Bethany McLeans’s and Peter Elkind’s ‘The smartest guys in the Room’ is the must-read story of Enron’s rise and fall.
The brilliant account of major corporate wrongdoings in the US comes at a time when many Chinese companies have been shown to be flawed, including the recent case of Singapore-listed China Aviation Oil.
The two cases throw up some interesting issues.
Technically, the nature of CAO’s collapse is more similar to the collapse of Barings Bank in the early 1990s when Nick Leeson kept doubling up his bets on the direction of the Nikkei, eventually crashing out when the Kobe earthquake finally quashed his desperate hope of an upturn.
The CAO case is broadly similar, with two traders in the company persistently betting that oil prices would go down by shorting oil futures. But with oil prices staying obstinately high for almost the whole of the past year, the company was eventually forced to announce a $550 million loss just before Christmas.
Enron was a great trading company, which failed badly at everything else, including a very expensive broadband venture and the building and operation of international power stations. CAO had an enviable cash rich position as a monopoly delivering jet fuel to China, but turned out to be rubbish at trading.
Some observers detect a similar arrogance, whether of the intellectual sort at Enron, indicated by the title of the book, or the arrogance of a senior government official who felt himself above the law.
Enron’s arrogance was fuelled by a fanatical devotion to the purity of markets and the belief that it was a duty to exploit loopholes in regulated, or poorly de-regulated, markets. None of Enron’s traders were bothered by the misery they inflicted through their ‘gaming’ of California’s’s admittedly defective energy market regulations.
A similar brazenness was on allegedly on show by CAO’s parent company. According to some disgruntled investors, the parent was hoping to pay off the trading losses by selling a 15% stake in the company while keeping the buyer in the dark about the problem.
One mainland report notes acidly that Chen’s business success was based on using political and administrative measures to consolidate China ’s jet fuel importers into a monopoly, and then cream off the profit. It was definitely not the result of being the best company in that particular space.
The CAO affair started in the first quarter of last year, and comes to a conclusion some ten months later. Although carrying $40 billion of debt and resorting to many blatant obfuscation efforts, Enron took several years to be found out, despite the observation of armies of analysts from ratings agencies, investment bankers and funds.
Where Chen seems to have gone wrong is that he forgot his company was listed outside China.
While Chen assumed that he was part of the inside circle of Chinese decision makers, always ready to help him out however much he broke regulations, it seems that the Chinese government decided that a bail out would send the wrong messages to the China’s numerous other foreign listed companies.
Going back to Enron, it was the success of the company’s trading operation that ended up being the problem. Chairman Ken Lay and former McKinsey partner Jeff Skilling has come up with the idea of buying and selling energy instead of just being paid to ship it around the country.
But that meant that the company would be treated as a trading company, to which investors don’t attribute the higher price earnings multiples of non-trading companies.
That’s how the problems started; with the company seeking out to smooth its huge trading gains into regular, quarterly earnings to increase the company’s attraction to Wall Street.
Eventually, the smoothing techniques seemed to have tipped into what the US government believes was outright fraud, thanks to an almost perfect record of failure in all the non-trading businesses Enron got involved in.
Greed was a strong factor in both cases, although some sources say Chen seems to have been relatively unexcited by money, counting rich and poor amongst his friends, and dressing simply.
However, his salary had a huge bonus component to it, which gave him the incentive to take disproportionate risks. How similar to Lay, CEO Skilling and the greediest of them all, CFO Andy Fastow, who each made scores of millions of dollars out of manipulating a constantly rising stock price.
Skilling, and certainly his crack traders, were motivated by a kind of free market idealism. But Skilling found himself in the awkward position of overseeing a string of failures while believing fanatically in a market-driven meritocracy. Unable to accept he was not as clever as he thought he was, he seems to have rationalized the fraud to protect his self-image. Even now, he claims Enron was simply the victim of a liquidity squeeze.
Chen achievements were more those of a civil servant with an eye for squeeze; but like Skilling he has been unable to admit any wrongdoing. Up to the end, he was handing out poems to journalists declaiming his sincerity and blaming his parent company and the government for not bailing him out.
Enron plundered far more capital than CAO. But the streak of idealism running through the chaos is a reminder that despite its many flaws, US capitalism is underpinned by some powerful ideas relating to fairness, legal protection, property rights, self-reliance, hard work, and innovation. It’s difficult to see any trace of idealism in the Chen case, only a reckless scramble for wealth and influence under the belief he was protected by the power of a complicit bureaucracy.
But the bureaucracy ultimately did not protect him, and the markets did eventually force a reckoning. Those are encouraging signs.