The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron

The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron Review

One thing I learned from "The Smartest Guys in the Room" that I had missed in the daily news coverage of Enron was that Ken Lay was always a cheat. At least, he was a cheat almost from the beginning of Enron in the mid-'80s, when he connived at the looting of his own company by the traders at the small, but at the time only profitable division called Enron Oil.

Not only that, but the secret cheating was exposed to anyone disposed to look carefully, through lawsuits. If this was known to the people who did business with Lay later -- and it would have been a part of their business to know it -- it did not seem to dissuade anybody. Of course, if someone chose not to deal with a crook, that would not usually be recorded; but Lay had a remarkably wide circle of friends. We can conclude that there was no strong prejudice in the business (and government and social and gimmee) community to dealing with a thief.

"Smartest Guys" tells a complicated story in a smooth fashion (too smooth for great precision, perhaps, but otherwise it would have ended up reading like a legal brief), and it raises a question that has bugged me during all of my 35 years as a business reporter: How do large organizations become psychopathological?

McLean and Elkind lay much of the blame on No. 2 Jeff Skilling. Perhaps he was the single germ that infected the organism, although Lay was already a crook, and Lay's top aides also had decided cheating was OK, before Skilling was recruited.

We can perhaps think of Enron, as it was created by Lay, who hired a lot of cronies when he formed the business via a merger of two more or less respectable old firms, as genetically ;predisposed to the disease of theft and fraud. Did people hire on and, learning what was happening, quietly leave? There is little evidence of that, although there were a few who cried caution.

Very few.

It is practically impossible for a moral man to influence a large psychopathological organization from the inside. It will crush or eject him.

That is why -- contrary to the dingbat free market economists that Lay (a Ph.D. in economics) emulated -- outside oversight is necessary. In the case of Enron, the only outside oversight came from a sector with no skin in the game: the business press.

While journalists did not run a campaign to clean up Enron, some of them did spot the signs of disease almost as soon as the disease broke out and pointed it out. As with Bernard Madoff, few people cared.

Government regulators, auditors, rating agencies and the supposed arbiters who are said to protect capitalism -- what former Federal Reserve chairman Alan Greenspan calls counterparty surveillors -- either bellied up to the trough or looked the other way.

The most amazing failure was of Enron's board. It is easy enough to see why a man like Lou Pai would have bent his ethics (if he had ever had any, which seems doubtful). He got 0 million. The directors got money -- chump change by comparison -- plus, I suppose, prestige. You could have bought their souls at Filene's bargain basement.

A second group of watchdogs eventually -- although not as soon as the journalists -- caught on, and they had skin in. These were the short sellers.

All in all, though, Enron not only underperformed the market in the long run, it undersold even the most virulent critics of market capitalism. Lenin may have believed that capitalists were so shortsighted that they would sell the rope the hangman wanted to hang them with, but he never thought capitalists were stupid. Enron proved him too sanguine.

In any event, Enron proves as conclusively as anyone could wish that there is no such thing as general intelligence. It also proves that when Wall Street says it must have extraordinary compensation programs in order to attract the best talent, Wall Street is an ass. Enron paid the most and got the least talent.

"Smartest Guys" is a longish book, but it rackets along at a sprightly pace. Part of this is due to the lack of supporting material. The authors say they interviewed hundreds of people and thousands of documents, and I believe them; and that many of the people spoke only on a promise of concealment, and I believe that, too. This is too bad, but McLean and Elkind are professional business journalists and so entitled to a certain assumption of honesty. More than anyone at Enron, anyhow.

The only really disappointing part of the book concerns the California electricity marketing crisis. One thing I did not understand at the time was how the Enron scam could work. It was close to a corner on the market, and corners usually fail because it pays other actors to break them. Yet somehow this corner held together.

McLean and Elkind don't explain how this happened, and they say it may be that no one will ever be able to reconstruct what happened. it should make for an interesting problem for the game theorists.

The California episode came late in Enron's life. McLean and Elkind say that the fundamental miscalculation at Enron was Skilling's creation of what he called the Gas Bank, a way of trading contracts. And that within this concept, the key error was to choose mark-to-market accounting. They do an excellent job of explaining how this worked in practice. It was a version of a Ponzi scheme, using money of account, rather than actual cash, to bilk investors.

