An American worker named George had his sights set on a comfortable retirement, perhaps some
holidays in the sun, relaxing in the garden with good novels and a gin and tonic by his
side. And then when the company he worked for, the energy giant called the Enron Corporation,
collapsed in front of his eyes those plans went up in smoke. Years later he was mowing
pastures when he should have been living on his retirement savings, which had been mostly
tied up in Enron company stock. No one ever thought such a behemoth of a company could
just go belly-up. It was a story that shocked the world, one involving mismanagement, corruption
and greed. This is what happened.
In its heyday Enron was one of the largest companies in the USA. At its peak its shares
reached $90.75, and when it declared bankruptcy in 2001 they were worth $0.26. Few saw it
coming, and to this day the downfall is a reminder to us all that indeed giants can
fall, and on top of that, giants aren’t always what they seem.
The story starts in 1985 when two companies merged. They were Texas-based Houston Natural
Gas Company and Omaha-based InterNorth Incorporated. At the beginning the new Enron was simply
a very big natural gas supplier, but then in 1989 it turned a leaf in its book and began
trading natural gas commodities. In 1994 it also began trading electricity. These changes
took place under its new CEO Kenneth Lay, who had formerly been in the big chair at
Houston Natural Gas. At the time Enron was said to be one of the most innovative companies
in the USA, but at the time of the downfall the New York Times wrote, “Enron is a new-economy
company, a thinking-outside-the-box, paradigm-shifting, market-making company.” It added to the
end of that paragraph, “It is also, at this point in time, a bankrupt company.”
As the story goes, before Enron got started gas and electricity were produced and sold
by state-regulated monopolies. But then there was deregulation, and as the Times writes,
“Enron used Wall Street magic to transform energy supplies into financial instruments
that could be traded online like stocks and bonds.” Prior to this, those energy monopolies
were always under government scrutiny, but after deregulation Enron had more freedom
and so started trading energy online, such as stocks and bonds, and also placing bets
on future energy prices. Enron started selling contracts, called energy derivatives, to investors.
Soon Enron was called “America's Most Innovative Company", and it won that accolade for a number
of years. At the time this looked good for the consumer, because with supply and demand
taking over fixed prices by monopiles, the prices for customers seemed fair. It seemed
like a dream story for capitalism.
There was a problem, though, and something didn’t quite add up.
You see Enron thought that if it could trade energy, then why not trade all kinds of other
things, such as insurance or advertising and then turn these into contracts and sell them
as derivatives, too. The company poured billions into these new trading ventures, but not everything
turned into gold. It later turned out that while Enron was winning on some levels, it
was losing on others, but the problem was it wasn’t always coming clean about where
it was losing. It was kind of fixing its accounts and reporting false trading revenues. As one
person pointed out, “Some of the schemes traders used included serving as a middleman
on a contract trade, linking up a buyer and a seller for a future contract, and then booking
the entire sale as Enron revenue. Enron was also using its partnerships to sell contracts
back and forth to itself and booking revenue each time.” It was in fact creating imaginary
revenues.
If that is confusing to you, The Wall Street Journal gave an example of one such piece
of Enron subterfuge. Enron got into a deal with Blockbuster, those guys whose stores
you’d go to in the past and rent out a movie. The new deal with Blockbuster was to do this
online. But it didn’t work out, and in eight months the business was a total flop. While
this was going on Enron had made a deal with a Canadian bank. If the bank loaned Enron
$115 million, Enron would then hand over its video deal profits for the first ten years
to the bank. As you know, Enron made no cash from this online video renting business with
Blockbuster, but it still wrote the $115 million down as part of its revenue, not a massive
loss. The Canadian bank was owed money, but on paper things didn’t look bad for Enron.
According to the New York Times, Enron did a fair bit of shady accounting and still Wall
Street bankers at J. P. Morgan, and others, were gung-ho about the company and its stock.
Some people, however, began to smell a rat.
The thing was, Enron was also seen as a fairytale winner in the years when deregulation and
online trading, embodied by a get rich quick culture, were admired by everyone. Leave the
innovators alone, this is the future. But things got out of hand, as they tend to do
when in Hobbesian terms the “Leviathan” goes missing and no one is watching over the
people to ensure nothing terrible is happening. Enron also invested heavily in high-speed
broadband telecom networks, but the company saw no profits from that, either. The most
innovative company in America was on a losing streak, but still those losses were not reported.
It was hiding all its financial losses, using something called mark-to-market accounting.
Investopedia explains that like this, “This technique measures the value of a security
based on its current market value instead of its book value. This can work well when
trading securities, but it can be disastrous for actual businesses.”
Another example given of the Enron way of hiding losses is this. If the company bought
a power plant it would first put the projected profit on its books. That’s a projected
profit, meaning nothing has actually been made. If then Enron actually didn’t make
a profit but a loss, it would transfer the loss to an off-the-books corporation somewhere
no one would find it. This way Enron’s bottom line didn’t look affected and everyone still
thought the company was booming, when in fact heavy losses were being incurred and then
hidden like soiled underwear at the bottom of a laundry basket. Enron used something
called off-balance-sheet special purpose vehicles (SPVs) to hide these failures, but all you
need to know is that this is a technique that can be used to fool investors and creditors.
The experts tell us this is not illegal, but it can be dangerous. At the same time, not
everyone understands how they work, so it could be said to be slightly unethical if
companies are not completely transparent about it.
And then the bubble burst, as bubbles tend to do. By April 2001 analysts were on to Enron,
they saw what was happening, realizing that accounting wizardry had been creating a company
not unlike the fantasy city of Oz. Behind the screen Enron was crumbling, and by summer
2001 the company was in freefall. Its stock was downgraded, sinking like a stone into
the abyss. By 2000 it was revealed that Enron had losses of $591 million and $628 million
in debt. In 2001 the company filed for bankruptcy, and a lot of poor folks whose pensions were
tied up in company stock were going to have to cancel their dream vacation in the Caribbean.
From 2004 to 2011 the company paid $21.7 billion to its creditors. It’s said shareholders
lost in total around $74 billion and employees lost billions in pension benefits, with one
such person being the guy we mentioned at the beginning of this story. There were many,
many more like him.
Some of the executives were charged with conspiracy, insider trading, and securities fraud. The
CEO we mentioned died of a heart attack before he could face any prison time. Others did
time for facilitating corrupt business practices. Another CEO, Jeffrey Skilling, was only just
released from prison.
Do you think government regulation of markets is good or bad after watching this video?
Let us know in the comments! Also, check out our other video How Jeff Bezos Gets His Money
From Amazon. Thanks for watching, and, as always, don’t forget to like, share and
subscribe. See you next time.