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July 08, 2002

The Enron Syndrome Explained (As Best I Can)

Right now the big news across the country, as it has been for several months now, is the Enron/Global Crossings/WorldCom scandals (if you wondering about Global Crossings, it's a company that went bankrupt under pretty much the same situation as Enron, except that it donated a heck of a whole lot more money to Democrats, so the media has been ignoring them, lest it make the DNC look bad.) Most people seem to know as much about it as I did about Watergate when it was going on, and I was 14. Politicians (mostly Liberal Democrat) have been trying to use it as some kind of bludgeon to beat Bush2 and the GOP with, but haven't had much luck, mostly because most people simply don't understand all that's going on. 

Let's start with how big businesses like that operate. If you've got a home, and plan, eventually to move to a nicer home, there are really two things you're going to focus on in maintaining your home, what needs to be done to make it a more comfortable home for you and your family, and what needs to be done to make it more appealing to a prospective, future buyer. Both goals overlap, but not completely. A new paint job and trim may not make it that much more comfortable, but will improve the sale value. The same goes for businesses, except if they are public (anyone can buy and sell shares of the company) then it's constantly being bought and sold. And so the value of the company is imported in two ways. It makes the owners (the stockholders) happy, and it allows the company more leeway in obtaining credit. But there's the other aspect of what a company needs to focus on -- profits. Ok, right now you're saying, "But aren't profits and value the same?" Well, no not always. If a company borrows a lot of money, it could find itself in the position of needing to make enough profits to not only cover the purchase price, new equipment as well as inflation (which is generally around 3%). So while it may be profitable, it may not be profitable enough to cover all of these, especially if the economy takes a downturn, and consumption (the amount consumers buy) goes down. Also, during the eighties companies were forced to rethink quite a bit of how they operated, and streamlined areas. We've all heard of "downsizing" which sounds harsh and cruel, but it was really a matter of the livelihood via jobs v. the livelihood via pensions. Quite a few of these companies were owned by pension funds, so it wasn't rich people who owned them, but retired people. (y'know, the ones Al Gore dragged out to make us feel sorry and vote for him). 

Companies were forced to reassess exactly what their employees were doing, and was it possible to get by with fewer. I was hired quite awhile back to do a job, and was at it about 6 months when a co-worker left. Their duties were added to mine. Shortly after that my boss left, they hired a new guy, who decided I needed to do about half the stuff the previous boss had done. Then another employee left, and, yes, all his stuff was added to my load. When I finally left, they tried hiring one person to do it, but they quit soon, as well. The point is, that initially, there was alot of duplication. I was able to handle twice the workload without a problem. In fact I was handling the entire load, and would have stayed had it not been for the owner deciding he needed to shout a litany of profanities at me. In that case the downsizing was voluntary, but realistically they did have too many employees.

Another reassessment that's recently come to the attention of many companies was discovered by Eliyahu Goldratt and outlined in his novel The Goal. It's been implemented in several companies with great success, but unfortunately some aspects of the theories don't translate too well in the current form of cost accounting. While a company may be streamlining and increasing efficiency and productivity, the overall face value of the company shows an initial decline. This doesn't sit too well with stockholders, so CEOs have to find ways of balancing out the changes they need to make, with the demand placed on them by stockholders.

Then along came Clinton. 

We were regaled with fictional illustrations of how "those corrupt Reagan years" made greed the bottom line. Except what really happened is that businesses woke up to the fact that they were wasting money, and making money was the reason they existed, and any humanitarian efforts they engaged in as a result of profits, came as the result of profits. Making money so you can help someone isn't greed. Forcing someone else to help someone against their will was, is and always will be immoral. So when the Socialists (Liberal Democrats) saw business turn away from social programs that were bankrupting them, toward actually making profits for the stockholders, they called it greed. (To a Liberal, greed is spending your own money, when you could be spending someone else's)

But during the Clinton years we saw lying and deception excused as a legitimate means of achieving one's goals. From Clinton's grabbing of thousands of FBI files, to Al Gore claiming that campaign violations by the DNC were necessary to ensure the GOP didn't take over. In this climate is it any surprise that some CEO's decided to use the same tactic in dealing with the shortfalls of our current methods of accounting in dealing with the real value of a company? 

You have to also keep in mind that in accounting the classification of something can be confusing, and can mean the difference between an asset (something you have) and a liability (something you owe). Take computer software. When a company buys software to run a computer, there is really little hope of ever reselling that software to anybody else. Once it's used it's gone. but many companies listed their software as assets. They paid for it, and they were using it, but as something that could be sold for cash, it was useless. So if a large company had spent, oh, say $10 million on computer software upgrades, then listed that as an asset, it increased how much the company appeared to be worth. If they then take out loans based on that claim, and can't repay the loan, there doesn't exist enough assets to cover the loan. If, as in recent cases, these fabrications are discovered, then banks and investors will leave that company high and dry, resulting in bankruptcy. 

Most of the shams these companies were pulling were much more complex than simply moving an item to a different list on the balance sheet, but the CEO's didn't do it by themselves. Many Enron employees who told stories of helping to set up fraudulent displays of increased business and profits, knowing they were fraudulent, were also the first to complain about their own pensions disappearing when the fraud was discovered. 

There are lots of businesses out there that do things right, and are truthful in how they represent their value and profits, but they are now suffering because of the unwillingness of people to invest, for fear that any company could be the next to "restate" their value. Most people who have money in the stock market are losing money right now, because of this, and most people who have money in the stock market aren't rich. Eventually the market will recover, investment will thrive again, and what's lost now will be quickly recovered. Hopefully a newer way of evaluating a businesses value can be found, and the stench of the Clinton era of deception and fraud can be wiped from the face of the nation.


Posted by Jack Lewis at July 8, 2002 05:31 PM