Enron a Rerun of History
When former Enron Chairman Kenneth L. Lay invoked the 5th Amendment against self-incrimination last week, he seemed to put the finishing touch on the energy trader’s transformation into the biggest, baddest corporate scandal ever to befall the nation.
But America has a rich history of financial fiascoes that foreshadowed Enron’s, and could even have provided the firm its playbook. Most involved extravagant claims of never-before-seen strategies. Many required “creative accounting” to turn losses into gains. Some featured generous campaign contributions. Virtually all came after long stock market run-ups.
More is at stake today: Three times as many Americans have money in stocks now as did during the last truly big bust in the late 1960s and early 1970s. But don’t count on legions of bruised shareholders to push through reforms that will put a stop to financial debacles. In the end, policymakers, economists and historians suggest, debacles may be the largely unavoidable price of America’s anxious love affair with its wide-open financial markets and their booms and busts.
“Booms bring out situations that breed financial scandal,” said former Securities and Exchange Commission Chairman Arthur Levitt Jr. “A culture of what-can-we-get-away-with takes hold.”
When that happens, Levitt said, regulators come to be viewed as “professional naysayers and doomsday predictors, and they lose credibility.
“That’s unfortunate,” he said. But, he added, “there is not much you can do about it.”
In its heyday, Enron went to considerable lengths to portray itself as something unfathomably new and, at least implicitly, deserving of special treatment. But its techniques came straight from the history books.
To help clear away what the company viewed as outmoded regulations that blocked progress, executives flooded politicians with campaign contributions, almost $2.5 million in 2000--most to now-President Bush--and almost $6 million since 1990.
To drive home the notion of the company’s uniqueness, executives adopted the latest business lingo, a nearly impenetrable “new economy-speak.”
Jeffrey K. Skilling, the Harvard Business School graduate and one-time consultant who became the company’s chief executive, regularly described Enron as an “asset- light” market maker and risk manager able to trade anything from energy to advertising.
In doing so, he glanced over the company’s distinctly heavy investment in such things as an Indian power plant, an English water business and a Brazilian electricity distributor. For those who sought to square the mismatch, he reserved a special kind of generational scorn.
His views were summed up in an explanation he offered for hiring the unusually young Andrew S. Fastow as chief financial officer: “We didn’t want someone stuck in the past, since the industry of yesterday is no longer.”
On such talk, Enron eventually ballooned from a mid-size regional company into one of the largest corporations in America.
So did the highfliers of a previous era: the conglomerates of the 1960s. Both the men and the methods behind Textron, ITT, Ling-Temco-Vought and other hot stocks of the “Go-Go Years” bear a remarkable similarity to Enron’s.
In each instance, the players claimed they had hit on something entirely new. In the conglomerates’ case, it was the then-unheard-of idea of plastering totally unrelated businesses together.
In each, executives offered elaborate rationales for what they were doing. The conglomerators talked about “synergy” and claimed--wrongly--that their companies were more stable than conventional ones.
The results ranged from disappointing to disastrous.
Yankee Royal Little took a placid New England thread-spinning company called Textron and turned it into a corporate behemoth by snapping up producers of zippers, pens, snowmobiles, eyeglass frames, silverware, golf carts, metalwork machinery, helicopters, rocket engines, ball bearings and gas meters.
The company survived, but only after spending the last two decades selling off most of what Little had bought. Investors who purchased their shares at the height of the conglomerate craze took a bath.
Harold S. Geneen at ITT carried the conglomerate approach so far that by 1972 Time magazine was noting that a consumer seeking to avoid the company “could not rent an Avis car, buy a Levitt house, sleep in a Sheraton hotel, . . . use Scotts fertilizer or seed, eat Wonder bread or Morton’s frozen foods.”
Like Enron, ITT was a big campaign contributor. But Geneen’s idea of how to use political influence made Lay and associates look like choir boys. In 1970, the company offered Republicans $1 million and consulted heavily with the Nixon White House and the CIA when Chile’s new socialist president, Salvador Allende, threatened to seize the ITT-owned Chilean Telephone Co. Allende was overthrown with U.S. aid.
