May 2002-- On December 2, 2001, Enron Corporation filed for bankruptcy. With the company's assets then estimated at $62 billion, it was the largest bankruptcy in U.S. history. What brought it about?
In Congress and the media, Enron's failure has been attributed to the "arrogance and greed" typical of capitalists. Defenders of capitalism generally take the line that the company's bankruptcy was brought on by dishonesty and fraud, and they point out, correctly, that capitalism neither entails those things nor guarantees their absence.
But in fact Enron's bankruptcy was an event of greater cultural import than either the Left or the Right perceives. It represented the failure of postmodern corporate values.
How Enron Failed
The narrative of Enron's collapse is well known by now. On October 16, 2001, Enron announced a third-quarter loss of $618 million, its first quarterly loss in more than four years. This loss resulted from a decision to take charges of more than $1 billion related to investment reverses in various businesses. The source of more than half the charge, $544 million, was reported by the New York Times as involving Enron's stake in the New Power Company, a joint venture with AOL Time Warner and IBM. Enron also announced a $1.2 billion reduction in shareholders' equity because of accounting errors made in 2000 and 2001 related to transactions with that same entity.
Enron's bankruptcy was an event of greater cultural import than either the Left or the Right perceives.
Given Enron's size, this announcement did not seem ominous. Excluding the one-time charges, Enron said, it had earned $393 million in the third quarter, up from $292 million a year earlier. That amounted to 43 cents a share, up from 34 cents a share. Revenue was up 59 percent, from $30 billion a year earlier to $47.6 billion. Investors considered the October announcement in this context, and Enron's shares rose 67 cents, to $33.84.
Then the other shoe dropped. On November 8, Enron announced that its financial statements for the previous five years had been wrong and that it was filing documents with the Securities and Exchange Commission (SEC) to revise those statements. Two partnerships that Enron had been treating as independent since 1997—Chewco and JEDI—were found not to be independent under generally accepted accounting principles. Another partnership—LJM Cayman, formed in 1999—was also found to have been wrongly treated as an independent entity. The result of retroactively consolidating these three entities with Enron was to reduce the company's profits since 1997 by nearly $600 million, or 20 percent.
Briefly, it looked as though Enron might escape outright destruction. On November 9, Enron's rival, Dynegy, agreed to a merger. But Enron's bad news kept coming; Dynegy saw itself being pulled into the maelstrom and the deal was off. On December 1, a proposal to declare bankruptcy was put before Enron's board and passed unanimously.
Why Enron Failed
The bankruptcy of a major American corporation has to be distressing to Objectivists, who tend to see businessmen as agents of rationality and productiveness. Some businessmen are fools, to be sure, and some are knaves. But everything we have so far learned about Enron's top executives suggests that they were neither. Kenneth Lay, Enron's CEO, had proved his mettle by taking a natural-gas pipeline company and, over the course of fifteen years, building it into the world's largest e-commerce trading firm. Chief Financial Officer Andrew Fastow had a shorter track record, but he had won CFO magazine's Excellence Award in 1999.
Nor does it seem that Lay and Fastow were using their undoubted intelligence to pull a fast swindle and skip town one jump ahead of the sheriff. On the contrary, their behavior indicates that they expected to be around, and to be rich, for a long time to come. Lay's donations to George W. Bush's campaign and inauguration imply that he was trying to assume the status of corporate statesman. Fastow had just begun to build an expensive new house in the exclusive River Oaks section of Houston.
But if Enron's executives were neither incompetent nor crooked, what brought Enron down? I believe it was a culture of corporate values rooted in postmodernism. These were not your grandfather's businessmen.
The philosophical essence of the postmodern, or anti-Enlightenment, outlook is that there exists no external reality to which our beliefs should conform. On the contrary, say postmodernists, the nature of reality simply is what people believe and say it is. Of course, people cannot believe and say anything they like. Their beliefs and speech must be coherent and consistent. And if they want to work with others, they must ensure that the group is in agreement about what to believe and say. But that is the goal: constructing a shared narrative that supports the group's desires and activities. So long as that is achieved, no "external reality" is going to come along to correct or punish them.
Now, such views are common coin in the humanities and social sciences, but can they really be believed by businessmen? Isn't this just a fancy way of describing a fraud?
Not at all. Consider a classic account of fraud: the story of the emperor's new clothes. A team of con artists who claim to be tailors pretend to make the emperor a suit of clothes from a material so superior that stupid people cannot see it. In fact, there are no clothes and the emperor parades naked before his people, all of whom are unwilling to admit they do not see any clothes, until a young boy cries out the truth and exposes the deception.
Now consider the postmodern version. In this story, the tailors do make the emperor a suit of clothes—from a material so sheer that it is utterly transparent. So long as everyone agrees that transparent clothes are nonetheless clothes, then the emperor is clothed—although he is exposing his nakedness. So long as everyone agrees that transparent clothes are nonetheless clothes, the tailors have committed no fraud. Indeed, they may start a fashion trend.
But again: Isn't that story too absurd to be applied to business? Not at all. Consider the business of buying and selling art. One might ask: Is expressionism really art? Of course it is, postmodernists will say. After all, reputable critics say it is art. Dealers buy and sell expressionist works. So long as we all share a narrative that supports expressionism's claim to be art, then it will be art—in our postmodern world. Anyone who says it is not really art must have a personal agenda. He must be trying to supplant our shared narrative with his own in order to gain power and status.
Such was the attitude that apparently prevailed at Enron, and particularly in the mind of Fastow, who created the company's complicated financial structure. Born in 1961, Fastow came of age in the era of postmodernism. And it is perhaps no accident that he was a leading patron of the contemporary art scene in Houston.
