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What's Going to Follow the Enron Mess?
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(January 26, 2002) This morning’s headlines of the suicide of an ex-Enron vice chairman add to the unceasing twists and turns of Enron’s unraveling. Meanwhile, ten Congressional committees hold hearings on the Enron situation, the Fifth Amendment is being invoked, and some people smell a political scandal. In fact, it's potentially much worse than that.
If you’ve been out of the country for a while, here’s a 3-paragraph summary of the most widely written about corporate collapse of all time:

A large, publicly traded Texas corporation with intimate ties to the Bush administration has gone belly up. Billions of investor dollars are gone, not the least of those dollars having formerly resided in the 401(k) retirement plans of past and present Enron employees. It is revealed that Enron hid potential and actual losses behind partnerships partially owned by certain Enron executives, and that some seventy-plus offshore entities were set up both to avoid federal taxation and to shield Enron’s exposure to derivative-based positions in natural gas, bandwidth, and a host of other commodities and near-commodities, including, of all things, the weather.

Big Five accounting firm Arthur Anderson had been doing Enron’s books for over a decade, while acting as consultant to the firm in other matters. And somehow Anderson put their accountant’s blessing on years of Enron earning statements that, we now know, stretched credulity to the limit. And it seems that the past few weeks of Anderson’s work have consisted primarily of massive document-shredding sessions.

Enron insiders sold millions of shares near the peak of their value, all the while issuing assurances to other shareholders, including Enron employees, that the stock was a solid, nay, even undervalued investment. Thousands of former Enron employees are out of work, and millions of shareholders (directly and through mutual funds) are out billions of dollars. The fallout from the Enron blowup means that the city of Houston and accounting partnership Arthur Anderson are both taking huge economic blows. Houston will no doubt survive, but Arthur Anderson likely will not.

- Thus ends our tidy summary. We just saved you hundreds of hours of reading the popular press, or, worse still, having the TV pundits loudly misinform you about the Enron story.

The Enron debacle is an event of epic proportions, the effects of which will be felt for years. And it's a vast oversimplification to try to make it a simple political scandal. A word here to Congress: call off your dogs, they're barking up the wrong tree.

First of all, this is not a political scandal to be called Enron-gate. Yes, Ken Lay was a major contributor to George W. Bush’s presidential campaign, even donating the use of his private jet for transport, and financing much of the Inaugural celebration. Ken Lay has been a friend of the Bush family for years, as part of the inner circle of the Texas oil business. Enron even went so far as to provide a consulting position for master political strategist Ralph Reed while Bush considered his own potential candidacy, just to help keep Reed’s talents out of the clutches of other Republican candidates. Kenneth Lay’s connection to the Bushes was never a secret, nor, until recently, was it controversial – witness the fact that Lay was the only member of Cheney’s controversial energy policy brain-trust whose identity the Bush administration would even publicly acknowledge.

So did Enron make contact with Bush administration officials when things started to fall apart? The answer is, of course they did. What good are high-level government connections if you can’t pick up the phone and use them?

Did members of the Bush administration return phone calls from Enron officials, perhaps even meet with Ken Lay or with envoys from Enron and discuss the company’s situation? Given the closeness of Enron to Bush administration figures, it would be impolite of them not to. If we find out later that they did, it's hardly what you would call a very shocking revelation.

The question is, did those high-level connections do Enron any good when the chips were down?

No, Enron sank like a stone without the benefit of any government help. And there is no evidence that President Bush, his Cabinet, or any Federal officials lifted a finger to 'save' it. Enron was decidedly not deemed ‘too big to fail.’

So now we face the specter of months of Congressional hearings and fingerpointing. And though complicated financial stories suffer a severe 'dumbing down' in the mainstream media, the Enron blowup is so big that it will attract much wailing and flailing about in that shallow end of the news pool. New revelations will pile up. And we will see new reforms and regulations being proposed in the areas of retirement plan ownership of company stock, accounting firms acting both as auditors and consultants, and insider trading versus employee stock restrictions. Everyone will be looking for bogeymen, scandals, indictments, and ways to ensure that none of this ever happens again. And Ken Lay, once the symbol of civic philanthropy in Houston, is now the most likely candidate for total demonization.

But the scandal here is not political, but corporate. The crew that ran Enron simply cooked the books, or at the very least had them lightly sauteed in ways unimaginable to mere mortals. Arthur Anderson, the soon-to-be-former accounting giant, perhaps only stood by and tacitly approved, but more likely it actually provided the recipes for financial disaster. And it finally caught up with them, in the sort of cataclysmic climax that puts a big-budget disaster movie to shame.

The real fallout from Enron will be the loss of faith by the investing public in what they are being told by the companies that they invest in, and the accountants who certify that corporate performance. The whole area of corporate reported earnings, already under widespread suspicion, becomes even more of a focus point when the public sees the sorts of tricks that Enron was up to. Seasoned investors are accustomed to phantom earnings such as revenue booked without being received, product shipped without being ordered, and today’s tendency to cite ‘pro forma’ earnings instead of earnings as defined by generally accepted accounting principles. But Enron’s manipulations of earnings and obfuscation of risk through partnerships, offshore entities, and the recognition of revenues that never actually occurred seem breathtakingly radical.

Investors are likely to ask just how widespread these practices are. What other large corporations, whether Arthur Anderson clients or not, are practicing the same sorts of financial legerdemain? The larger and more diverse the corporation, the harder its business is to understand, and the more it resembles a multi-headed conglomerate, the more it will come under suspicion.

A strong possibility exists that for some time to come a shadow will be cast over the whole stock market, particularly over the larger firms that are more likely to be guilty of ‘sophisticated’ methods of accounting. After all, corporate earnings, or the anticipation thereof, are the reason that people buy stocks in the first place. It’s a very dangerous atmosphere for the stock market when people start to get a gnawing feeling in the back of their minds that maybe things with their favorites stocks are not as they were led to believe.

The idea of earnings sleights-of-hand accomplished with undisclosed partnerships, hidden debts, and offshore entities, all shepherded by lap-dog accounting firms is bound to be upsetting to investors. A number of them may even begin to question the earnings quality of their whole portfolio or mutual funds holding.

This is likely to be very threatening to an already disrupted stock market. How much more, after the past two years, can the average market investor take? The Bubble Market of the 1990’s (which carried Enron and a legion of others to astronomical P/E ratios) was based on perceived earnings growth. Investors and fund managers bestowed fantastic rewards on companies that showed growth performance every quarter. When that growth broke, both in the economy and in earnings, so did the stock market.

Now the questions are these:

Have any, or all, of the other major accounting firms been as lackadaisical as was Arthur Anderson in keeping their clients honest? How many skeletons are hidden in other corporate closets? Which company will be the next to present us with a major restatement of earnings?

The Enron debacle strikes at the heart of the stock market investor, who takes much on faith. More than ever, it seems that faith is untenable, and the equities investor is getting very little real, tangible value for his or her money.

 

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