Enronomics 101

Even more than the dot-coms, Enron — the aptly nicknamed ​“crooked E” — was the star of the new ​“information economy.” During the past decade, economic fortune-tellers said that the future of business lay in exploiting the Internet and information technologies to create boundless productivity growth and profits. At the same time, there was a continued ideological push toward deregulation of all markets, and financial firms increased their domination over producers of goods and services. Tapping into and deceptively feeding the decade’s collective delusion of unlimited wealth through computerized financial wheeling and dealing, Enron soared in a few years from a sleepy utility to the seventh-largest company in the United States — and one of the most widely praised.

The sordid, still unfolding tale of Enron’s crash is a story with several themes: common greed that soared to uncommon dimensions; the failure and foiling of government regulation; duplicitous accountants, lawyers, bankers, executives and politicians on the corporate take. But it also makes a compelling argument that the new information economy should really be called the disinformation economy.

In the disinformation economy, there is a systematic effort to hide, distort and lie as a way of gaining wealth and power. In itself, this is old stuff, but the techniques for such deception are more sophisticated and elaborate than ever. Even though insider dealing is a crucial part of the disinformation economy, on the surface the economy relies heavily on public information, certainly much more than in the era of handshake deals between private capitalist titans. In this time of deregulation and globalization, as markets grow more all-encompassing and less constrained, failures of information can have much more dire effects. Even on capitalist terms, markets require full, accurate and universally available information to guide rational decisions by investors, consumers and citizens. Disinformation raises the level and cost of irrationality even as it promises a free market utopia.

Enron’s stock market success was based on systematic exaggeration of its financial strength. Its explosive growth and sudden collapse both were linked to the creation of more than 3,500 subsidiaries that were often used to keep debt off Enron’s balance sheets, which in turn helped prop up its credit rating and reduce the cost of borrowing for further expansion. Unlike Enron shareholders, insiders — the corporate executives and selected investors, including divisions of banks that were lending to Enron — knew these subsidiaries were dubiously structured. But they ignored the dangers because Enron held out hope for fantastic returns — doubling their money or better in some years. The auditors for Arthur Andersen did not just overlook this chicanery. Like the lawyers who said it was all legal, the accountants were apparently paid well to help set it up. Nearly 900 of these subsidiaries were established in offshore tax havens like the Cayman Islands, notorious centers for money-laundering and financial concealment. 

Fundamentally, Enron transformed itself from an energy supplier into an almost totally unregulated financial institution. The profits Enron generated came mainly from its on-line trading of electricity and natural gas. (Other trading, especially in telecommunications bandwidth, was less successful.) The bulk of this trading was in ​“derivatives,” complex financial instruments used to hedge or speculate about future prices. Unlike open futures markets in agricultural or financial commodities (like Treasury bonds), Enron not only ran the marketplace, but was a major participant in the trades. The derivative contracts were often opaque and confusing, even to experts. So this market was especially murky and open to manipulation.

To succeed Enron needed markets — starting with energy — that were deregulated, volatile and actively traded. Deregulation provided the instability that created an incentive for hedging and speculation as well as opportunities for Enron to profit, often by taking advantage of minor discrepancies in prices within the marketplace. Clear, predictable information about energy prices typical of regulated utilities hurt Enron; chaos and confusion were its manna. Keynes described financial euphorias as bubbles forming on bubbles. Enron was blowing its own bubbles.

In the real-world economy, electricity deregulation has been a massive failure for consumers. Many can’t easily take advantage of the confusing choices in deregulated markets — just like for telephone service. For them, deregulation most often means disinformation and overwhelming marketing madness. And in most places, energy prices have actually gone up.

Enron’s machinations played a major role in driving up energy costs in California. (Emergency shortages soared after a bill deregulating energy trading pushed by Texas Republican Sen. Phil Gramm on behalf of Enron was passed, then ended when federal price controls were reimposed, according to Public Citizen.) One study concluded that electricity prices on the California-Oregon border recently dropped 30 percent simply because Enron went bankrupt and could no longer use its market power to set prices. Yet with widely fluctuating prices, it is harder for utilities to plan for new generating capacity, setting the stage for future shortages or supply manipulation and price hikes.

