Enron

Mike tells Sarah how a "bad apples” explanation kept us from seeing the real scandal at the heart of America's largest corporate bankruptcy. Digressions include “Casino,” Thanksgiving economics and corruption catchphrases. Neither co-host truly understands how the stock market works.   

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Transcript

Enron

Sarah: I would also submit that All the President's Men movie they're constantly leaning on women. They're like always getting most of their scoops from like receptionists and wives.

Welcome to You're Wrong About, the show where we talk about the business-se scandals that you never understood the true human horror of, because you were focused on the business-se parts, but we help you see through the business-se parts and into the pure horror. Is that accurate? 

Mike: A little bit. We're going to learn that people are sometimes not at the center of business scandals. Boom. 

Sarah: Oh. 

Mike: I'm Michael Hobbes. I'm a reporter for the Huffington Post. 

Sarah: My name Sarah Marshall and I'm writer in residence at the Black Mountain Institute. 

Mike: And today we're talking about Enron. 

Sarah: Yes. Which I saw the documentary about Enron whenever it came out, and I don't think I understood it at all. I remember being like that lady has a great blouse.

Mike:  I feel like that's how most people went through the Enron scandal was like, it's something bad and the people are terrible, but I don't know if a lot of us really understood the mechanics of how it actually works.

Sarah: Let me actually try very hard to tell you, and I'm going to like mis speak in all kinds of hilarious ways, I think if I try and summarize. 

Mike: I'll just make a series of buzzer sounds. 

Sarah: Oh God, I really hardly know anything. Were they friends with Halliburton?

Mike: No.

Sarah: There was something going on where some of the guys in the company were creating like shell companies or LLCs or something. 

Mike: Yes. 

Sarah: Okay. I remember that one of the more dramatic parts of the documentary that I therefore retain to some extent had to do with Enron causing the rolling blackouts that California was experiencing.

Mike: Yes.

Sarah: Looking back. I have no actual memory, as far as I can tell. When you say stuff, it's going to sound familiar, but I have no way of saying like, what did they do? What kind of crime was it? How did it leave people feeling defrauded? But what I remember is that like the word Enron became, it became a household word. Everyone knew that it was shorthand for like this really egregious corporate fuckery. And then it seems like we didn't really do anything about that all then maybe we did. It doesn't seem like it based on what happens when I go outside and look around. 

Mike: And not too much spoily, but we having to remind ourselves that businesses can be bad. 

Sarah: Right.

Mike: We have the same epiphany over and over again that like, oh wow, we've given a lot of power over to these giant profit maximizing entities, is this bad? And then we come to that realization that we have like a two-year period where we believe it for a while, and then we all forget it again. And I think Enron is the perfect example of that.

Sarah: All right. So, let's start at the beginning, I'm excited. It's going to be like a full Godfather, if not a full trilogy.

Mike: As usual, it was actually a very lucid overview of the story we're about to tell. 

Sarah: Well, I can say what happened emotionally, I guess can't say what happened actually.

Mike: Yeah. 

Sarah: Comma, the Sarah Marshall story. 

Mike: And that's more than I knew a couple of weeks ago. I think one of the things that I didn't know is just like how big of a company Enron was. Enron was the seventh biggest company in America at the time that it crashed. 

Sarah: That's incredible.

Mike: I looked this up, the seventh biggest company in America now is GM.

Sarah: Oh. 

Mike: So if you imagine GM going along doing its thing and then in the space of 24 days, it doesn't exist anymore.

Sarah: Oh my God. That's like a corporate Titanic. 

Mike: $60 billion disappeared from the US economy

Sarah: Wow. 

Mike: Another thing that I cannot get over is that the last year, the last full year that Enron was an operation. They faked 96% of their income and 105% of their cashflow. 

Sarah: That's too much percent. 

Mike: This was not someone forgot to cross some T's, someone didn't file paperwork on time, I mean, this was basically a giant Ponzi scheme.

Sarah: And it's the seventh biggest company in America. 

Mike: Yeah. 

Sarah: And so were they allegedly in the business of energy before all this emerged.

Mike: I think as the real story of Enron that I don't think has really been told is the transition of this company from a normal ass gas company to a criminal organization. So what's weird about Enron is Enron was founded in 1985 and it goes down in 2001. So, the company only exists for 15 years and the first 5, 7 years of its existence, it's just a normal gas company. It's a company that owns a bunch of pipelines. So, it's essentially a middleman between people that are producing natural gas, you know, Exxon or whoever, and then itself the natural gas to LA or Denver or whoever needs the natural gas.

Sarah: So like Macbeth, that sent an important but boring job in a vast hierarchy thing. 

Mike: Yes. The whole thing like the way that natural gas pipelining worked at the time was it's all these long contracts. So, you go to Exxon, and you say, okay, we're going to buy natural gas for, you know, a million dollars a gallon, and then you go to Denver or LA, and you say, okay, we'll sell you natural gas for $1.2 million a gallon. Like you buy a little here and you sell a little there and it's slightly more expensive when you sell it then when you buy it and it's all in these long-term contracts. Because everybody wants to lock in a price, right, for natural gas for the next 10, 20 years, whatever. It's this really boring company where all of their cash flow is just this drip, drip of invoices on these, you know, 150, 200 however many 10-year contracts they have. It's like, oh, well, every month we get a little bit of money from them. 

