The Business Deception That Cost $60 Billion

The Business Deception That Cost $60 Billion

An American worker named George had his sights
set on a comfortable retirement, perhaps some holidays in the sun, relaxing in the garden
with good novels and a gin and tonic by his side. And then when the company he worked
for, the energy giant called the Enron Corporation, collapsed in front of his eyes those plans
went up in smoke. Years later he was mowing pastures when he should have been living on
his retirement savings, which had been mostly tied up in Enron company stock. No one ever
thought such a behemoth of a company could just go belly-up. It was a story that shocked
the world, one involving mismanagement, corruption and greed. This is what happened. In its heyday Enron was one of the largest
companies in the USA. At its peak its shares reached $90.75, and when it declared bankruptcy
in 2001 they were worth $0.26. Few saw it coming, and to this day the downfall is a
reminder to us all that indeed giants can fall, and on top of that, giants aren’t
always what they seem. The story starts in 1985 when two companies
merged. They were Texas-based Houston Natural Gas Company and Omaha-based InterNorth Incorporated.
At the beginning the new Enron was simply a very big natural gas supplier, but then
in 1989 it turned a leaf in its book and began trading natural gas commodities. In 1994 it
also began trading electricity. These changes took place under its new CEO Kenneth Lay,
who had formerly been in the big chair at Houston Natural Gas. At the time Enron was
said to be one of the most innovative companies in the USA, but at the time of the downfall
the New York Times wrote, “Enron is a new-economy company, a thinking-outside-the-box, paradigm-shifting,
market-making company.” It added to the end of that paragraph, “It is also, at this
point in time, a bankrupt company.” As the story goes, before Enron got started
gas and electricity were produced and sold by state-regulated monopolies. But then there
was deregulation, and as the Times writes, “Enron used Wall Street magic to transform
energy supplies into financial instruments that could be traded online like stocks and
bonds.” Prior to this, those energy monopolies were always under government scrutiny, but
after deregulation Enron had more freedom and so started trading energy online, such
as stocks and bonds, and also placing bets on future energy prices. Enron started selling
contracts, called energy derivatives, to investors. Soon Enron was called “America’s Most Innovative
Company”, and it won that accolade for a number of years. At the time this looked good for
the consumer, because with supply and demand taking over fixed prices by monopiles, the
prices for customers seemed fair. It seemed like a dream story for capitalism. There was a problem, though, and something
didn’t quite add up. You see Enron thought that if it could trade
energy, then why not trade all kinds of other things, such as insurance or advertising and
then turn these into contracts and sell them as derivatives, too. The company poured billions
into these new trading ventures, but not everything turned into gold. It later turned out that
while Enron was winning on some levels, it was losing on others, but the problem was
it wasn’t always coming clean about where it was losing. It was kind of fixing its accounts
and reporting false trading revenues. As one person pointed out, “Some of the schemes
traders used included serving as a middleman on a contract trade, linking up a buyer and
a seller for a future contract, and then booking the entire sale as Enron revenue. Enron was
also using its partnerships to sell contracts back and forth to itself and booking revenue
each time.” It was in fact creating imaginary revenues. If that is confusing to you, The Wall Street
Journal gave an example of one such piece of Enron subterfuge. Enron got into a deal
with Blockbuster, those guys whose stores you’d go to in the past and rent out a movie.
The new deal with Blockbuster was to do this online. But it didn’t work out, and in eight
months the business was a total flop. While this was going on Enron had made a deal with
a Canadian bank. If the bank loaned Enron $115 million, Enron would then hand over its
video deal profits for the first ten years to the bank. As you know, Enron made no cash
from this online video renting business with Blockbuster, but it still wrote the $115 million
down as part of its revenue, not a massive loss. The Canadian bank was owed money, but
on paper things didn’t look bad for Enron. According to the New York Times, Enron did
a fair bit of shady accounting and still Wall Street bankers at J. P. Morgan, and others,
were gung-ho about the company and its stock. Some people, however, began to smell a rat. The thing was, Enron was also seen as a fairytale
winner in the years when deregulation and online trading, embodied by a get rich quick
culture, were admired by everyone. Leave the innovators alone, this is the future. But
things got out of hand, as they tend to do when in Hobbesian terms the “Leviathan”
goes missing and no one is watching over the people to ensure nothing terrible is happening.
Enron also invested heavily in high-speed broadband telecom networks, but the company
saw no profits from that, either. The most innovative company in America was on a losing
streak, but still those losses were not reported. It was hiding all its financial losses, using
something called mark-to-market accounting. Investopedia explains that like this, “This
technique measures the value of a security based on its current market value instead
of its book value. This can work well when trading securities, but it can be disastrous
for actual businesses.” Another example given of the Enron way of
hiding losses is this. If the company bought a power plant it would first put the projected
profit on its books. That’s a projected profit, meaning nothing has actually been
made. If then Enron actually didn’t make a profit but a loss, it would transfer the
loss to an off-the-books corporation somewhere no one would find it. This way Enron’s bottom
line didn’t look affected and everyone still thought the company was booming, when in fact
heavy losses were being incurred and then hidden like soiled underwear at the bottom
of a laundry basket. Enron used something called off-balance-sheet special purpose vehicles
(SPVs) to hide these failures, but all you need to know is that this is a technique that
can be used to fool investors and creditors. The experts tell us this is not illegal, but
it can be dangerous. At the same time, not everyone understands how they work, so it
could be said to be slightly unethical if companies are not completely transparent about
it. And then the bubble burst, as bubbles tend
to do. By April 2001 analysts were on to Enron, they saw what was happening, realizing that
accounting wizardry had been creating a company not unlike the fantasy city of Oz. Behind
the screen Enron was crumbling, and by summer 2001 the company was in freefall. Its stock
was downgraded, sinking like a stone into the abyss. By 2000 it was revealed that Enron
had losses of $591 million and $628 million in debt. In 2001 the company filed for bankruptcy,
and a lot of poor folks whose pensions were tied up in company stock were going to have
to cancel their dream vacation in the Caribbean. From 2004 to 2011 the company paid $21.7 billion
to its creditors. It’s said shareholders lost in total around $74 billion and employees
lost billions in pension benefits, with one such person being the guy we mentioned at
the beginning of this story. There were many, many more like him. Some of the executives were charged with conspiracy,
insider trading, and securities fraud. The CEO we mentioned died of a heart attack before
he could face any prison time. Others did time for facilitating corrupt business practices.
Another CEO, Jeffrey Skilling, was only just released from prison. Do you think government regulation of markets
is good or bad after watching this video? Let us know in the comments! Also, check out
our other video How Jeff Bezos Gets His Money From Amazon. Thanks for watching, and, as
always, don’t forget to like, share and subscribe. See you next time.


  1. The point is simple we need an economic regulation that promotes fair business practices that allows people like me to open a business.

  2. Creative accounting. Is that what they teach in college? I have ask in reflection of the last forty years, what do they teach in an economics class?

Leave a Reply

Your email address will not be published. Required fields are marked *