Another Look at Enron

Corporate fraud or government misconduct?

When Enron executives Ken Lay and Jeffrey Skilling were convicted in federal court four years ago, the typical media response was that justice had been done. Bethany McLean wrote in Fortune:

Guilty! … Guilty! … Guilty! Judge Sim Lake’s reading of the jury’s findings had a staccato rhythm to it. Lay, who was standing not with his lawyers but in the front row of spectators close by his wife, Linda, clutching her hand, turned red, his face strained. Skilling responded with a peculiar smirk. The prosecutors remained impassive, but celebrated later that evening at a Houston tapas restaurant, clearly relieved to have won.

Why was this such a “great” victory for federal prosecutors? McLean goes on:

Let’s acknowledge some unambiguously positive implications of the Enron verdict. First, it finally offers a measure of consolation – or retribution – for those employees who lost everything in Enron’s bankruptcy. And it reinforces a critical notion about our justice system: that, despite much punditry to the contrary, being rich and spending millions on a crack criminal defense team does not necessarily buy freedom.

The response from journalists and politicians across the country was unanimous: Enron was a fraudulent entity and a number of executives and employees got what they deserved by going to prison. However, I have been among the critics not only of the verdicts, but also of the government’s conduct throughout this sorry affair. Thus I am part of a larger public effort to tell people there is another side to the story.

Before going further, however, let me say that Enron’s demise should not have been a surprise, as it was a product of the Federal Reserve’s late 1990s boom. Alan Greenspan’s easy-credit regime permitted Enron and other firms to boost their stock prices to levels well above where the fundamentals said they should have been. Furthermore, because it was too easy to borrow money and paper over fundamental issues, Enron’s leadership began to believe the “Masters of the Universe” accolades that came from a then-worshipful financial press.

When the stock bubble burst and interest rates went back up, Enron’s leadership was in a hard place. Available cash dried up, and the company was leveraged well beyond its capacity to fund that debt service and still pay its bills. In short, even though Enron was riding high during the boom, it clearly was not prepared for the bust, which none of the leadership really understood. (The late Ken Lay, Enron’s chairman for many years, was a Ph.D. economist, but he should have received an education in Austrian economics; at least then he might have understood why his company was in so much trouble.)

Short Sellers Not to Blame

Lay’s contention that Enron was “done in” by short sellers was incorrect. Short sellers exposed Enron; they did not bring it down. When the market spoke, it spoke harshly, and both Lay and Skilling, who had almost all of their wealth tied up in Enron stock, lost millions.

Unfortunately, federal prosecutors are armed with “legal” weapons that permit them to criminalize all sorts of entrepreneurial error, and I believe Enron was such a case. As Harvey Silverglate has noted in his classic book, Three Felonies a Day, Enron’s accounting methods were legal and Enron reported the details in its financial documents. However, the legality of what Enron’s leadership did was not an obstacle to federal prosecutors, and that hardly should surprise anyone, given the absolute power that federal officials have in this country, something I pointed out in my column last week.

I am participating with attorneys and other economists and financial experts in a project that urges people to take another look at the Enron story, called “Ungagged.” We take a hard look at what really happened, and we also scrutinize the government’s conduct and find it wanting. (Subornation of perjury was a favorite tactic of federal prosecutors. Houston attorney Tom Kirkendall has an excellent account of one incident on his own blog.)

There is another story to tell about Enron, and I am helping to tell it.

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