Sarah: There's no way for a coke addicted maniac to get rich quick in a market like that. 

Mike: Yes, the transition of this company is really all about the colonization of the entire US economy by the stock market. There's this guy called Jeffrey Skilling who ends up being the CEO of Enron, but at the time is just a consultant for McKinsey. And he goes to the CEO, Ken Lay, and he says, you know, you're never going to have a rising stock price with this business model. You can't be doing 10 years contracts; you can't be doing these slow burn types of business models. You need to have something bigger and sexier and more profitable. You're just not going to work as a company if you don't do this. And so, what happens is around the mid-eighties, a lot of states are deregulating their natural. 

Sarah: Oh, so like so many of our stories, Ronald Reagan is one of the shadow villains pulling the strings in this one, hoorah.

Mike: A lot of these markets you don't have to sign 10-year contracts anymore. You can actually sign one month contract or one day contract. And all of a sudden, these gas pipeline folks can start playing different cities and different producers against each other, right? That you can basically put this up on the open market and like, well, Denver wants to pay $20, but LA wants to pay $25.

Sarah: So, it's like the pipeline companies are like a girl who grew up in a very conservative household and it's like, you can only hold hands with one boy at once, you've got to be serious and a good, whatever we are. And then she goes off to the big city and she's like, I'm seeing Brian for breakfast at 9:30, and then I'm seeing Alexander at 11 and then I have roller skating with Tad. You know, she's just like date crazy because she's suddenly free and she just wants to see the world through boys or through middlemen who will pay her a better contract fee.

Mike: Yeah, and this is the entire insight that Jeff Skilling comes up with. That Enron is essentially a monopoly. It owns more gas pipelines than anybody else. And so, it can squeeze the producers so that they pay more to get the gas into my pipelines. And you can start squeezing the customers and say, well to get it out of the pipelines, I have to start charging you more. It's actually a pretty good business model. 

Sarah: Well, yeah that's how Joe Pesci’s character always wins when he gambles in Casino, because when he loses, he doesn't pay and when he wins, he collects. It does seem like a very American thing to have your business model be like, I'm going to be bigger than everyone else. And it's like, well, yeah, you can't really lose if you are a behemoth and you're crushing everyone around you, but you don't have to be that smart to win that way. Don't you want it to mean something? Apparently not. 

Mike: Apparently not. No, I mean, transformations that happened before all of the fraud is that in 1985, when Enron is created, the vast majority of its contracts are these long-term contracts. By 1990, before anybody starts lying about anything, 75% of the sales are on these spot markets where it's like fluctuating prices and it's volatile and it's playing different players against each other. That's the company's central insight is that we have to use the volatility of gas prices to make money because everybody wants to hedge against this volatility. 

Sarah: That's interesting.

Mike: Another thing that Enron does is they set up something called a gas bank where people can buy futures in gas prices. So, in the same way that, you know, corn prices fluctuate, and people will buy futures so that when the price of corn goes down, you get a little extra money or if the price of corn goes up, you get a little extra money. Enron essentially sets up a bank to do the same thing with natural gas, basically an insurance policy. If the price of gas goes too high, or the price of gas goes too low, but it works out really well for them because either way they're getting fees, right? They're getting a percentage of all of these deals and again, they're a monopoly. They're the only people that have this giant gas bank set up. Does that make sense? The whole futures thing, I had to look up like eight different YouTube explainers to figure out what all these futures thing means. 

Sarah: Let me try and explain back, like my understanding of it. They've essentially just created another means of generating profit, right? Where people who want to engage with like gas stocks can do so in a way that allows them to collect fairly easily, but in order to do so, they have to go through yet again Enron acting as a middleman. But in this case for the futures that they're buying and so, the fees that they pay on the futures, regardless of what happens or how much payout they get go to Enron. 

Mike: Yeah, exactly.

Sarah: So it's just another can't lose game. 

Mike: Yes. 

Sarah: Living in Las Vegas has honestly, really helped me to understand. It's like great, all-American businesses are essentially casinos, QED.

Mike: Yeah. I mean the whole thing is like, you want to be the dealer at the casino, right? You don't want to be the player sitting at the table and that's essentially what Enron does. And so, there's actually, if you look at the economics literature, there's a lot of Your Wrong About style academic articles of like, well, Enron was actually a really innovative company before all of the fraud came out. Enron did establish a bunch of things that are sort of still with us, like this idea of a gas bank is still around. 

Sarah: It apparently did a lot of great paintings.

Mike: Enron entire business model was based on the deregulation, without the deregulation Enron never could have done this. It's only because they were allowed to sell gas at prices that fluctuated that they were allowed to do this. 

Sarah: And they found a way to bend government to their strengths. 

Mike: Yes.

Sarah: It's essentially amoral behavior. 

