The History of the Natural Gas Industry

Natural gas, primarily methane, was originally an unwanted byproduct of petroleum extraction. For many years when an oil well vented gas it was simply flared; i.e., burned off. But people eventually learned the uses and virtues of natural gas and built pipelines to convey it to the cities where it took the place of coal gas for residential and industrial lighting and heating.

The market for natural gas has three major types of economic units: 1. Suppliers, 2. Customers, 3. Pipeline companies. In a competitive market the fluctuations in the supply of natural gas creates fluctuations in the spot market price of gas. Such uncertainty in the price of gas creates problems for the suppliers and customers. The suppliers who are making decisions about exploration for natural gas worry that they may invest in development of fields only to find a downturn in the market price which may result in losses. Customers, such as electrical power generators, face investment choices between equipment to use natural gas or fuel oil. They worry that they may invest in equipment for one type of fuel and later find the alternative would have been more economical. This led to businesses entering into long term contracts for natural gas. It also led to the government trying to eliminate the price uncertainty by price controls. The natural gas industry became heavily regulated. The unavoidable problem of price controls is market shortages.

Often the participants in an industry under price controls do not perceive the source of the shortages as being price controls. In the case of the pipeline companies, particularly in the late 1970's and early 1980's, they had customers whom they could profitably serve if only they had additional supplies of gas. The pipeline companies entered into long term contracts with suppliers to take all the gas the suppliers wanted to sell them at a specified price. Those long term contracts could have specified the maximum amounts the pipeline companies were committed to purchase but they did not. At the time it seemed to the pipeline companies that they could use all the gas they could get. These long term contracts to buy any amount of gas at a specified price were called take or pay contracts.

When the demand for natural gas declined in the 1980's the pipeline companies found themselves committed to purchase gas for which they had no customers. This put the pipeline companies with take or pay contracts in a financial bind. The situation became worse when the government started to deregulate the industry. The flood of gas developed brought the price of gas down and the pipeline companies found that the take or pay contracts committed them to buying an unlimited amount of gas for long contract periods above the market price of gas. Under such take or pay contracts the suppliers could not only market their own production at above market prices but buy up gas on the market and extract a premium from the pipeline company they had a contract with. It is easy to see how the pipeline companies in the 1980's would be under financial stress to restructure.

The Formation of Enron

The core of Enron was the merger of Houston Natural Gas of Houston, Texas and InterNorth, a natural gas pipeline company of Omaha, Nebraska. Houston Natural Gas had pipeline running east-west and included lines for serving the Florida market and the California market. InterNorth's pipelines ran north-south and served the Iowa and Minnesota markets.

InterNorth had been operated conservatively and had little debt. This made it a target for corporate raiders who sought to use its cash holding and borrowing capacity to extract funds for themselves. After fending off one takeover attempt InterNorth officials were looking for another pipeline company to merge with that would reduce their attractiveness to corporate raiders. They found it in Houston Natural Gas. Houston Natural Gas had borrowed to make justifiable acquisitions of pipelines to the Florida and California markets.

At that time the executive control of InterNorth had passed from an executive who had pursued cautious, conservative policies to Sam Segnar, who lacked executive experience. Segnar initiated negotiations with Houston Natural Gas for a merger. The negotiations for Houston Natural Gas were handled by John Wing, an individual of extraordinary talents. Wing managed to negotiate a price for Houston Natural Gas shares that was about 40% higher than the current market price of the shares and furthermore got an agreement that after 18 months Segnar would retire and turn over management control of the merged company to Kenneth Lay and the executives of Houston Natural Gas. InterNorth was much larger than Houston Natural Gas so John Wing had negotiated the takeover of a larger company by his smaller company.

The top people of Houston Natural Gas did move to Omaha. They did not have to wait 18 months to take control of the company however. The Board of Directors of InterNorth fired Sam Segnar early and made Kenneth Lay the head of the company. The InterNorth people did extract a concession that the corporate headquarters of the merged company would remain in Omaha.

