"For three decades now, the dominant strain of economics from the University of Chicago has been teaching gullible undergraduates and journalists that there is no such thing as the public interest. Efficient outcomes are just the aggregation of selfish private interests, and government's main job is to get out of the way. Well, after Enron, these theorists should learn some other useful trade." — Robert Kuttner, "Enron: A Powerful Blow to Market Fundamentalists," BusinessWeek, February 4, 2002.
"Enron should be remembered as the antithesis of a true capitalist enterprise.... Enron lived, thrived, and perished in and through the mixed economy.... The capitalist worldview is stronger, not weaker, post-Enron." —Robert L. Bradley Jr., Capitalism at Work: Business, Government, and Energy (Salem, MA: M & M Scrivener Press, 2009), pp. 293, 302.
In mainstream thought, the fall
of the once-iconic Enron Corporation (1986-2001) has become "Exhibit
A" against unbridled business. To capitalism's critics, its collapse was
about more than one company's bad management. Enron exposed the economic truth
about the deregulation movement that had begun in the late 1970s, as well as
the moral truth about the ebullient profit-seeking ethos that went along with
it. And that truth was: In underregulated markets, greed will shamelessly
sacrifice the virtues of fairness, honesty, justice, and even legality.1
"I predict that in the
years ahead Enron, not Sept. 11, will come to be seen as the greater turning
point in U.S. society," Paul Krugman wrote in theNew York Times.2 Why? Because it will mean "ending an
era of laxity, in which nobody asked hard questions as long as everything
looked O.K."3And Robert Kuttner, in BusinessWeek, said
that Enron "should signal the collapse of a whole economic paradigm"
and "signal a whole new era of re-regulation."4
Rice University business
ethicist Duane Windsor lambasted "the Enron value set" of "an
extreme laissez-faire ideology of absolutely 'free' (i.e., absolutely
unregulated) markets."5 Diane Swanson of Kansas State University,
with Enron in mind, complained that "most MBAs will graduate without an
anchor in social and environmental management," leaving them with "an
amoral, even brutish theory of management [that] has long been taught in
business schools."6
In short, Enron seemed to
embody the Progressives' view that the "idealistic" 1960s and 1970s
had been overthrown by a revivified capitalism, coming out of the right-wing
think tanks with a new confidence, based on Ayn Rand's ethical individualism
and Milton Friedman's libertarian economics. The result was plain to see:
America's most admired company (according to Fortune magazine)
turned out to be America's biggest bankruptcy, and its top executives turned
out to be criminals. Textbooks immediately began to incorporate this
interpretation, and ten-year retrospectives of the company have not changed it.7
A False Narrative
"I believe in God, and I
believe in free markets," stated Ken Lay, the founder and chairman of
Enron during its entire life.8 At a Cato Institute conference on natural-gas
deregulation, Lay intoned: "Imperfect markets are often better than
perfect regulation."9
In some ways, Enron was entrepreneurial
and free-market. The company's large interstate natural-gas pipelines,
regulated under the Natural Gas Act of 1938 by the Federal Energy Regulatory
Commission (FERC), energized a staid public-utility-regulated industry with new
services and pricing terms. Enron challenged regulation that advantaged coal
against natural gas at both the state and federal level.10
But the historian must look
deeper. Was Enron really a free-market, capitalistic company even when its
apparent self-interest lay elsewhere? Or were profit centers dependent on tax
subsidies, advantageous regulation, or checks written on the U.S. Treasury? Was
Enron passive or active in seeking and receiving special government favor?
As it turns out, Enron was a
political colossus with a unique range of rent-seeking and subsidy-receiving
operations. Ken Lay's announced visions for the company—to become the world's first
natural-gas major, then the world's leading energy company,
and, finally, the world's leading company—relied on more than
free-market entrepreneurship. They were premised on employing political
means to catch up with, and outdistance, far larger and
more-established corporations.