Mike: Yeah. It's profit maximizing. I mean, this is what companies do, right? They profit maximize and they want their stock to go up. Like, that's what they do. Right, it's not a defense of them. It's an argument to regulate them really heavily.

Sarah: It's like, say you have a cheetah and you're like, look at my beautiful cheetah, what a beautiful animal full of grace and speed. And it's like, yes, it's also a big cat and it might claw you someday just because.  

Mike: Yeah, put it in a cage. What's interesting about Enron's sort of insight here is that because this gas bank thing is going so well, they figure, well, why don't we expand into doing this for other things, they have so much money. That they can then establish themselves as a player in markets for electric power, coal, steel, paper, pulp, there's buying and selling water. Like they're getting water pipes. 

Sarah: There just like, hey, let's do other stuff that you need pipes for. 

Mike: Yeah. All they were doing throughout the 90s was establishing themselves in markets where they could be a monopoly. At one point they buy up 18,000 miles of broadband cable. 

Sarah: Boardwalk.

Mike: Yeah. Essentially, and this way they can go to Comcast and say, we'll buy some of your capacity and then they go to Philadelphia, and they say, we'll sell you some of this capacity. And the whole thing is just, we are the bottleneck in between these two actors and so we're going to charge both of them.

Sarah: Yeah. 

Mike: The thing that's really important for understanding Enron is the run-up to the fraud is the dot com boom, right. I mean, all of this happens before the dot com bubble burst. 

Sarah: Yeah. While we're on the subject, what was that? 

Mike: Well, I mean, we will get into this more later, but essentially the idea is that the rules of business don't apply to the internet. That anything that's on the internet, we think like, oh, you don't really need to make money and you don't need to have a bunch of employees that do stuff, and you don't need to have a business model that makes sense. You just need to be there. And so, Enron sets up something called Enron online, where you can do all of this weird trading stuff and within two years, it's the biggest e-commerce site in the world. 

Sarah: Wow. 

Mike: The real downfall of Enron begins or like the seeds are planted once the company, you know, they started diversifying into all of these other industries, which they don't really know that much about. And they don't mostly have all that much physical capacity. They don't actually know how to run stuff in these other industries. Jeffrey Skilling, the guy that's behind all of this, what they say about him afterwards is that he's somebody who loves ideas, but it's totally uninterested in implementation. So, he's like, oh let's expand into electric power. And then someone's like, well electric power is actually different in that you can't store it. It's like a whole different industry then natural gas, and much more difficult to sell futures on it. And he's like, dah, dah, dah, dah, I don't want to hear about that. Let's expand into electric power.

Sarah: Pam, Pam, Pam, Pam, Pam, yeah.

Mike: It's this tension between Ken Lay, who's the CEO of the company, who's like an old school oil guy. Like he's worked in oil his whole life, he's worked in physical infrastructure. He's somebody who's very much just like an old school business dude. And then there's Jeff Skilling, who's like so enamored with his own ideas, but so uninterested in how they're actually being implemented or any of the realities on the ground.

Sarah: Hmm. Sounds like me.

Mike: I know. He's like the perfect millennial, every stereotype of millennials. It's like, you don't want to do the work, you just want to talk the talk. 

Sarah: Well, based on what it was founded Enron itself as a millennial. So that's the first great millennial casualty/villain. 

Mike: And Skilling eventually ends up basically winning this argument, and he talks Ken Lay into selling off the company's actual physical stuff.

Sarah: Wow. 

Mike: So, because the trading is so profitable, Skilling essentially says, look all of our money is coming from this trading. 

Sarah: The future is not in things old man and then he skateboarded away. 

Mike: I mean, that's only a slight exaggeration in that somehow the company starts selling off all of its physical assets. By the year 2000 the company is making three times more from trading than it is on the actual oil pipelines that it owns. The company basically is a financial services company by that point and an online company, and this oil stuff is an afterthought. 

Sarah: It feels like there's a unifying feature here and some of the great meltdowns of recent history, because it feels like the subprime mortgage crisis. You know, a nonexistent commodity became much more lucrative than the things that existed and so all this wild speculation took place that had no, you know, no real-life correspondent to rein it in any way. 

Mike: Oh, totally. I mean, one of the statistics that's amazing is that in the second half of the 1990s, Enron spent $0 on research and development. 

Sarah: Good God. 

Mike: It just completely gave up on being interested in oil. 80% of its profits by 2000 came from businesses that didn't exist in 1988. So, the company is really just taking this right turn to, we are up in the clouds, we're an information company, we're big and weird and sexy, and nobody really understands what we do anymore. 

Sarah: That's like exactly like me, I'm big and weird and sexy, and nobody really understands what I do, I need more. 

Mike: So, my favorite little snapshot of where Enron is and why everybody bought into this myth is, I found a Houston Chronicle article from the year 2000. Which is basically saying like, look at this hometown company, you know, it's the biggest company in Houston, the stadium is named after Enron, everything's going really well.

Sarah: They don't do anything as far as we can tell, but that's not the point.