Although the headquarters of the merged company did remain in Omaha for a period of time there were legitimate business reasons for a natural gas company to be located in Houston which was the center of the energy industry. Those reasons combined with the natural inclination of Kenneth Lay and the other Houston executives to return to their home territory resulted in the corporation moving to Houston. At that time the company was known by the awkward title of InterNorth-Houston Natural Gas. The company sought recommendations for a new name and the first choice was Enteron. But after it was pointed out that the word enteron had a technical definition of intestine and was an entirely inappropriate name for a natural gas company the second choice of Enron was accepted.

Enron: The Nature of the Problems

The name Enron has entered the American lexicon as being synonomous with greed and excessive profit by whatever means possible. Yet Enron was a corporation that went bankrupt and some of the outrageous corporate misdeeds occurred in an effort to stave off bankrupcy. The nature of the problem of Enron was quite different from the public's perception of the corporation.

Kenneth Lay

Enron started out as a natural gas company put together by Kenneth Lay. That core enterprise was put together, in part, to profit from the deregulation of the natural gas industry. The enterprise did some things right and gained considerable credibility on Wall Street.

Trouble in Vahalla

In the course of acquiring companies the enterprise acquired a team of financial market speculators whose original function was to hedge the risk that the parent company incurred in its field of operations. That team of hedgers got involved in market speculation and by luck and perhaps accounting subterfuge apparently made a lot of money. The top people at what became Enron thought that those profits were dependable and they kept the team of speculators, who now were called traders, as an integral part of the company but tried to disguise the nature of their operations.

The problem for Enron was that after some successes the traders began to have some financial failures and Enron was no longer really making a profit. The market traders, who were effectively just high-stakes gamblers, were no source of profits but instead a major source of loss themselves. The losses, however, could be covered up in a number of ways and the deficits covered by effectively borrowing from Wall Street.

Jeff Skilling

One source of the coverup of the operating losses was the Mark-to-the-Market accounting that was insisted upon by Jeff Skilling when he reached the highest level of management of Enron. Mark-to-the-Market accounting is a legitimate form of accounting for an enterprise involved in buying and selling securities. It is a very dangerous form of accounting for a firm engaged in building projects. Under Mark-to-the-Market accounting when a power plant is completed the entire present and future discounted stream of net cash flows are entered into the accounts as a credit. For example, suppose a firm decides to build an electrical power plant which is going to last 50 years and is expected to bring in a net cash flow of $1 million per year. The present value of those fifty years of a million dollars a year, when the market interest rate is 10 percent, is $9.9 million. If the plant cost $4 million to construct that is a net gain of $5.9 million. Under the Mark-to-the-Market accounting system Enron was using the completion of that power plant which would show up as an entry of $5.9 million even thought the company had not yet received a penny of revenue.

Note that in the above it was said that the power plant was expected to earn $1 million per year. What if that expectation was not fulfilled? Suppose that events led to a reduction in the expections to $800,000 per year for the fifty year life. Under Mark-to-the-Market accounting that is taken care of by entering a subsequent loss when the expectations changed by $2 million, the difference between the present value of $1 million per year and $0.8 million for fifty years when the market interest rate is 10 percent. The practical problem is that once the corporation has booked a $5.9 million it is very difficult to get any one to agree to book a loss resulting from a change in expectations. So the firm under Mark-to-the-Market ends up with its accounts highly slanted to dubious initial expectations about the projects.

Andrew Fastow

The other major way Enron disguised its losses was to keep the borrowing necessary to finance the deficits off the books. This was arranged by Chief Financial Officer Andrew Fastow. The accounting rules allowed borrowing to be kept off the books if a portion of the source of the borrowing was from lenders outside of the company. The portion was surprisingly small and Andrew Fastow found it relatively easy to put together lending packages to the company that were only nominally from outside of the company.

