that executives should have spread the gloom around the office so that they would have known to dump their shares. So far, only columnist Ann Coulter has exposed the immorality of this position: The employees wish that they had known to sell their stocks to some other sucker. They're not angry that Enron was running a scam. They're angry they weren't in on it. Whatever they knew, employees were in a better position to see the company's weaknesses than outside investors.
The alternative is that Ken Lay should have made a general announcement to the entire investing public that his stock was likely to tank — and then faced lawsuits from all his stockholders about his violation of his fiduciary duty to them.
The employees have one more complaint: There was a "lockdown" from October 26 through November 12, during which they were unable to trade shares in their 401(k)s, although their bosses could. A lot of bad news came out during that period. On October 31, it was announced, for example, that the SEC was conducting a major investigation. The stock price fell from $16.34 to $9.98.
Sympathy for Enron employees should be tempered by two considerations. First, they knew a lockdown was coming. The accounts were frozen because administration of the 401(k)s was moving to an outside contractor — a decision made in February 2001. Employees were told when the accounts would be frozen in early October, and reminded in the weeks thereafter. Second, the stock had been steadily falling. People who still owned Enron stock of their own volition had already ridden it from a high of $90 in August 2000 to $16.34. They had already taken most of their losses — and they had only themselves to blame.
In some quarters, the Enron bust is being taken as an indictment of 401(k)s and "do-it-yourself investing" in general. But 401(k)s let Enron employees, if they so chose, reduce their risks: They could invest in other companies so they were not wholly dependent on Enron's fortunes. If Enron had managed their pensions directly, as was the practice before 401(k)s, they would have been even more dependent on the wisdom of its managers and would have had even less control. (Florida state workers in an old-line pension system lost money in Enron stocks without ever choosing to invest in them.)
All of us participate in a retirement plan that has the worst features of investing in Enron but no chance of escape: Social Security. That program uses misleading accounting, has undiversified assets, and faces the threat of bankruptcy, too. It's destroying more wealth, for more people, than Enron ever has. Voters know that they can't afford to rely on it — which is why, contrary to Broder's remark, they are continuing to invest in the markets. After weeks of non-stop Enron coverage, Gallup found in late January that 63 percent of voters still favor a right to invest some of their Social Security funds.
In Washington, of course, that reform is taking a backseat to the task of preventing "another Enron." President Bush has proposed two reforms. One would require lockouts to apply to top executives as well as lower-level workers. Another would prevent companies from giving stock to employees without letting them sell it after three years (so there'd be no more waiting until age 50). Neither reform would likely have saved the fleeting fortunes of Enron employees. Neither seems terribly harmful, either — although some Democratic proposals being floated would be.
The most promising area for reform is not pensions, but accounting standards. Enron's financial arrangements have justly earned its executives public censure and may earn them jail time. In addition, one popular proposal would forbid accounting firms from doing consulting work for companies they are auditing. This would keep the accountants from having conflicts of interest, and keep companies from floating skyward on a wish and a dream. The logic is sufficiently compelling that as staunch a free-marketeer as NR's Lawrence Kudlow has endorsed it.
On the other hand, there will be some conflict of interest as long as companies hire their own auditors. It's also worth asking why the market has not produced "clean audits" on its own. Maybe they're not worth the trouble. When audits come back positive, it doesn't raise shareholder value. It may be that policing companies' books is primarily a job for big lenders. Every once in a while these lenders fail spectacularly, and then learn to be more careful.
This is a useful, if dry, debate. It concerns something less than a crisis of capitalism. In mid January, Gallup reported that "the American public has paid relatively scant attention to the Enron controversy as a news story." Sounds about right.
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