Mike: Yeah. And the entire article is basically looking back on it now is just a parade of red flags. So, it's saying one of the things that Ken Lay did that was really interesting was, you know, after they switched into all of these financial markets stuff, he took the innovative step of firing all of the managers were older and knew anything about oil and hiring a bunch of 23-year-old kids from business school. It's like what an innovative step and then it's got all of these examples of the new markets that the company is getting into and how innovative and cool the company is and then it caveats them with like they all failed.

It's like the company is expanding into India. What an interesting step. Well, the company did actually lose $3 billion on that deal and the power plant never opened, but it's so innovative. And like the company tried to have a streaming service with Blockbuster that also failed, and the company had to write down $150 million worth of debt, but it's such an innovative idea. Like all of their examples of the company's innovations are failed ventures.

Sarah: I feel like just as Americans, we're very prone to falling prey to stories about con men, because we read the things that cause people to fail as the things that caused them to succeed.

Mike: Oh, totally. 

Sarah: Because we're so obsessed with like the unschooled, unqualified, rogue, whatever who swoops in and knows more than all old man. And it's like, you know, there is a reason that people learn things. 

Mike: Yeah. I mean, it's really interesting in the Enron story too, in that all of the fraud and all of the weirdness was in plain sight. I mean, in the same way, this Houston Chronicle reporter you're giving six examples of the company's innovation, all of which failed. And that doesn't make you think like, hey, maybe I should look into this a little bit more. The information of the company's true nature is available. It's right there in front of you if you just know how to see it in a different frame, like it's all about putting it into this narrative of innovation. Whereas if you put it into a narrative of failure, it's like, well, this failed in India and this failed in Thailand and this failed the UK. You can find examples of a different narrative, but even the failures got put into this narrative of success.

Sarah: Yeah. 

Mike: And so, I mean, one of the things that's glaringly obvious is between 1985 and 1995, the company is running, you know, 13% above the standard Import Index. Like it's a reasonably good investment, but it's not a Blockbuster. Between 1996 and 2000 its revenue goes up 750%. Its revenue goes from $13 billion to a $100 billion a year and at this time, every other energy company in the country is showing growth of two or 3% a year, right. There’re companies that do exactly the same thing as Enron and they're like, times are good, we're growing by 3% and then Enron is like, oh, we're growing by 750% and everyone's like, wow, that's innovative.

But nobody really like really sniffs around of like one company that doesn't do things all that differently from its competitors is 10 times more profitable than they're like, we never want to believe that anyone is rigging the game. Right, we always want to make it seem like the rules are fine, everyone's on a level playing field and its innovation that brought a company to these heights. 

Sarah: What of innovation is a finance type person word for crime?  What if when they say innovation, they mean crime?

Mike: I'm going to try now to get into the mechanics of how the fraud worked. 

Sarah: Yes. 

Mike: I feel like there's this thing where podcasts will sort of apologize and like, oh we're going to get into the weeds now. Like it's about to get really detailed, but I think details really matter. 

Sarah: I love the weeds; just throw that tennis ball and I'll go get it every time. 

Mike: Yes. I mean like the world takes place mostly in details and it's important to understand the details of how things work and I'm not going to apologize for them because I got really interested in this and I think it's totally fascinating. 

Sarah: I agree with you and support you. 

Mike: Thank you. 

Sarah: Continue.

Mike: Ordinarily, like I said, the way that you calculate your profits are just normal. We had it, we sent them an invoice. This much money came back. You know, you count your trickle of money that comes in and your trickle of money that goes out and that's how much money you made that year.

Sarah: You just plot along, boringly running a business with real money. 

Mike: Yes, normal ass accounting procedures. What Enron does in 1992 is they changed to something called Mark to Market Accounting. So, this is something that the financial sector uses, but no one outside of the financial sector had ever used before. And it basically says once I go into a deal, however much profit I think I'm going to earn on that deal, I can book that as income now. 

Sarah: Oh no. 

Mike: It's essentially like me saying, oh, I just got a new job and for the rest of my life, I'm going to earn, you know, $1.2 million in salary. I can put on my Tinder profile that I made $1.2 million this year.

Sarah: It's also asking people to speculate about their earning potential, IE the very core essence of their own ego, if they work in this field. Which I feel like is something that wouldn't necessarily lead to but could certainly facilitate some light fraud.

Mike: Exactly. And also, I mean, financial sector companies that do this, the logic behind it is, you know, if you buy a bunch of treasury bonds or something, that's a really safe bet.

You're guaranteed to get whatever it is, 5% returned back. You're really guaranteed that return. So it makes sense for safe bets to book that as income. I mean the financial sector also does all kinds of shenanigans with this, but the logic is sound, right. Whereas if you're a company that is like going into business like Enron did with AOL and Blockbuster to deliver streaming video to people, in 1996. 

Sarah: I was watching streaming video in 1996. It took 40 minutes to load an Upright Citizens Brigade sketch. 

Mike: Yeah. Like don't book that income Jeff, like just wait, wait on that, Jeff, like maybe hang on. 

Sarah: Hold on loosely, but don't let go.