Rich Kinder

It should be noted at this point that before Jeff Skilling headed the company it had from 1990 to 1996 a real manager, Rich Kinder (KINN der), who operated the company based upon cash flow performance. Kinder was a lawyer by training and came to Enron by way of Enron's acquisition of Florida Gas. Kinder and Lay had both been trained at the University of Missouri. Ken Lay over the years became more or less a political public relations specialist, Jeff Skilling was a brilliant business concept man and Rich Kinder was the real, brass tacks corporate operations manager. With those talents the three of them were an awesome force. Unfortunately, due to nonbusiness circumstances, Enron lost Rich Kinder. Jeff Skilling moved into the job of CEO for Enron but Skilling, brilliant though he may have been, did not have the management skills that Kinder had. Without the anchor of Rich Kinder the Enron ship went adrift and eventually collided with hard cash-flow reality.

After he left Enron, Rich Kinder went on to build a multibillion dollar energy company, Kinder Morgan, proving that his was the talent, rather than those of Lay and Skilling, which was the essential, critical factor in building a business.

(To be continued.)

Off-the-Balance-Sheet Financing

Enron had a great array of foreign assets such as powerplants and pipelines that were not doing as well financially as the company hoped and counted on in its accounting. Enron set up a subsidiary in 1997 called Whitewing. Whitewing was created to purchase the underperforming Enron assets. Whitewing was then to sell off the underperforming assets. As a subsidiary the financial state of Whitewing would show up in the accounts for its parent company Enron. In 1999 Enron sold off slightly more than half of Whitewing so it would not be treated as a subsidiary in the accounts of Enron. Whitewing was created to buy the underperforming assets from Enron at a generous price, a price higher than it could sell those assets for. So Whitewing was destined to take losses on its assets acquired from Enron. In order for Enron to find buyers for the half share in Whitewing it had to agree to compensate Whitewing for any losses on its sale of the underperforming assets with shares of Enron stock. A group of investment bankers was found to acquire the half share of Whitewing.

Here is how Whitewing would enable Enron to hide a failed investment project. Suppose Enron built a small power plant for $8 million expecting the project to be worth $10 million and entered a $2 million profit on its books. When the power plant did not perform up to expectations and had a market value of only $7 million Enron should have cancelled the $2 million profit and entered a $1 million loss on its accounts. Instead it sold the plant to Whitewing for $10 million thus validating its booked $2 million profit. Whitewing would then sell the power plant for $7 million and get $3 million worth of Enron stock under the agreement. The $3 million of stock issued to Whitewing would not show up as a loss for Enron and thus Enron would have turned a $1 million loss on an investment into a $2 million accounting profit.

(To be continued.)

Foreign Projects

Teeside, England

One of the first foreign projects of Enron, under the guidance of John Wing, appeared to be spectacularly profitable. The project was the building of a gas-powered electrical generating plant at Teeside, England. There were many discouraging aspects to the project but John Wing was able to drive through them to project completion. England had an energy economy historically based upon coal. Coal mining had become more and more costly over the years and the government nationalized the coal mines to keep them operating. The coal miners through their union were a potent force in British politics that had gained political protection for their industry. One of those protections was a law declaring illegal the use of gas for electrical power generation.

But in the time since that protection had been enacted Britain had acquired natural gas sources in the North Sea. And more recently Britain had acquired a prime minister, Margaret Thatcher, intent upon bringing rationality to the social welfare state that existed. John Wing got the necessary approval for building the Teeside plant and negotiated a long term contract with the companies operating the offshore natural gas wells. The contract called for Enron to purchase much more gas than it needed for the Teeside plant but the expectation was that Enron would be able to market the excess. The problem later turned out to be that the market price of natural gas in Britain fell below the contract price and Enron spent years resolving this problem. But the initial perception was that Teeside was a resounding success.

The Dabnol Power Project in Maharastra State, India

John Wing left Enron but before he did he tutored his assistant Rebecca Mark in his style of project development. Teeside created the feeling that if the political and financing problems of power plant projects could be overcome then that guaranteed the success of the projects. John Wing seemed to have an instinct for the profitability of projects that Rebecca Mark lacked. She was able to guide the projects through the approval stages and even the completion stages but in many cases the projects were still financial failures. The worst case of this was the Dabnol power plant in the western Indian state of Maharastra.