Postmodernism at Enron
If a postmodern mentality brought about Enron's collapse, how exactly did it do so? One anecdote provides insight. In February 2001, Fastow went to New York to offer representatives of the bond-rating agencies some arguments that would lead them to raise their evaluation of Enron's bonds. There is nothing unusual in that. The evaluation given to a company's bonds determines the interest rate the company must pay when it borrows money. That, in turn, determines how much a company can borrow. On this particular occasion, however, the agencies' representatives said that the facts Fastow presented did not justify a change. Fastow's response? If the agencies changed Enron's ratings, Enron would be able to strengthen its finances, which would justify the higher rating. In short: if everyone would agree on a narrative that was supportive of Enron, reality would snap into line. The agency representatives laughed.
Getting everyone to agree on a supportive narrative seems to have been the principal goal of Enron's postmodern accounting. The rating agencies would not sign on to the narrative until Enron was able to say certain things. Therefore, Enron must be able to say those certain things.
As noted above, Enron's downfall was precipitated by the need to readjust the way it had dealt with several partnerships. In journalistic accounts, the explanation usually given is that Enron violated some rules of generally accepted accounting principles. That is true, but it is not the essential truth. The fundamental problem was that these partnerships were set up principally to affect what Enron could say about itself, and what others—such as investment advisors and bond-rating agencies—would then say in turn.
The key story begins in 1993, when Enron and the California Public Employees' Retirement System (CalPERS) became equal partners in a joint-venture investment partnership called Joint Energy Development Investment Limited Partnership (JEDI). In 1997, Enron wanted CalPERS to invest in a new, $1 billion partnership, but CalPERS would not do so while still involved with the original JEDI venture. Enron therefore undertook to arrange for CalPERS to sell its interest in JEDI to another "outside" partner, for a price eventually set at $383 million.
Enron needed an "outside" partner because, in 1990, the Emerging Issues Task Force of the Financial Accounting Standards Board, the accounting standards-setting agency, declared (in EITF 90-15) that a sponsoring company could consider a special-purpose entity like JEDI to be "independent" only if outside investors had at least a 3 percent equity stake at risk in the SPE. If the SPE were independent, then the sponsoring company could record gains and losses on its transactions with that SPE, and yet keep the assets and liabilities of the SPE off the company's balance sheets. Keeping JEDI's liabilities off Enron's books, of course, made Enron more attractive to investors and bond-rating agencies.
Rather than finding some stranger to invest in JEDI, however, Enron created an independent partner: a partnership called Chewco, to be managed by Michael J. Kopper, who was an employee of Enron Global Finance. On the basis of various loans, loan guarantees, and credit lines arranged by Enron, Chewco was able to purchase CalPERS's $383 million stake in JEDI with a personal investment in Chewco of about $125,000 from Kopper. He was able to say that he met the mandate for having a 3 percent equity stake in Chewco by obtaining $11.4 million from Barclays, in the form of "certificates" and "funding agreements." These instruments bore a striking resemblance to non-equity promissory notes and loan agreements, but that is not how they were described and therefore they could fit into the narrative being constructed. With Kopper's 3 percent "equity" stake in Chewco, and Chewco's stake in JEDI, Enron was able to keep JEDI's debt off its books, at least until November 8, 2001.
The point here is not that Enron was engaged in fraud. On the contrary, the point is that Enron was not engaged in fraud. It wanted to be able to say the words: "Kopper has a 3 percent equity stake in Chewco, and, according to SEC rules, it is therefore an independent partnership." Enron wanted to be able to say the words: "JEDI is an independent partnership because Chewco owns a $383 million share." It wanted to be able to say the words: "JEDI's debts are not Enron's"—because those are the words that the investment advisors and bond-rating agencies needed to hear. What eventually tripped up Chewco, JEDI, and Enron was a little $6.6 million error that put Kopper's equity stake in Chewco below 3 percent. Had that error not occurred, Enron might not have had to utter the disquieting words of November 8, 2001, and might be alive today.
What no one at Enron, from the board on down, seems to have asked is whether JEDI and Chewco were truly independent partnerships. Pamela Stumpp, chief credit officer at Moody's Investor Service, puts the relevant standard in terms that even the dimmest board member could use to query management: "For debt to be considered truly off balance sheet, there would have to be full and complete risk transference. If there is any hook to the parent or if the parent is liable for any aspect of the operation, then it might not be a true off-the-balance-sheet liability" (New York Times, December 23, 2001). Since the board was told that Chewco's purchase of CalPERS's share of JEDI would involve a $250 million loan guaranteed by Enron, a question about the truth of Chewco's independence would seem to have been in order. But postmodernists don't use words like "truth."
Reality Strikes Back
Even as Enron teetered on bankruptcy, even as it ran to Washington for help, the company maintained its postmodern outlook. Not that there is anything distinctively postmodern about running to Washington. But consider: Unlike Chrysler or the steel industry, Enron didn't go to Washington seeking old-fashioned assistance like loan guarantees or tariffs. What the company's executives wanted was to have someone in the Treasury Department speak to someone at the banks and debt-rating agencies. If only the right people in Washington would say the magic words to the right people in New York, a narrative supportive of Enron might be rewoven and the company might survive. It was a very postmodern bailout that Enron was requesting. Members of the Bush administration, to their credit, rebuffed the requests — the external world came crashing in.
This article was first published in the May 2002 print edition of Navigator magazine, the predecessor of The New Individualist.