Mike: You know, there's three huge problems with switching to this kind of accounting that only become clear later on. The first problem is that if I'm booking all of my income for my new job this year, well then next year, my income is zero, right? Because I've already booked all the income that I'm making. So, to do this, it's like a Ponzi scheme where if you've already booked all of the millions of dollars, you're going to make from your partnership with AOL and Blockbuster last year. Well, then this year you have to sign a bigger contract with someone else or else your income's going to go to zero.

Sarah: And you must maintain your quality of life.

Mike: Yeah, exactly. You need to pay the pool boy and to do that, basically it becomes this escalating thing where you have to keep booking new deals and new deals and new deals to keep your stock price going up. Because all of this depends on the stock price has to be keep   going up. That's one thing, the second one and this is the really obvious one, a lot of the profits never come true, right? They booked all of these profits from this power plant that they built in India. But people in India can't afford the power that they're providing and no one, no American company has ever successfully run a power plant in India. And so, there's all kinds of problems, there are huge human rights violations, and this becomes a huge political thing there. 

Sarah: Oh no. 

Mike: So again, it's like, they're not actually earning money that they've already booked. 

Sarah: Yeah. If you stop lying, the stock prices go down and then everyone loses money, and everyone's upset.

Mike: Well, that's the thing. I mean, that's why this works for seven years and then, in 24 days, it doesn't work anymore. 

Sarah: Let's literally like a fairytale spells seven years of good luck and then you will all fall from our pedestals. 

Mike: The amount of money that they lost on this stupid Blockbuster, AOL deal. It's $110 million. So that's not that much money to a company that's earning a couple billion in revenue every year. 

Sarah: So yeah, a Jerry Bruckheimer movies worth of money. 

Mike: Right. You can write that off, it's not that big of a deal. You can hide it, but it's like if you have $110 million this year and then $200 million next year and then $300 million, then like if it becomes this rolling snowball. 

Sarah: Right. Because the scale of the fraud has to keep getting bigger and so when they get caught, it has to be that much worse. 

Mike: And that's essentially what happens is by the late 90s, they have this deal to sell electricity to Indiana, to the state of Indiana, which is worth a $1.3 billion. But Indiana hasn't deregulated its energy market yet. So, Indiana is like, hang on, we don't want this. We don't want to do this, goodbye. And then Enron is like, well, wait a minute, we have $1.3 billion of income on our books that is now zero. 

Sarah: Was Enron brought down by the state of Indiana? 

Mike: No, I mean, there's hundreds of these deals.

Sarah: Okay. That would have been great though, go on. 

Mike: Well, so the third reason why Mark to Market Accounting is a really bad idea. It's actually the most important one, in that it doesn't generate any cash flow. So, in the same way, if I tell you my income was $1.2 million last year, and then you look in my bank account and there's $18, you'd be like, hmm, something's a little weird here, right? 

Sarah: Yes. 

Mike: And in the same way, companies have to report their cashflow and how much cash they have on hand to Wall Street. So, if you're reporting billions in revenue and you have no cash flow, your stock price isn't going to go up because everyone's going to see that your stock is fake, that all of your revenues could come crashing down because you have no actual money. The thing that Enron has to do, and this is what motivates all of the fraud is they have to show cashflow. They have to say, we're earning whatever $10 billion in revenue, and we brought in $1 billion in cash because that's the way that you know, oh, well this has to be a real company. It's not just speculative. It's not a bubble because look how much cash they have, and they have to do increasing shenanigans to bring in the cash. 

Sarah: So, how do you fake cashflow? What do they do? 

Mike: This is where that like savage fraud comes in. Most of this is done through this guy named Andy Fastow, who's the chief financial officer, and he's really the mastermind behind all this. He comes up with all of these structures and it's complicated. I read a million documents, there's been a million congressional hearings about it, and it is legitimately very complicated on purpose, right. Like the reason why white-collar scandals are always boring is because companies make them boring because they don't want you to understand it and they don't want regulators to be able to figure it out. So, it's mind numbingly boring, but what it basically is, it's like taking out a credit card to pay off your previous credit card and then taking out another credit card to pay off that credit card. I mean, that's essentially the model.

So they set up hundreds of shell companies. They're all under this thing called a special purpose entity, which is a normal thing that companies do. When Coca-Cola wants to invest in the Cambodian market, it'll set up Coca-Cola Cambodia, which is a legally separate entity. It has legally separate investors. It's like a company that you set up to do a project. What the company does over and over again is they hide their debt in these shell companies. They say, oh look, we got a $10 million payment from Raptors Incorporated. That's one of the companies that they have. They make it look like, oh, Raptors is like this separate company and like, it's connected to us, but it's not the same. Our income from Raptors is like real income, but actually Raptors is just a wing of the company that's being controlled by this Andy Fastow guy. And they do a couple of times where one shell company will buy another of their shell companies. And then Enron will count that, Enron will be like, oh, we sold our company to another company, and we booked $20 million in income. But like, it's just selling, you're selling one of your credit cards to another one of your credit cards.