Politics in India are complex and perhaps unfathomable to outsiders. It was foolish for Enron to get embroiled in this matter. But the economics of Dabnol were dubious even aside from the political quagmire. The plant was very expensive and there is serious doubt whether the West Indian economy could afford such expensive power. Indians wanted more power but a significant portion of the existing power supply was simply stolen. Urban and rural users simply tapped into the power lines, as they do in most Third World countries. Or they wired around their power meters so their use was not recorded and billed for. Other users simply got electrical power at prices below the cost of generating it. These users felt they had an entitlement to subsidized electricity. Such losses on the generation of electrical power by the state-owned power companies placed a major burden on the government. That financial burden had to be covered by taxing the existing businesses which discouraged their operation and development.

It is not politically feasible to curb even the theft of electrical power because the power thieves constitute a significant bloc of the electorate and will punish electorally any politicians who try to stop the theft of power. Another bloc of the electorate is dependent upon subsidized power. Into this electrical-entitlement culture comes Enron with a plan for a very expensive plant for producing power.

The Dabnol plant was a multi-billion dollar operation to be built in two stages. The first stage involved the use of naphtha as fuel. Naphtha is a petroleum derivative in between kerosene and gasoline in volatility. This fuel would have to be imported and India had a political climate that disdained imports because India had relatively little in export earnings to pay for such imports. But the second stage was much more expensive and technologically sophisticated than the first. The second stage was the conversion of the plant to the use of liquified natural gas (LNG). LNG requires very expensive infrastructure. The LNG would have to be brought to a special port by refrigerated tankers costing hundreds of millions of dollars each. The port for handling such tankers was correspondingly expensive as was the facilties for transporting the gas to the plant itself.

No company wants to undertake such an investment in specialized equipment unless it has some guarantee of a market. Enron negotiated a contract with the politicians in the government of Maharastra state that called for payments of about $1.3 billion per year over a twenty year period. The public multiplied the annual payment times the number of years and screamed, "$26 Billion!!!" This led to the political opposition campaigning on a platform of cancelling this Enron contract. It could well have been that the politicians who contracted with Enron had no intention of fulfilling the contract but they could not very well say that publically.

The opposition party won the election and their government reneged on the contract. Enron meanwhile had invested about a billion dollars in the plant. The loss on this project alone was enough to put the Enron company into financial difficulties. But in Houston Enron had passed beyond the mundane world of profit and loss into a nether world of Special Purpose Entity financing.

The Azurix Water Company

A good deal of competition and antagonism existed between Rebecca Mark and Jeff Skilling. Both expected to advance to the top level of management. When Skilling got the promotion Mark sought a way to be her own boss while perserving her ties with Enron. She decided that she would take the expertise that Enron had developed in the natural gas and petroleum fields to the water industry.

In 1998 she settled upon Wessex Water Co. headquartered in Bath, England as the nucleus for her international water development company. In July of 1998 Enron and Wessex agreed on purchase price of a bit under $3 billion. Water treatment uses a good deal of energy so that offered a possible tie to Enron's other specialties. The water industry was a regulated utility in most places in the world and the possibility of deregulation offered an opportunity for Enron to capitalize on its knowledge of the profit opportunities under deregulation. The idea of Enron entering the water industry was not totally unreasonable.

Rebecca Mark

Wessex Water was acquired and a new Enron company called Azurix was created. (The name Azurix has the connotation of blue (azure) like large bodies of water.) Almost immediately Rebecca Mark started preparing to sell stock in Azurix to the public. It was unusual for a company to attempt an Initial Public Offering (IPO) so soon, particularly before there had been a testing of the basic plan of operation of the company. In the case of the Dabnol plant the problem was the public's feeling that it was entitled to cheap power. The feeling of entitlement concerning water was far stronger than any feeling of entitlement to electrical power.