Enron is not the only sinner; neither is Andersen. Over the past six years, Business Week reports, investors have lost $200 billion as a result of 783 audit failures at firms that overstated profits, and such incidents doubled from 1997 to 2000. The fallout from Enron has helped to precipitate other major bankruptcies, like Global Crossing, or reorganizations, like Tyco, as investors worry about the reliability of all corporate statements. Former Securities and Exchange Commissioner Arthur Levitt, whose efforts to tighten accounting practices were blocked by Congress, says that a ​“culture of gamesmanship” — a polite term for lying, cheating and deceiving — took hold in the frenzied new economy of the ​’90s.

Politicians helped create the fertile environment for growth of the disinformation economy. Gramm and his wife Wendy, a former director of the Commodity Futures Trading Commission who joined Enron’s board shortly after retiring, pushed through key regulatory rulings and legislation that fostered derivative trading and kept Enron free from regulation. Enron’s political contributions — disproportionately to the Republicans, especially to Bush and his cronies, but also to many Democrats — are now notorious. Maybe Bush didn’t bail out a failing Enron, but he did end Clinton’s plans to rein in foreign tax havens.

Bush’s energy plan promoted 17 policies that Enron had lobbied for, including six visits with Vice President Dick Cheney while he headed the energy task force. Even within the industry, most of those proposals are controversial, such as promoting energy deregulation and derivatives, guaranteeing energy traders open access to all transmission lines, and repealing the Public Utility Holding Company Act (which restricts multi-state holding companies from diversifying into ventures unrelated to their core utility business). But as part of the disinformation society — and in keeping with other Bush moves to restrict freedom of information and access to presidential records, Cheney is fighting to keep secret the deliberations of the energy task force, despite a lawsuit being filed by the General Accounting Office.

But Enron hasn’t just corrupted individual politicians by buying influence through campaign contributions. The irony is that the political corruption ends up destroying one foundation of the market economy itself — reliable information — and exacerbating what economist Michael Perelman calls ​“the natural instability of markets.”

Until the dot-com and stock market collapse, many analysts argued that computers, the Internet and telecommunications had created a ​“new industrial revolution” that had transformed the economy into a recession-proof fountain of growing productivity and profits. But Northwestern University economist Robert Gordon has concluded that nearly all of the accelerated productivity growth in the late ​’90s came from growth in manufacturing of durable goods, especially computers and related equipment. There was virtually no acceleration of productivity in the rest of the economy.

The hype about Internet business and the information economy spurred an investment boom, fed by brokerage firm stock promoters (“analysts”) who even late last fall rated Enron a ​“buy.” Enron was worth $60 billion to shareholders before it tanked, wiping out many of its own workers’ retirement funds. But most observers ignore damage Enron wreaked on the way up: Its exaggerated promise of returns drew investment away from other potential investments. What would the country be like if the billions wasted on Enron had been used rationally and for some real social good, not swept up in the throes of an economy built on lies and deceit?

Even within its own corporate walls, if Enron had plowed money into its wind power division instead of its fraudulent trading division, it could have helped reduce national dependence on Middle Eastern oil and created more stable energy prices. Similarly, illusory high rates of return — profit and growth in stock value — at Enron and other ​“revolutionary” companies put unrealistic pressure on other businesses to match those returns, distorting investment decisions and helping to undermine some industries, including many domestic manufacturers.

The tentative moves emerging in Washington toward regulation of accountants, pension plans, accounting rules and other troubled aspects of the Enron debacle are small, if necessary, steps toward the broader task of unmaking the disinformation economy. But the entire political culture has been so contaminated with disinformation that now — even in the wake of this scandal — both Republicans and Democrats are promoting further energy deregulation. Greed undermined professions that once claimed the public trust — accountants, lawyers, bankers — demonstrating the need for tighter regulation. But who can do that if government itself is corrupted?