Sarah: So they have a fairly stagnant amount of money that they're just pushing around.

Mike: Yeah. 

Sarah: Okay. 

Mike: And they're actively losing money. I mean, the real thing that starts bringing all of this down is that gas prices start to go down. Their actual business, like their normal ass business starts to lose money and doesn't bring in as much as it used to. And this whole idea of having a gas bank and being a middleman and like trading futures and all this stuff, other companies aren't stupid. So Merrill Lynch opens a trading floor that trades futures of natural gas. Other energy companies are trading their own natural gas. Pretty soon, Enron, isn't actually a monopoly in all of this trading stuff anymore. So, by the late 90s, everyone else has figured out and run secret sauce and is doing exactly the same thing.

So it's actual businesses aren't making money anymore and this fraud is now rolling up to the point where there's a bigger debt and bigger debt and bigger debt, and they have to do more drastic things to hide it. One of the main ways that they hide the money is they make loans, look like income. So, they'll get like a $3 billion loan, like some massive sum from, you know, Goldman Sachs, but then they'll do it in a way that like, they use the loan to buy treasury bonds and then they sell them back and then they loan them.

This weird opaque shit that nobody can ever figure out. You know, it's like going to the Cayman Islands and then it's going to another shell company. I mean, they basically bounce this $3 billion around 50 times and then get it back to themselves like, oh, hey, we made $3 billion like that the whole model is to get all of these loans and make them look like revenues.

Sarah: It's pretty unsophisticated when you describe it that way. 

Mike: Yes.

Sarah: Yeah.

Mike: And of course, at the center of this, this Andy Fastow guy is skimming money off the top, right. That he's like paying himself a bonus of $5 million to sell one shell company to another shell company and there's no money. There's no real money there.

Sarah: Right.

Mike: Somehow, he is able to pull out $5 million for himself. 

Sarah: Probably because it's only $5 million dollars because they're committing fraud, you know, on the scale of the billions. No one's going to notice $5 million in actual money go missing. 

Mike: And also, like a rising stock price is a hell of a drug. If the stock price is rising, everybody's getting richer, every employee is paid in stock options and encouraged to own stock options, right. They're being told constantly to put their 401k all into Enron stock and so it's like, okay, Fastow has got his hand in the cookie jar, but whatever, I made $80 million last year. So, like, if he's skimming five, like whatever, I'm probably skimming a couple here and there and my stock price is going up, like those papers over a lot. 

Sarah: Well also I'm sure everyone at this level knows that the company essentially is a fraud machine. And so, if someone is, you know, skimming all of these ill-gotten gains, like who cares? That's pretty low stakes compared to everything else that's happening.

Mike: I mean, another way that the company is getting income is basically just like shitty ass business practices. So this is where the California thing comes in. I mean, the thing that I cannot get over, so in 2000 and 2001, California has six days of rolling blackouts and they're constantly having these problems. California's power plants are capable of producing 45 gigawatts, Californians on any given day need about 28 gigawatts. There was never a power shortage. There was never close to a power shortage, but because Enron owned all of the wires that transfer electricity, not just throughout California, but across the entire west coast, Enron would like take power capacity from California and sell it to Arizona. And then once there was a shortage in California, it would then sell it back to California for five times more. We didn't know this until 2002-2003. Like we knew California had this huge power crisis, but we didn't know how created and how fake it was.

It was a conspiracy theory for a long time, Enron is manipulating the supply and then we got all the discovery files from Enron in 2002. Oh yeah, the conspiracy theory is true, it is Bible fact, like the company was doing this. So what it basically was, is California generates its own electricity and it sells its own electricity to itself, and it has like standard prices. It's all regulated, blah, blah, blah. But because you can't store electricity. Whenever Californians use more energy, you have to generate that energy right now. 

So, if California's energy use goes over these 45 gigawatts, California then has to buy energy on the open market, which is much more expensive and it's basically you, you pay whatever someone is selling energy for. Right, it's just supply and demand stuff. 

Sarah: How does energy work, Michael? How does our whole modern world exist? This is all so mind blowing.

Mike: I mean, me too, I didn't know any of this stuff two weeks ago.

Sarah: Like where do you get it from if you can't save it and store it, are you just like, hey Wyoming, we need some energy you got any?

Mike: Yeah.

Sarah: Wow. 

Mike: There are a million middleman in this whole process but at the end of the day, it's like, LA will call up Wyoming and be like, hey, we're a little short on energy. Do you guys’ mind rerouting some to us? And Wisconsin is like, well, we're having a light day today, so yeah, no problem. 

Sarah: You guys confused Wyoming and Wisconsin, but I still love you.

Mike: Are those not the same?

Sarah: One has more Cowboys.

Mike: So basically, what Enron starts doing is they will lie to California and be like, wow, Californians sure using a lot of energy today. I don't think we're going to have enough, by the way, we can sell you some energy to fill in the gap. Right because they are the producer of the energy and the pipeline of the energy and your source of information.

Sarah: You can see how that would create the potential for some shenanigans such as these. 

Mike: I am telling you there's a problem and then I'm telling you that if you pay me, I can fix the problem. 