A big-picture Ph.D. economist
with Washington, D.C. experience regulating oil, gas, and electricity, Lay
found his niche in the private sector managing federally regulated interstate
gas-transmission companies, first at Florida Gas Company and then at Transco
Energy Company. When Lay became CEO of Houston Natural Gas Corporation, he
transformed a largely unregulated intrastate natural-gas company to a federally
regulated (interstate) one in 1984-85. Then, during the next 16 years, he
steadily moved the renamed Enron into rent-seeking.11
Political Profit Centers
Government and energy in the
United States have a linked history, and the links became more numerous during
and after the 1970s' shortages of oil and gas as a result of price and
allocation controls.12 Still, the number and range of Enron's
politically connected profit centers was unique.
· Enron Cogeneration Company
built gas-fired electricity plants for utilities that were required to buy
power at an "avoided cost" under the Public Utility Regulatory
Policies Act of 1978.
· Enron Oil & Gas Company
specialized in tight-sands gas production eligible for the IRS Section 29
federal tax credit (1980-2000).
·
Enron Gas Marketing became a major profit-center in
the mandatory open-access era, whereby federal law required interstate
pipelines to offer "nondiscriminatory" transportation at "just
and reasonable" rates to nonaffiliated marketers (FERC Order 636, et
seq.).13
· Enron Capital & Trade
Resources (a successor to Enron Gas Marketing) marketed electricity under
mandatory open access rules at the federal and state levels (FERC Order 888, et
seq.).
· Enron International
specialized in project development in developing countries eligible for
taxpayer-backed loans from the Overseas Private Investment Corporation and the
Export-Import Bank.
· Enron Renewables Energy
Corporation's subsidiaries in solar power and in wind power received Department
of Energy grants and benefited from the federal renewable electricity
production tax credit.
All of the above divisions
relied directly, not tangentially, on government regulation, special tax
provisions, or grants. The profitability of Enron's interstate pipelines was
also tied to government (FERC) regulation, which meant replenishing the rate
base for maintaining profitability.
Environmental Regulation
Enron publications and
speeches incorporated a "green" theme in 1988, the year that
(anthropogenic) global warming became a national issue. Greenhouse-gas
emissions, led by carbon dioxide (CO2), were in the spotlight, and
natural-gas-centered Enron found new advantage over coal and oil. And so Enron
became "the company most responsible for sparking off the greenhouse civil
war in the hydrocarbon business."14
To receive preferential government treatment, Lay/Enron:
· Lobbied for and supported the
Clinton-Gore proposal for a Btu energy tax (1993),
· Aggressively invested in solar
power (1994),
· Jump-started the ailing U.S.
wind industry with the purchase of Zond Corporation (1996), and
· Spearheaded the effort behind
what became the nation's most strict renewable-energy mandate (Texas: 1999).
For its efforts, by the way,
Enron received a climate-protection award from the Environmental Protection
Agency (EPA), a corporate-conscience award from the Council on Economic Priorities,
and numerous other awards and recognition from pro-interventionist groups.
Enron did fall short, however,
in its 13-year drive to persuade the federal government to regulate (price) CO2 emissions,
an intervention that had promised profit opportunities in seven company
divisions: natural-gas production, transmission, and generation (relative to
oil and coal); energy outsourcing (a/k/a energy efficiency) services; renewable
energy generation (wind and solar); and CO2 emissions trading
(joining company trading in sulfur dioxide and nitrogen oxide).
The Kyoto Protocol of 1997, an
international treaty regulating greenhouse-gas emissions,15 was the outcome of a process that no U.S.
company supported more than Enron. Thus, Enron's climate lobbyist excitedly
wrote from Kyoto, Japan:
If implemented it will do more to promote Enron's business than will almost any other regulatory initiative.... The endorsement of [CO2] emissions trading was another victory for us.... This agreement will be good for Enron stock!!16
"Enron now has excellent credentials with many 'green' interests," the memo added. "This position should be increasingly cultivated and capitalized on (monetized)."17
Gaming Regulatory Complexity
Any analysis of Enron's
business history will reveal entrepreneurial error and unhealthy government
dependence that left major divisions of Enron in the red or just marginally
profitable. But rather than make midcourse corrections, Enron manipulated the highly
prescriptive—indeed politicized—tax and accounting systems to
create the illusion of profitability. Such gaming was another crucial
government front for the company.