ITT started selling off parts of itself in the mid-1980s and split in three in 1995.
Oklahoma electrician Jimmy Ling discovered the wonders of stock by selling shares in his contracting business from a booth at the Texas State Fair in the mid-1950s, and in just more than a decade turned Ling-Temco-Vought into the 14th-largest industrial company in the nation with 120,000 employees.
Like Skilling, Ling insisted that only young, fresh minds could appreciate his strategy. When a leading Wall Street analyst questioned his methods, Ling demanded the man appear before him and, discovering he was middle-aged, dismissed him with a contemptuous, “What could I expect from someone over 40?”
By 1969, LTV was selling $1 billion of meat, $1 billion of steel and $700 million of planes and aerospace hardware. It had become the world’s largest manufacturer of sports equipment. It made chemicals, cable, drugs and stereos. Its stock reached $136 a share.
Today, all that’s left is a bankrupt steel producer.
Few things about Enron have attracted as much attention as the company’s extraordinary talent for painting whatever financial picture it wanted by hiding debt, converting losses to gains and making whole operations vanish at will.
Unluckily for ordinary investors, the company’s off-the-books partnerships, stock-backed deals and less-than-arm’s-length transactions were not unique to it. A substantial number of companies use similar practices, despite the fact that some contributed to many of the greatest corporate crackups of the last century.
Perhaps the clearest link to past debacles involves Samuel L. Insull, the British-born onetime private secretary to inventor Thomas Edison.
Insull is widely credited with figuring out how to make money from the new electrical technology of the early 20th century, and with assembling one of the largest regional power distribution systems in the country during the 1910s and 1920s.
Lay, Skilling and Enron could rightfully claim to be Insull’s historical heirs. They, more than anyone, pressed for taking the next logical step from where Insull left off, linking the country’s disparate regional distribution systems into a single national power grid. Their proposal, for which they lobbied heavily with the Bush administration, lies buried in the fine print of the president’s yet-to-be-acted-upon energy plan.
But Enron executives were much more interested in following Insull’s lead in another area, creative accounting, and the result was a tottering financial structure that ultimately collapsed.
Details of the two groups’ methods differed. But their aims were the same: to ensure that insiders maintained control over their respective empires, to ensure that they did so with other people’s money, and to attract as little unwanted public or government notice as possible. Their fates were also the same.
Insull’s debt-laden empire crumbled in September 1931 in what newspapers at the time said was “the biggest business failure in the history of the world.” The collapse took 600,000 shareholders and 500,000 bondholders down with it.
“People felt so swindled they never went near the market again. There was a lost generation of investors,” business historian Ron Chernow said.
More than Enron’s political clout or its dubious accounting practices, what most outrages the public about the company’s collapse is the idea that top executives could walk away with millions of dollars while ordinary employees lost their jobs and retirement savings.
“Americans have always been deeply ambivalent about capitalism,” Columbia University historian Alan Brinkley said. “Most people see it as fine as long as it is working for everyone. But they get very distraught if it is not working well or seems to be serving only the top few.”
That distress was fed mightily by news that Lay, Enron’s former chairman, sold $100 million of company stock last year even as he was trying to persuade company employees to hold on to their shares. That was substantially more than previously reported.
But even with the latest report, the executive who ultimately could come in for the nastiest criticism may not be Lay or Skilling, but former finance chief Fastow.
That’s because in addition to designing many of the off-the-books partnerships that fooled the public about Enron’s true financial condition, Fastow and an associate are accused by their own board of tweaking the arrangements to draw tens of millions of dollars out of the company for themselves.
In authorizing Fastow to set up key partnerships, the Enron board appears to have allowed him to treat them almost as personal property, even letting him name them after his wife and children.
If board members had looked at similar deals from the past, they might have seen what was coming.
During the 1920s, Albert H. Wiggin, the head of New York’s giant Chase National Bank, created a series of private companies, including two named for his daughters, to speculate in Chase stock.
When the 1929 crash occurred, Wiggin was put in charge of propping up the bank’s share price. But he used his private firms to take out loans from the bank with which to bet against the stock. During the darkest period of the crash, September through November, he made more than $4 million.