One of the first ventures of Azurix was the purchase of a water company and franchise to supply water in the Buenos Aires area. Azurix won the bid but its bid was almost three times higher than the next highest bid indicating that Azurix did not know what it was doing. Two other developments gave further evidence that Azurix was not prepared for the differences between operating a water company in England and operating one in Argentina. First there was a large number of missing records of customers. There was a strong possibility that the employees of the old water company were deleting the names and records of their friends and relatives so that Azurix would have no way of knowing of their existence and billing them. Second the customers who came in to pay their water bills in person had no way of finding the new Azurix offices. Later there was an algae bloom in the water system which angered the customers and they stopped paying their water bills.

Azurix's IPO did go through and it raised almost $700 million in the spring of 1999. But Azurix and Rebecca Mark were spending at a rate exceeding $100 million per month so the IPO funds did not last long. At the beginning of 2000 Azurix had to sell $600 million in junk (below investment grade) bonds. But even that cash infusion was not enough to stave off the financial collapse of Azurix. Rebecca Mark retired from Azurix and Enron in August of 2000. For retirement she sold her Enron shares for something upwards of $80 million.

Unwise Domestic Ventures

The early success of Enron engendered a hubris among the Skilling group of executives that they could make any venture a success. When the apparent success continued despite the lack of real profits and in the face of cash flow problems it promoted that notion that real profits did not matter, mark-to-market accounting profits were enough. At the turn of the millenium the dot.com bubble was the focus of attention and the Enron people looked for a way to share in the bonanza of the New Economy where firms had huge valuations despite the lack of profits or any plausible potential for profits. The concept they came up with is the provision of internet service with Enron Broadband Services and the future possibility of trading rights to broadband capacity as a commodity. This idea was not so entirely divorced from the pipeline business as one might think. In 1985 a pipeline company in Tulsa, Oklahoma, the Williams Companies, began stringing fiber optic cable in some of its unused pipelines and transferring information instead of energy. In 1995 it sold this subsidiary operation to WorldCom for $2.5 billion in cash. It also happened that one of Enron's acquisitions, Portland General Electric, was involved in creating a fiber optic ring for the city of Portland. Enron thus thought it had a natural entry into the New Economy.

Ken Rice

Ken Rice was chosen to head the broadbank project. Rice had come to Enron from InterNorth and had successfully promoted Skilling's Gas Bank concept by negotiating contracts for the longterm supply of natural gas.

Rice was well rewarded by Skilling for his contributions to Enron's success. Rice had become wealthy and influential within Enron. He no longer had a hunger for achievement so when he was made head of Enron Broadbank Services he was not the go-getter that he had been years before. He tended to devote his time to other things such as racing cars and motorcycles rather than making Broadband Services work. This might have been alright if the second in command could fill in for him. But the second in command was Kevin Hannon who lacked people-skills and generally just irritated people. Hannon had been hired from Bankers Trust which was the pre-eminent trader in derivative securities. So he was someone with a sense of high status but with absolutely no technical expertise in the field of broadband services.

In actuality the project probably would not have worked even if it had more suitable managers because Enron entered the field along with a flood tide of other providers. Analysts within Enron were warning that the price of internet services was likely to fall and continue falling. Any firm surviving in that commercial climate was likely to be one proficient at economizing. Unfortunately this was not the type of manager Ken Rice was or wanted to be. He was more interested in the flashy gesture such as classy motorcycles on display at the company offices.

But Enron did launch its Broadband Services quite spectacularly in January of 2000. At a meeting of financial analysts Enron had Scott McNealy, the CEO of Sun Microsystems, announce that his company would supply 18,000 of its internet servers for the fiber optics equipment of Enron Broadband Services. This was a public relations triumph and the price of Enron stock jumped 25 percent.

