Enron and the Myths of Runaway Capitalism

By Marjorie Kelly, Business Ethics. Posted February 20, 2002.

Sometimes it's the little things that say it all. The little thing that lingers in my mind is the story about Enron's creation, when the original plan was to call it Enteron -- until somebody figured out this was the Greek word for "intestines." There you have it. In the end, the story of Enron's implosion is not about one diabolical company. It's about the guts of our economy.

It's about many gut-level issues that confront us: corporate control of politics, executives getting rich while their company sinks, employees laid off by the thousands, 401(k) plans tanking, messes left by deregulation, a corporate board asleep at the switch. All are themes in the Enron soap opera, yet not one is unique to Enron. The problems the scandal reveals are systemic. The individuals involved may have been uniquely greedy and unethical, but they were empowered by a system that exalted greed as it diminished ethics and accountability.

The most basic issues of Enron are system issues. These come down to two, not unrelated truths:

1) The ideal of the unregulated free market is flawed, and it's time we said goodbye to the invisible hand.

2) Managing a company solely for maximum share price can destroy both share price and the entire company.

These are foundational flaws in theory, flaws in how we conceive of markets and how we define business success. They are system design flaws. For beyond the juicy tales of villainy at Enron, the deeper issue is why the system lent so much power to villainy, and why there were so few checks and balances to stop it.

A key reason is that we are told -- and, more incredibly believe -- that checks and balances are bad, because free markets are good. Unregulated markets are ideal. Left free to work its magic, self-interest (ie. greed) ostensibly leads things to work out to the benefit of all, as though guided by an invisible hand. This myth is taught in Economics 101 as gospel truth, trumpeted routinely in the business press, and sold abroad as the cure for what ails all economies.

The lie of it has been exposed many times. Think of the Great Depression, the savings and loan crisis, or the collapse of Asian economies in 1997-98. Unregulated free markets often lead to disaster. Self-interest is an insufficient regulator for a complex economy. (Duh.) Yet we seem to have to learn this lesson again and again.

Enron is the latest case in point. Consider California's experiment with electricity deregulation. At an Enron Senate hearing, Sen. Barbara Boxer demonstrated how the experiment left the state "bled dry by price gouging." Jeffrey Skilling, as CEO of Enron, had predicted deregulation would save California $9 billion a year. But as Boxer noted, the state's total energy costs instead soared from $7 billion to $27 billion in a single year. Prices rose a gut-wrenching 266 percent.

Not coincidentally, Enron's stock also shot up. Total return to shareholders in 1998 was a remarkable 40 percent. The next year, a miraculous 58 percent. And in 2000, a jaw-dropping 89 percent. Deregulation did indeed work the magic it was designed to work, by turning Skilling's stock options into a gold mine -- just before it turned the company into rubble.

California wasn't the only one duped by the magical thinking of deregulation. Enron helped convince Massachusetts, New York, and Pennsylvania to deregulate energy markets. And it did the same with Washington.

In 1993 Enron persuaded the SEC to grant it an exemption from the Public Utility Holding Company Act (PUHCA), a Depression-era law that prevented utilities from diversifying into unrelated risky businesses. Enron pursued this diversification, to its disaster. As Rep. Ed Markey (D-Mass.) put it, "If Enron had been regulated under PUHCA, I seriously doubt that the types of transactions that brought this company down would have occurred."

Strike two against the myth of deregulation came in 1997, when the company won exemption from the Investment Company Act of 1940, allowing it to leave debt from foreign power plants off its books. This led to dubious offshore partnerships, which contributed to the firm's undoing.

Strike three came in 1999, when Congress killed the Glass-Steagall Act of 1933, which had separated commercial from investment banking. This allowed J.P. Morgan, to use one example, to entangle itself with Enron in dangerous conflicts of interest. It underwrote bonds for Enron, traded derivatives contracts with the company, bought stock in the firm, and had a research analyst covering the company (recommending it as a buy until last fall), even as the bank risked billions in loans to Enron. Lured by millions in investment banking fees, J.P. Morgan was left holding the bag on $2.6 billion in Enron debt. And that's what Glass-Steagall was designed to prevent.

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