Sarah: It's exactly like the scammers who call you and instead of trying to sell you antivirus software, or like, oh my God, your iCloud has been compromised. Give us money right now. 

Mike: California apparently doesn't have systems to actually double-check. They were like, wow, thanks Enron, you really saved our lives. 

Sarah: And then Enron skateboards away with its bag of cash, sideways baseball cap.

Mike: So, all of these documents come out later where Enron calls it, the death star strategy. There are all these great memes right, it's like the fat boy’s strategy or something called megawatt laundering. 

Sarah: You know, if they were calling it the death star strategy, you have to think about the kind of self-image that they had at this time.

Mike: The death star strategy is apparently there's only one wire or one set of wires that take energy from Northern California to Southern California. It's this huge bottleneck and Enron owns it. Enron deliberately congested that one bottleneck and would say like, oh, sorry, you guys can't, you can't buy energy from Southern California today. I guess you'll have to buy it from out of state. So even though the power plants in California were producing enough energy Enron pretended that the entire Southern half of the state was off limits. And so Northern California has to buy it from Wisconsin, or it has to buy it from Arizona or whatever at up to five times the price.

Sarah: And that's how these brown outs happen.

Mike: Yeah. And so that's how the brown outs happen. There just isn't enough power that because they've rerouted it somewhere else, or they've created this phantom congestion on the line.

Sarah: Oh boy. You know, once you know how it literally happens, you're way more pissed off. 

Mike: You know, people got trapped in an elevator for hours, they did this during a summer when it was a hundred degrees. And so people couldn't use their air conditioners. Another, the most cynical thing is that while all of this happening brown outs crisis, whatever, and Enron starts going to companies and they say, you know, because the state's power supply is so inconsistent, we're going to sell you Bespoke Energy. They go to like Cisco Systems and they're like, you're a computer company, we know you need reliable energy. We're going to sell you our energy directly so that you don't have to go through the state regulators.

Sarah: Right. Because they have a sanctuary, torched a neighborhood and then gone to the one surviving treasury and been like, oh, be kind of a shame if this restaurant burned down too, why don't we sell you arson protection?

Mike: Yeah. This is from one of the Academic articles I read. During the height of the crisis Enron signed more than $1 billion in long-term energy deals with companies such as Compact Computer, Starwood Hotels, Rich Products Corporation, and Prudential Insurance.

Sarah: So, you can also see that at this point, they're really maximizing every possible avenue for profit. You can see how little foresight they have at this point, because this is high risk behavior. One of these chickens is going to come home to roost, but like they're so focused on covering their ass because they have so much money in the hole that it just, it feels like no stone is left unturned.

Mike: Although what's actually super dark is that it's not clear, the traders, the energy traders actually knew how much of Enron was fraudulent. They might have just been doing this to be profit-maximizing. I mean, it's not clear that they had the same sense of panic that say Jeff Skilling and Ken Lay did. A lot of the rank and file were just assholes.

Sarah: Right? They're like my bosses are telling me to destroy people's lives.

Mike: I mean one of the forgotten things in all this is that like three or four other energy companies we're doing the same thing. 

Sarah: What?

Mike: Yeah, this is not something that Enron was entrepreneurial about. We know that Enron was doing it because we have the discovery files because the company was under trial, right. That all this stuff became public, but there's like three other energy companies that are supplying energy to California at this time and also run power lines. And they're making a shitload of money too. We just don't know because nobody's done a criminal trial against them because it's just basic profiteering. It's not really illegal. It's just morally catastrophic. And so, one of the things I think is actually really interesting about this is reading all of the law review articles and the investigations and the criminal stuff, this thing is nowhere in there.

Sarah: Wow.

Mike: The California thing, isn't even a blip. It's all about defrauding the investors. It's all about, you know, faking the financial statements. The fact that California's energy costs went up eight-fold for people. 

Sarah: Oh my God. 

Mike: And the state went from spending $7 billion on energy to $27 billion on energy. Like it caused a budget shortage, they had to cut funding from universities in California because of this. None of that shows up in any of the criminal indictments of Enron because it's just companies be companies like, that's it.

Sarah: It's very interesting what constitutes a white-collar crime, essentially, because it does feel like there's a lot of manifestly immoral stuff that's just fine.

Mike: Yeah. That's the story of a lot of corporate malfeasance and especially Enron that the worst shit isn't technically a crime. The last thing I want to say before we get to the downfall is the role of Arthur Andersen. Do you remember this company?

Sarah: No. 

Mike: You know the auditing firms, the big four auditing firms, Deloitte, PricewaterhouseCoopers, KPMG. 

Sarah: I don't know, I don't even really know what auditing is, if I'm going to be completely honest with you.

Mike: I feel like this is useful in that most of us don't know this shit, but basically, I mean, the entire purpose of auditing firms, every company that's publicly listed has to have all of its accounts investigated essentially. An auditor, they go in and they look at all your Excel spreadsheets and they say, okay, well, Coca-Cola you say that you sold a million cans of Coke last year, okay. Where were they? Who sold them? Who bought them? Where are the receipts? Where did the money go? Which accounts is it in?  Just basic health of the corporation. Do you have cashflow? What was your revenue this year?

