Idiots in the boardroom

Why did Enron crash? How did a company almost universally perceived as one of the best run, most innovative, most profitable operations in the world collapse so suddenly? It's a question that has almost as many answers as there are books about Enron.

From a journalistic standpoint, one of the most impressive aspects of the story is the role the press played. If there's any lesson to be taken from the story of Enron, it's to never underestimate the power of negative stories in Fortune and the Wall Street Journal. Financial markets get spooked easily, and once the media turned against Enron, the company was effectively doomed.

But even the best reporters can't bring down a Fortune 50 company without help. And the most popular answer explaining Enron's demise is that it wasn't actually making money -- that it was all a sham, that a combination of flawed accounting schemes and outright fraud covered up for the fact that the company made a series of very bad business decisions over the years, and eventually all the mistakes caught up with it. Enron spent billions purchasing and building power plants all over the world that never earned out. It made an ambitious foray into the water business that proved to be a financial disaster. It had no internal controls on expenses -- or even any clear idea of how much it was spending, or how much it owed, on a given day.

From this perspective, Enron's collapse was inevitable -- the only mystery is how long it managed to pull the wool over everyone's eyes.

But there is an opposing view. At least one account of the business disasters of the turn of the century, Frank Partnoy's brilliant "Infectious Greed," argues that Enron's energy derivatives business, its buying, selling and trading of complex contracts to deliver electricity and natural gas, was hugely profitable. In Partnoy's view, Enron was the victim of a Wall Street panic, abetted by terrible leadership. If the company's managers had actually known how profitable their core business was, he argues, they could have avoided bankruptcy.

Partnoy's take is intriguing, but moot. And no matter how profitable Enron's derivatives business was, Enron's love for such complex financial instruments also played a huge role in its downfall. Which is why Jeff Skilling's concern about the stock price seems, in retrospect, so damning.

A derivative is a contract whose value is tied to another asset. Derivatives include options and future contracts -- commitments to buy a certain commodity at a certain time at a certain price -- and they get only more complicated from there. Enron was a major derivatives player. It traded energy derivatives, derivatives based on the weather, derivatives meant to insure against bankruptcy. In fact, by the time of its collapse, Enron was no longer a pipeline company, or even really an energy production company. It was primarily a derivatives trader.

But Enron didn't just trade derivatives with other companies. It engaged in such dealing with its own self. The "special purpose entities" that Fastow set up were basically derivatives deals. Enron would set up a partnership to buy Enron assets, and then it would loan that partnership the money to buy those assets, in some cases guaranteeing the loan with Enron's own stock. So if the value of the asset -- a power plant, an Internet bandwidth provider, etc. -- fell, Enron would make up the difference with its own stock. The variety of ways in which these deals were structured was endless -- a tribute to Fastow's creative imagination -- but the bottom line was often the same. As long as Enron stock price continued to rise, everything would be fine. But if Enron's stock price fell, the whole scheme would fall apart. Enron would be on the hook.

It seems inconceivable that Skilling did not know this. Perhaps he was unaware, as he maintains, of how much Fastow stood to profit from the deals he was setting up. And maybe we can give him the benefit of the doubt that he didn't know the full extent of the structure of some of the more questionable partnerships. In any event, it's likely that he considered Fastow's deals perfectly legal. As Eichenwald notes, he stressed, again and again, that he had done nothing "wrong." But it seems baffling that someone as smart as Skilling, someone who had personally been the leader in the transformation of Enron from a pipeline company to a derivatives trader, did not understand that the deals his golden boy was setting up would threaten disaster if Enron's stock price plummeted, or even worse, if its credit rating was downgraded.

Was his decision to abandon ship criminal behavior or just cowardice? Depends on the perspective. The employees who lost their jobs and the investors who lost their shirts may have one point of view. Derivatives traders at other companies busily doing exactly the same thing as Enron might have another. But the most perplexing aspect of "Conspiracy of Fools" is that at the end of the story, we really don't know what to think. Eichenwald is a master of telling us what happened, day by day. But he avoids interpretation. He eschews the larger context. We get no clue as what he thinks it all means.

That is unfortunate. The story of Enron is a golden opportunity to explore fundamental questions about how government, financial markets and corporations work together. Taken with the rest of the scandals that plagued the turn of the century, Enron offers a way into assessing what role government should play in regulating new markets, and what risks we face in the future as market dealings become even more complex than they already are.

Enron wasn't the only company to explode in scandal half a decade ago. But by isolating Enron's story without referring to larger trends in finance or markets or policy, Eichenwald makes it hard to draw any conclusions from what happened.

In the wake of those financial scandals, one major piece of legislation was passed, the Sarbanes-Oxley Act, which tightens financial reporting guidelines, increases the independence and responsibility of directors, and is theoretically aimed at preventing future Enrons. But already, there is strong pressure from the business community to weaken the requirements of Sarbanes-Oxley. Compliance is too expensive -- a cry that is heard everywhere from Fortune 500 companies to tiny nonprofits. Will Sarbanes-Oxley be just a bump in the road as we proceed to ever more deregulated markets? Are bigger and better Enrons to come, or are we all smarter now?

Eichenwald's retelling of the story is riveting, but it's a story that has already been told many times. The bigger question -- what does it all mean -- remains unaddressed. It's an opportunity missed.

Editor's note: This story has been corrected since its original publication.

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