This part is clear enough. Enron, which had originally been in the business of buying and selling natural gas, created a pretend business where it gambled on pieces of paper that were labeled "natural gas production" and "natural gas delivery" but could just as easily have been labeled aces and deuces.

It was gambling, no different from little boys pitching pennies against a wall. It turned the natural gas business into a bucket shop.

I would judge that there was an even more fundamental error that supported the concept of the Gas Bank (aside from the foolish worship of free markets), and that was the failure of these smarties to understand what accounting is. Almost all the players in "Smartest Guys" were CPAs or MBAs (mostly from Harvard) or both, but not one of them was intelligent enough to understand what every community college freshman is told on the first day of accounting class: Accounting is not a set of arbitrary rules that you use to trick saps into giving you their money, it is a way to quantify how your finances are doing.

For nearly every quarter for over 50 quarters, Enron had to devise one or another doubtfully allowable accounting trick to "make the numbers." You would suppose that a really smart guy would figure out that this was a signal that his business was failing.

The crazy thing is, after Enron collapsed in 2002 (following right behind Long Term Capital Management), the smart money on Wall Street all chorused: Hey, we want some of that, and they extended the Enron model to the entire economy.

Many of the biggest players had intimate knowledge of what Enron had done, had helped Enron do it and, often enough, got burned when it ended. It turns insider trading on its head. Usually the insiders are considered, in law and in practice, to have an unfair advantage. Not these wise guys.

"The Smartest Guys in the Room" was published in mid-2003 and stops at the bankruptcy.

In an epilogue that in 2010 sounds naïve, McLean and Elkind relate what happened when some of the players were taken to the woodpile: "At is annual meeting in May, J.P. Morgan Chase issued a statement saying, `We have seen more than the usual number of serious accidents at the intersection of Wall Street and Main. And our financial institutions, including J.P. Morgan Chase, must take their share of responsibility for that.' Two months later, J.P. Morgan Chase and Citigroup agreed to pay a combined 6 million for 'helping to commit a fraud' on Enron's shareholders, as SEC enforcement chief Stephen Cutler told reporters. The two banks also agreed to ensure that their clients who used complex financial structures account for them in ways that investors could readily understand. Investors will have to wait until the next bull market to gauge whether anything has really changed."

They didn't have to wait long.

The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron Feature

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The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron Overview

Just as Watergate was the defining political story of its time, so Enron is the biggest business story of our time. And just as All the President’s Men was the one Watergate book that gave readers the full story, with all the drama and nuance, The Smartest Guys in the Room is the one book you have to read to understand this amazing business saga.

The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron Specifications

Like its subject, The Smartest Guys in the Room is ambitious, grand in scope, and ruthless in its dealings. Unlike Enron, the Texas-based energy giant that has come to represent the post-millennium collapse of 1990s go-go corporate culture, it's also ultimately successful. Penned by Fortune scribes Bethany McLean and Peter Elkind, the 400-page-plus chronicle of the scandal digs deep inside the numbers while, wisely, maintaining focus on the "smart guys" deep-frying the books. The likes of paternal but disengaged CEO Ken Lay (dubbed "Kenny Boy" by George W. Bush, one of many prominent public figures with whom he rubbed shoulders), cutthroat man-behind-the-curtain Jeff Skilling, and ethically blind numbers whiz Andy Fastow vividly come to life as they make a mockery of conventional accounting practices and grow increasingly arrogant and bind to their collective hubris. They're not a likable lot, and the writers find it difficult to suppress their astonishment and revulsion with the crew who rapidly went from golden boys and girls of the financial world to pariahs when the bill finally came due. The authors' unrepressed sarcasms are more than often unnecessarily given the scope of the outrage. Enron's leading lights were or a time celebrated for their ability to concoct nearly unfathomable business schemes to hide mounting shortfalls and keeping track on their machinations can be a chore, but, by sticking hard to the story behind the fall, McLean and Elkind have reported and written the definitive account of the Enron debacle. --Steven Stolder

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