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 t'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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