BW: Enron: Repeatedly Missing the Obvious

BusinessWeek: Years ago, I met ex-CEO Ken Lay, liked him, and dismissed my misgivings. Now, two new books show selective blindness was endemic

Ken Lay and I go way back. I first met the now reviled ex-CEO of Enron in 1993, when I flew down to Houston from New York to interview him for a BusinessWeek story on the former high-flying energy giant. Over the next few years I met with him several times when he visited BusinessWeek for meetings with editors

I thought Lay was a straight-shooting executive with a good -- if risky -- strategy. The basic idea at the time was to capitalize on U.S. energy deregulation by financing independent natural-gas-fired power plants and creating an electronic market in which electricity and other energy could be traded. Seemed to me like a strategy to promote efficiency, energy self-sufficiency, and reduce U.S. air pollution. And I thought it could reap big profits as energy markets around the world deregulated, too.

From the painful perspective of having misjudged Enron and its CEO, I recently read two of the more authoritative books (out of dozens published so far) on the Enron fiasco: Power Failure: the Inside Story of the Collapse of Enron, by journalist Mimi Swartz and Enron whistleblower Sherron Watkins, and Infectious Greed: How Deceit and Risk Corrupted the Financial Markets by Frank Partnoy, an ex-Wall Streeter who's now law professor at University of San Diego. Among other qualifications, Partnoy gave expert testimony to the U.S. Senate committee in Washington that investigated Enron's collapse.

Power Failure is a readable narrative with lots of inside detail and dirt, much of it apparently supplied by Watkins. It gives a good feel for the personalities of the drama's main players and the atmosphere of hubris that reigned during Enron's go-go years. Infectious Greed is a dense and sometimes turgid analysis of the financial markets' general corruption in recent years, with a detailed discussion of Enron as one of the prime examples. Partnoy dispassionately lays out a provocative thesis: Most of what Enron did was not only legal but pretty typical of the practices at Wall Street brokerage houses and some other financial institutions.

The books do leave many questions unanswered and, in some cases, seem to give conflicting interpretations of the same events. A couple of new Enron books due out in September -- one by Fortune's Bethany McLean and Peter Elkind and the other by Wall Street Journal reporters John Emshwiller and Rebecca Smith -- may fill the holes. In any event, some tentative lessons are emerging from Enron's meltdown. Here are a few of them:

Enron Didn't Have to Fail
According to Partnoy, Enron's bread-and-butter energy-trading operations were hugely profitable right up until its collapse. In the first eight months of 2001 (up until Skilling's resignation), Enron's North American trading operations were up $2.9 billion, he says, with profits from energy trading more than offsetting huge losses in newer businesses. In fact, Enron's traders were doing everything they could to hide their energy-trading profits to avoid being accused of profiting from the California power crisis, Partnoy says.

Yet Enron ended up failing because a sudden loss of confidence among investors, bankers, and credit-rating agencies plunged it into a liquidity crisis. Partnoy leaves the reader with the impression that Enron's basic business might have been strong enough to survive if CEO Lay had better managed the crisis. Lay seems to have been asleep at the wheel for many years at that point, failing to heed warnings from Watkins and others before the crisis, leaving him unable to quickly unravel and assess the risks his lieutenants had taken.

Character Matters
According to Power Failure, signs emerged very early on that neither Skilling nor Andrew Fastow, Enron's former chief financial officer, may have had the moral fiber or psychological resources needed to run a major corporation. For instance, the book alleges that Fastow raised eyebrows as early as his first job after graduating from Northwestern University's Kellogg School of Business. As a member of Continental Bank's executive-training program, he was once "reprimanded by a supervisor for talking to co-workers about using inside information to make a profit trading stock in Coastal Corp.," one of the bank's major clients, the book claims. If true, the incident presaged the questionable financing schemes Fastow later came up with at Enron.

Indications also surfaced that Skilling's immaturity and extreme perfectionism would make it hard for him to withstand the pressures of being a CEO. In the late 1990s, according to Power Failure, this man, who had once believed he would never fail at anything, personally or professionally, was talking about chucking it all and going to live on a Caribbean Island. He got divorced and went into a sort of delayed adolescence, losing weight and taking up extreme sports like rock-climbing and bungee jumping, the book reveals. Skilling took to making passes at women employees, the authors allege. They also claim he was completely miserable during his few months as CEO. To distract himself, he drank heavily and began hanging around college bars hitting on coeds half his age, according to the book.

Much of What Enron Did May Have Been Legal
For instance, Partnoy notes that the partnerships Fastow created in which to stash billions in debt outside Enron's balance sheet were both relatively commonplace and also disclosed in its financial statements. Dynergy, a rival energy outfit that for a time tried to play the white knight by taking over Enron, had set up similar partnerships. The apparent conflicts of interest that allowed Fastow and others to reap huge profits at Enron's expense were "not unusual by Wall Street standards," Partnoy contends.

Power Failure makes much of the California energy crisis, which may have been largely manufactured by energy traders, many of them at Enron. But Partnoy notes that experts eventually concluded that strategies such as selling California electricity to other states to create an appearance of shortages and congestion were "perfectly legal." He also says most of Enron's huge electricity-trading profits came from trading in other areas of the country, notably the Northeast.

Little Fish Were as Greedy as the Big Ones
Sherron Watkins is generally portrayed as a whistleblower, but she actually raised alarms very late in the game. One of the striking things about Power Failure is how often she went back to the Enron well -- jockeying for new jobs, despite her doubts about the outfit, because the pay was so good. To her credit and Swartz's, the book does make it clear that the people who raised alarms earlier were marginalized or forced out of the company for their honesty.

The Big Worry: "Enronization" of U.S. Financial Markets
Megainvestor Warren Buffett, among others, has been warning that the use of Enron-style financial derivatives has exploded and could threaten the stability of the entire financial system. Partnoy makes a strong case that the real problem is that "efforts to deregulate pockets of the markets, at the urging of financial lobbyists, have created an admixture of strict rules governing some dealings and no rules governing others."

Partnoy points out that "as a result, the markets are now like Swiss cheese, with holes -- the unregulated places -- getting bigger each year, as parties transacting around legal rules eat away at the regulatory system from within." In his epilogue, Partnoy lays out some proposals for changes that might curb the abuses.

As for me, Enron's failure is a lesson in humility. Reading Power Failure reminded me that I had doubts back in 1993 about the risks Enron was taking. Notably, Skilling's faith that he could hedge almost any financial risk made me nervous. B