In July of 2000 Enron was able to announce another coup. It had negotiated a contract with Blockbuster, the video rental company, to create a movies-on-demand network. Although this alliance sounded promising it turned out that with the amount of investment in expensive equipment that Enron would have to make it would be virtually impossible for Enron Broadband Services to derive a profit from it. An analyst at Enron estimated that to just break even on the investment the project would have to have about one half of all American households as subscribers and these subscribers would have to be watching on average an implausibly large number of movies (such as ten) per week. Otherwise the project would be losing hundreds of million, if not billions, of dollars per year. The financial world however did not know this.

Six months later however some of the polish was wearing off the Enron image. At a meeting of stock analysts that Enron called in January of 2001 Jeff Skilling tried to make the case that Enron stock, selling then at about $80 per share, was undervalued. He asserted that it was worth $126 per share and that Enron Broadband Services, despite its having lost $60 million on revenues of $408 million in 2000, was worth $40 in Enron share price.

Some analysts at that presentation did not believe the Enron story and said in print that Enron was overvalued at its current price and should sell for more like $53 per share. Generally Enron could keep financial analysts in line because it had a lot of financial business their institutions would lose out on if they ever said anything pessimistic about Enron. The analysts that said Enron stock was overvalued worked for a financial research company that did not provide financial services. They were not worried about offending Enron.

By 2001 Enron Broadband Services was hemorrhaging money. In the first quarter it lost $35 million on revenues of $83 million. Notice that the revenues was down from about $100 million per quarter in the previous year and the losses up from about $15 million per quarter. In the second quarter of 2001 the picture got even darker. There was a loss of $102 million on revenues of $16 million.

At a time when the prospects for Enron Broadband Services were looking very bleak Andrew Fastow came to the rescue with one of his Special Purpose Entities called LJM2. LJM2 purchased the fiber cable capacity of Enron Broadband Services at an inflated price which allowed Enron Broadband Services to book a profit. But LJM2 bought the fiber cable capacity with a guarantee that Enron or one of its subsidiaries would buy it back for LJM2 at an even higher price. If such financial legerdemain could turn the catastrophic losses of Enron Broadband Services into a booked profit then it could do anything.

Extravagant Corporate Expenditures

The cases of corporate management expending corporate funds for luxuries are inumerable. It is only the fortunate stockholders who have management that is frugal with their funds. But in most cases the prodigal managers are expending the corporate profits. In the case of Enron the managers in the latter stage of the firm operation before its bankrupcy the luxuries were paid for from the firm's borrowing because it had no real profits. Thus those extravagances were at the expense of the company's creditors rather than its stockholders.

One common extravagance of corporate managers is on corporate airplanes. These corporate airlines costs many, many times what the travel would cost on commercial airlines. This is not only because of the high operating costs (in the neighborhood of $5 thousand per hour) but also because often the corporate plane flies without any passengers to pickup the corporate executives (or family members or friends) and takes them to their destination and flies back to the home base again without passengers.

When Rich Kinder was effectively in charge of day-to-day operations of Enron he kept Airline Enron under tight contol. There were corporate aircraft but most of them were purchased over his strenuous objections. During Kinder's time there were five corporate aircraft, two of them Cessna Citations. The Cessna Citation was a relatiavely low cost jet that would carry six passengers at 400 miles per hour. Its hourly operating cost was $1500. It was also small enough to take to the smaller landingstrips where real corporate pipeline business required Enron to visit. This was not true of the larger corporate jets.

When Kinder left Enron the staff waited expectantly to see how many corporate airplanes Ken Lay would buy. They did not have to wait long. A few weeks after Kinder left, the company sold the Cessna Citations and bought two Hawker 800's to replace them. The Hawker 800's were bigger and faster and more expensive than the Cessnas. They cost $10 million a piece and cost $4200 per hour to operate.

Kinder was able to severly limit the use of the corporate aircraft to company business. With Kinder gone the personal use of the aircraft esculated. For example, Lou Pai had a ranch in Colorado. Every time he went to visit it using Airline Enron it cost the company about $45,000.

Enron moved up from the Hawker 800's with the purchase of two Falcon 900's. A Falcon carries 13 passengers but has a price tag of $30 million and cost about $5200 per hour to operate. Also another Hawker 800 was purchased so Airline Enron consisted of six planes.

