Tuesday, June 7, 2016
The Smartest Guys in the Room, by Bethany McLean and Peter Elkind
This book takes a very holistic approach to analyzing Enron's collapse and the authors do a very good job of showing how it was a combination of things over time and gradual shifts that led to the eventual collapse rather than one specific decision or event. Certainly specific decisions had more influence than others, but it was a combination of decisions rather than just one choice. The authors also go into the lives of key figures such as Ken Lay, Jeff Skillings, and Andy Fastow and how their decisions, or lack thereof in some cases, influenced Enron's eventual, inevitable collapse. We get to watch as Enron grows from a natural gas pipeline company under Lay's leadership to the biggest energy trading company in the world, to a byword for corporate corruption and excess in the aftermath of its collapse.
So, what made Enron collapse? Well there's no one thing, but there are definitely a couple of things which made large influences. The title, The Smartest Guys in the Room, comes from the public perception of Enron's executives as the brightest people in the business world. To give him credit, Jeff Skillings effectively pioneered the creation of the natural gas commodity trading, something which just didn't exist previously. But, Skillings and other Enron executives assumed intelligence and mastery in one area would equate to intelligence and mastery in other areas. Skilling assumed that the principles he used for natural gas trading could easily be adapted to trading in electricity, water, pulp and paper, metals, broadband, and even financial instruments. And whenever anyone doubted that they could be successful, the doubters were simply written off as not being smart enough to ''get it''. Which created a sort of echo chamber where every idea Skilling had, no matter how improbable, must have been a good idea because he's the smart one and nobody wanted to be called stupid. Which only led Enron into a series of terrible, terrible business decisions which made the company hemorrhage money.
To understand why Enron's stock rose to such tremendous heights, you have to understand the nineties stock market. According to the authors, the only factor that mattered was earnings per share (EPS). If a company met or exceeded EPS, their stock would continue to rise with no apparent limit. This put a strong incentive on companies to manipulate how their EPS was reported to meet Wall Street's expectations and be rewarded with a higher stock price. Enron wasn't the only company that used a variety of tricks to make their earnings look prettier, but they were probably the most egregious abusers. It may have started innocently enough, but it very quickly grew into outright fraud and a lot of confusing double-speak that a large number of investors and analysts simply couldn't make heads or tails of. However, everyone wanted to get in on the next big thing and continued to sing Enron's praises despite their earnings reports not making any sense. It eventually got to the point where Enron was disguising loans as income on its balance sheet, and actually had an insane amount of debt, a significant amount hidden off the balance sheet, and a lot of it backed by the value of Enron stock. If the stock continued to rise then everything was okay, but once the stock took the slightest tumble things started going downhill and the entire structure collapsed under its own weight.
On top of that, Enron got a very bad reputation thanks to their involvement in the California energy market in the early 2000's. California decided to partially deregulate its energy economy and allow large companies to trade energy as a commodity, much like natural gas. However, as some of you might remember this very quickly turned into a situation where California was plagued by frequent blackouts and energy costs, instead of going down, continued to rise. Enron alone cannot be blamed for the problems however their decision to game the system as it existed to extract maximum returns for the company certainly did not help the situation in the least. And yes, people need to make money, I'm not arguing against that. But Enron's actions during this time period were focused entirely on making money with no thought for the consequences to the lives of ordinary people. Many people came to blame Enron, the strongest support of energy deregulation, for being responsible for the headaches that followed. And while they're not entirely responsible, their decisions to game the system certainly did not help in the least.
And finally there was just the culture of excess at Enron which almost boggles the mind. Ken Lay as CEO lived an extravagant lifestyle and his friends and family greatly benefitted from the use of Enron resources, including the use of a fleet of corporate jets pretty much any time they desired. This certainly set a bad example for the other corporate employees. Expense accounts were used to pay tabs at strip clubs, people ordered phones, computers, and other devices which were paid for by the company, pay was extravagant, and severance packages were extremely generous. As Enron drew towards the end, billions of dollars disappeared into severance packages for executives fleeing the sinking ship. And of course the best example is Andy Fastow, the CFO of the company for a number of years, who created a number of companies to help hide debt off of Enron's balance sheet and create the illusion of cashflow for Enron while at the same time picking the company's pocket for millions. With so many people raiding the till, it's a small surprise the company collapsed.
Overall I don't think I can recommend this book enough. I admit I don't really understand high finance all that well but I still have a strange fascination with it and I really enjoyed listening to this book. The authors do a pretty good job of explaining all of the confusing loopholes and chicanery that went on at Enron and perhaps more importantly it serves as a cautionary tale against future disasters. Although if history is any indicator, I'm sure there will be other disasters in the future which will appear equally obvious in hindsight. Even if it has an awful ending, it's a pretty fascinating story.