Analysts agree that stopping the likes of Wiggin in advance may be nearly impossible, but some argue that the addition of new laws and regulations over the years has helped discourage fraud by raising the cost of getting caught.
“I doubt any of the principals of Enron or the partnerships are going to look back on this and say, ‘Boy was that a wild ride, but was it worth it,’ ” UC Berkeley economic historian Brad DeLong said.
It remains to be seen whether anyone forfeits his fortune. Ex-junk bond king Michael Milken, who spent almost two years in federal prison for securities fraud and paid more than $1 billion in fines and penalties, was recently estimated to be worth $800 million.
Officially, the Enron hearings underway on Capitol Hill are to help members of Congress decide whether new laws are needed to prevent such a collapse from happening again. But as almost everyone involved understands, they are really morality plays intended to reward good and punish evil.
Most of the executives who have been paraded before the committees and the cameras, including Lay and Fastow, have taken the Fifth and endured hours of insult. Skilling took a different tack and denied knowing of any improper activities or even financial problems, and was ridiculed for his claims.
Lawmakers and historians say that such public pillorying helps build momentum for political change. In Enron’s case, the company is quickly emerging as a symbol of business excess that’s already helping to prod passage of campaign finance reform, and probably will result in new controls on corporations, pensions and accounting.
But some of the regulators who have won broad new powers through the hearing process argue that, in the final analysis, it is not the extra laws or regulations that are most important, but the public glare on the rich and powerful.
“Whatever rules we pass will not assure us that we will not have another cycle” of Enron-like scandals, Levitt, the former SEC chairman, said last week. “In America, humiliation and embarrassment tend to change behavior faster.”
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Financial Scandals
After the 1990s Boom
1/2002: Telecom whiz Global Crossing goes bust amid vast overbuilding of fiber-optic networks. Founder and former Drexel Burnham Lambert executive Gary Winnick says there is no wrongdoing. The SEC and FBI are investi-gating.
12/2001: Enron files for bankruptcy protection. Investigators and the firm’s own board of directors blame lax controls and thousands of partnerships that hid debt for a loss of investor confidence.
11/2000: Dot-com darling Pets.com goes bankrupt only nine months after going public, signaling the end of an era during which investors snapped up stocks of Internet start-ups that eventually went bust.
After the 1980s Boom
1990: Brokerage firm Drexel Burnham Lambert declares bankruptcy. Junk bond king Michael Milken goes to jail.
1989: Regulators shut Charles H. Keating’s Lincoln Savings & Loan at a $3.4-billion cost to taxpayers. Keating is convicted of fraud, although some charges are ultimately thrown out.
1987: Stock speculator Ivan F. Boesky is sentenced to three years in prison for insider trading.
After the 1960s Boom
1975: The SEC censures accounting giant Peat Marwick for giving clean bills of health to five firms that quickly thereafter go bankrupt.
1970: Investors Overseas Services and its early mutual fund, the $2.5-billion Fund of Funds, lose millions.
1969-70: Shares of go-go conglomerates such as Litton, Gulf&Western; and Ling-Temco-Vought plunge, losing 80% or more of their values in months.
After the 1920s Boom
1938: Former New York Stock Exchange President Richard Whitney is convicted of pyramiding debt and fraud. He spends more than three years in prison.
1933: Congressional investigators discover that Chase National Bank Chairman Albert H. Wiggin ran a series of private companies on the side that, among other things, used Chase loans to bet against the bank’s own stock by selling it short.
1932: Samuel L. Insull’s chief electrical holding company, Middle West Utilities, goes bust.
After the 1900s Boom
10/1907: F. Augustus Heinze’s scheme to manipulate United Copper stock exposes a web of connections among New York financial institutions and starts a run on the city’s trust companies. The Panic of 1907 is the most severe in a series of bank runs dating to the Civil War.
7/1907: John D. Rockefeller is dragged into court to testify in an antitrust case against Standard Oil. He acts like a bumbling old man, unable to explain his company’s business or to see anything wrong with its practices. The government eventually breaks up the oil giant.