The corporate tax division
acted as a profit center at Enron by meeting earnings targets.18 Federal investigators identified 881
offshore subsidiaries as part of Enron's tax-sheltering strategy.19 Enron's general tax counsel remembers
reaching his gaming limit: "When the [tax-saving] number got up to $300
million [in 2001] I said... 'We have to come up with a way to get this through
[real] earnings—through regular business'."20
Gamed financial reporting was
a second "profit center," as Enron scoured the Generally Accepted
Accounting Principles (GAAP) rulebook to book paper earnings where economic
profit (positive cash flow from operations) was absent. "Financial
engineering" also hid liabilities and inflated assets, allowing Enron to
meet investor expectations and concoct peculiar narratives about its business
performance.21
A particularly contrived
business in this regard was Enron Energy Services (EES), which purportedly
split energy savings with customers via long-term outsourcing agreements. EES
buttressed Enron's "green" image, but the green was not monetary.
Mark-to-market accounting turned into mark-to-model, under which arbitrary
assumptions about future energy prices turned losses into profits. The GAAP
game was even explained in Enron's employee Risk Management Manual:
Reported earnings follow the
rules and principles of accounting. The results do not always create measures
consistent with underlying economics. However, corporate management's
performance is generally measured by accounting income, not underlying
economics. Risk management strategies are therefore directed at accounting
rather than economic performance.22
A third exercise in government
gaming that gave Enron false profitability concerned electricity trading in
California in 2000-2001. Through contrived schemes with code names like
"Get Shorty" and "Ricochet," Enron exploited loopholes in
the state's highly regulated system, which generated hundreds of millions of
dollars of paper profits that utilities and their ratepayers could not and would
not pay. One manipulation was described in an Enron memo: "The net effect
of these transactions is that Enron gets paid for moving energy to relieve
congestion without actually moving any energy or relieving any
congestion."23
Conclusion
Enron was essentially a
political company, not a free-market one. Ken Lay's creation would be unknown
to history were it not for the distorted incentives from the government side of
the mixed economy.
For classical liberals, Enron
is a case study in support of the separation of government and business. There
is egregious rent-seeking, whereby the company worked to shape political
intervention for economic advantage. There is bootleggers and Baptist
politicking, whereby Enron teamed with nonprofit groups to win support for what
was in the company's narrow self-interest.
There is the peril of
half-slave, half-free. Partially deregulated markets (such as with electricity in
California) created a devil's sand box for profit-making that otherwise would
have been absent in a free-market order.
Although an Enron could not
have been predicted, it is yet another example of the unintended consequences
of interventionism in the field of energy, as well as from the politicized
accounting and tax systems that governed all corporations.
And then there is the ultimate
consequence from the dynamics of intervention. Historically, the failures of
the mixed economy have been an excuse to further politicize the economy.
Richard Epstein warned: "The greatest tragedy of the Enron debacle is not
likely to be the consequences of the bankruptcy, but from the erroneous
institutional reforms that will take hold if its causes are not well
understood."24 The Sarbanes-Oxley Act (2002) and the
Bipartisan Campaign Reform Act (2002), enacted with Enron in mind, proved him
right.25
Both the false narrative and
the real story of Enron impart lessons for intellectuals and pundits alike.
Sound theory makes complex history intelligible; bad theory blinds us to
recognizing what is there for the taking. Enron fooled many people in its
active life, and it continues to fool in death. A true understanding of
"Exhibit A" deserves to enter into the mainstream of thought.
Footnotes
1. "Perhaps more than any
other company, Enron became a symbol of corporate excess and fraud."
Robert Frank et al., "Scandal Scorecard," Wall Street Journal,
October 3, 2003.
2. Paul Krugman, "The Great
Divide." New York Times, January 29, 2002.
3. Ibid.
4. Robert Kuttner, "The
Enron Economy," The American Prospect, January 1-14, 2002.