In March of 2001 Ken Lay decided that the prestige of Enron required an even bigger airplane. He petitioned the Board of Directors of Enron for the company to purchase a GulfStream-V (five) corporate jet. This plane would carry 16 passengers and could fly nonstop from Houston to Europe. Its cost was $42 million. Surely Enron could afford such necessities; it had lost only $464 million in that first quarter of 2001.

Another Enron executive who was notorious for extravangant cost of air travel was Rebecca Mark. Rebecca Mark, as head of Enron International, did have a great deal of required air travel. She insisted upon using the corporate planes even when it involved flying her as a single passenger half way around the world. Some felt that most of her trips were not really justified. But nevertheless when a corporate airplane was not available she charted a plane at a cost estimated to be $100,000. An outlay like this made even the corporate airplanes seem to be bargains for air travel.

The Exploitation of Market Control
in the California Electrical Power Industry

The Collapse and Bankruptcy of Enron

Bankruptcy does not mean a company ceases to exist. It means that it cannot pay its contractual obligations and seeks protection from its creditors through the courts. In return for holding the creditors in abeyance the court takes charge of arranging the ultimate disposition of the company's assets in satisfying the debts of the company.

Enron was not devoid of assets. It in fact had billions of dollars worth of assets. The problem was that it had more liabilities than it had assets. More particularly it ran into insurmountable cash flow problems. Also some of the assets like the power plant Dabnol in India were white elephants. A white elephant is an asset that is potentially valuable but at the present has no benefit.

In 1999 Jeff Skilling was raising cash by selling off assets. The assets for which there was a market, such as Enron Oil and Gas, were the ones that were well-run and producing cash. Skilling sold Enron 53% interest in Enron Oil and Gas for about $600 million. This was a help but Enron had a burn rate for cash in its various projects that was at the hundreds of millions of dollars level.

Skilling did try in 2000 to sell Enron's herd of international white elephants, projects that had a book value of upwards of $7 billion, to investors in the United Arab Emirates but the deal fell through.

(To be continued.)

The Debacle and Denouement

In 2004 the top executives of Enron, Kenneth Lay and Jeff Skilling, were indicted. They were tried and convicted in 2006. They are yet to be sentenced in 2006, but the public was expecting sentences to involve terms of years in prison. Before imprisonment could be imposed Kenneth Lay, at age 64, died.

Some people, even ones that should know better, assert that greed was behind the collapse of Enron. Here are two dictionary definitions of the word greed:

• An excessive desire to acquire or possess more than what one needs or deserves, especially with respect to material wealth. (Webster�s Unabridged Dictionary)
• An excessive, inordinate, rapacious desire, esp. for wealth. (Random House Unabridged)

First of all these definitions are defective, but more importantly the assertion that greed per se was behind the collapse ignores the obvious point that Enron collapsed because it was losing money and had been doing so for a long time. Enron lost money because its management made some disasterous decisions. Typically these disasterous decisions were from over-and-unjustified confidence in their ability to manage. They went into risky fields where they had no experience and failed, failed miserably. They developed an expertise in disguising and covering up these failures, but ultimately these financial failures showed up on the bottom line. The relevant failings of the Enron management was mismanagement, their crimes had to do with violating rules and not with greed according to the dictionary definitions. However, the dictionary definitions are defective because what people have in mind in the use of the term greed is an inordinant desire for wealth leading to a violation of moral or legal rules. No one classifies the Beatles as being greedy even though they made a lot of money and consciously put forth effort to do so. Ivan Boesky made a lot less money than the Beatles but he was classified as being greedy because he violated the rules. The salaries and stock options received by the Enron management were set by the board of directors of the corporation. They may have been high, particularly in relation to the quality of the management performance, but they were not what produced the collapse of Enron. The illegal acts were carried out to stave off collapse rather than what caused the collapse. The collapse came as a result of management errors, management errors that were driven by unjustified overconfidence.