Kuttner said elsewhere: "Defenders of deregulation are mounting a heroic
effort to insist that the debacle was merely a business model gone bad, not an
impeachment of freer markets." "The Lessons of Enron: Regulation
Isn't a Dirty Word," BusinessWeek, December 24, 2001.
5. Duane Windsor, "Business
Ethics at 'The Crooked E'," In Enron: Corporate Fiascos and Legal
Implications, edited by Nancy Rapoport and Bala Dharan, 659-87. New
York: Foundation Press, 2004, p. 661.
6. Diane Swanson. "The Buck
Stops Here: Why Universities Must Reclaim Business Ethics Education." Journal
of Academic Ethics 2 (1): 43-61 (March 2004), pp. 49, 53.
7. Enron 10 Years Later - Media
Roundup - Business Ethics Expert Quotes — January, 2012, at the Institute for Corporate Ethics.
8. Quoted in Sandi Dolbee,
"Prophet or Profit?" San Diego Union-Tribune, February 2, 2001.
9. Quoted in Robert L. Bradley
Jr., "Foreword," in Jerry Ellig and Joseph Kalt, New Horizon
in Natural Gas Regulation (Westport, CT: Praeger, 1996), p. ix.
10. Under state public-utility
regulation, electric utilities had an incentive to build coal plants instead of
gas-fired power plants because the former created more rate base upon which to
apply the allowed rate of return. The federal Powerplant and Industrial Fuel
Use Act of 1978, repealed in 1992, blocked gas usage in favor of coal on the (errant)
belief that natural gas was running out.
11. This history is taken from
"Introduction," Capitalism at Work, pp. 1-13.
12. The dynamics of U.S. energy
intervention are surveyed in Robert L. Bradley Jr., "Interventionist
Dynamics in the U.S. Energy Industry." In The Dynamics of
Intervention: Regulation and Redistribution in the Mixed Economy, edited
by Peter Kurrild-Klitgaard, 301-34. Special Issue of Advances in
Austrian Economics 8 (2006).
13. Critics called mandatory
access "infrastructure socialism." See Adam Thierer and Wayne Crews, What's
Yours Is Mine: Open Access and the Rise of Infrastructure Socialism (Washington,
D.C.: Cato Institute, 2003).
14. Jeremy Leggett, The
Carbon War (London: Penguin Books, 1999), p. 204.
15. The climate-change accord
included a voluntary U.S. reduction target of 5.2 percent in CO2 emissions
by 2008-12, compared to 1990 base levels. It was never submitted for
ratification to the U.S. Senate and has expired on its own terms.
16. John Palmisano,
"Implications of the Climate Change Agreement in Kyoto & What
Transpired" (Enron memo), December 12, 1997, pp. 1, 3. This memo is
reproduced at http://www.politicalcapitalism.org/enron/121297.pdf.
17. Palmisano, p. 2.
18. April Witt and Peter Behr,
"Enron's Other Strategy: Taxes." Washington Post, May 22,
2002.
20. April Witt and Peter Behr,
"Enron's Other Strategy: Taxes," Washington Post, May 22,
2002.
21. "The Enron scandal grew
out of a steady accumulation of habits and values and actions that began years
before and finally spiraled out of control." Bethany McLean and Peter
Elkind, The Smartest Guys in the Room: The Amazing Rise and Scandalous
Fall of Enron. New York: Portfolio, 2003), pp. 132-33.
22. Quoted in Bethany McLean and
Peter Elkind, The Smartest Guys in the Room, p. 132.
23. Mark Martin, "'Smoking gun' Enron memos /
'Death Star,' 'Get Shorty' Strategies,"San Francisco Chronicle, May 7, 2002.
24. Richard Epstein, "Praise
for Corporate Aftershock," in Christopher L. Culp and William
A. Niskanen, eds., Corporate Aftershock, (New York: John Wiley & Sons,
2003), back cover.
25. Bradley, Edison to
Enron: Energy Markets and Political Strategies. Hoboken, NJ: John Wiley
& Sons and Scrivener Publishing, p. 16.
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