Sarah: Do you have hundreds of shell corporations?

Mike: Exactly. So, you know, as soon as the Enron scandal breaks, the question is you were being audited every year. So how did like professional, independent investigators not notice this? And one of the quotes later is Enron rob the bank, Arthur Andersen provided the getaway car. Enron wouldn't have been able to do any of this shit, if Arthur Andersen's giant accounting firm, hadn't signed off on every single year of revenues, right? Like you're booking $1.3 billion from this weird shit in Indiana, okay. You got this loan, but you're booking it as revenue, sure seems fine to us. 

Sarah: Okay. So, Enron is doing all of these fraudulent things and all of these unethical things, some of which are illegal and some of which are not, what actually ends up being the thing that people notice, like how do they get caught?

Mike: There are two whistleblowers within Enron.

Sarah: Oh boy. 

Mike: When you hear whistleblower you want it to be this like Erin Brockovich, great story of crusading internal voices and fixing the company from within. And they're both just the worst stories like this totally anticlimactic way that we learn about the whistleblowers is through all this discovery, right? The $10 billion or whatever Enron emails get put into the public record and then people start looking through them and you're like, holy shit, there were internal voices that tried to stop all of this. 

And so, the first potential whistleblower that comes out of all these documents is this guy named Jordan Mintz, who was a tax attorney. He is working for Andrew Fastow. He's looking at all of these special purpose entities, these shell companies, and he sees some sort of accounting irregularities and then the whole story culminates in him noticing that Jeff Skilling has not signed some of the documents that are establishing the shell companies. And then he sends a memo to Jeff Skilling saying, hey, we need your signature on this, and Jeff Skilling never writes back and that's it. That's like the closest thing to whistleblower we have is like some tax lawyer who's just like, we're missing your signature. 

Sarah: That is not a whistleblower. That's no, that's like you see a whistle over there and you're like, oh, hey, a whistle back to my lunch. 

Mike: This was a woman named Sherron Watkins, who Pamela Colloff, one of our favorite writers wrote a profile of a couple years after this happened, where she hung out with Sherron Watkins for the day. Hers is a little bit more dramatic. She was an accountant. She got hired again by this Andrew Fastow guy, the guy who's running all the shell companies. She essentially sits down with an Excel spreadsheet and it's like immediately obvious to her that it's a giant fucking scam. She looks at some of these shell companies and she's like, these companies have hundreds of millions of dollars in debt and we own these company. So, we're liable for this debt, but we're telling our investors that we're not. 

Sarah: Could it be that the emperor has no clothes on at all?

Mike: She wrote an anonymous memo to Ken Lay, like you should know about this. This is a giant scam and then Ken Lay hires a law firm. She's like, yep, it was me, I'm pretty concerned about this and then this law firm, they're like, oh, this is really troubling. Like, we're going to look into this, we're going to do all the paperwork. We're going to go through the Excel spreadsheet and then like a month later, they get back to her and they're like, we don't see any problem here. And she's like, okay and that's it. That's the whole story. 

Sarah: I am just thinking about like, what is it like to work for Enron? And this is like your workplace in your community and maybe most of the people, you know, work there. And even if you figure out what they're doing, you're like, well, it's working, and everyone else's fooled. Like how real my thing can be. 

Mike: I mean, I think it's a nice corrective to the whistleblower myth that the whistleblower narrative that, you know, she looks into this, what she says later is she's like I found, you know, one company with a bunch of debt on its books. I had no idea of the scale of the scam. I didn't know there were hundreds of shell companies. I didn't know there was billions of dollars that was being faked. I found this one thing, like a little thread. I pulled on a little bit, someone with more authority than me, lawyers who said that they had investigated this came back to me and said that it looks fine to us. And so, it's like, well, I guess I must've been mistaken, I must've been misreading the Excel spreadsheet. 

Sarah: And she did what you can expect of an employee and a hierarchy that demands loyalty and, you know, knowing one's place, she pushed it a little bit nothing really happened. She moved on like, this is what we train workers to do in this environment. 

Mike: Yeah. The real downfall of the company begins in March of 2001. So, by December of 2001, the company doesn't exist anymore. March of 2001 is when, for the first time there's an article that starts to ask questions about how Enron is making its money. The writer is Bethany McLean who's a 30-year-old fortune writer. The headline of the article is, Is Enron Overpriced? It's like, I read it, it's like the cutest article. It's basically just like, how does Enron make its money? She keeps calling around and like, no one will tell her. 

Sarah: Oh, that's so great.

Mike: So, I mean, I think it's the second paragraph of the article, she says, “Start with a pretty straightforward question, how exactly does Enron make its money? Details are hard to come by because Enron keeps many of the specifics confidential for what it terms, competitive reasons, even quantitatively minded Wall Streeters, who scrutinize the company for living think so. If you figure it out, let me know laughs credit analysts, Todd Shipman at S and P.” Like even the people that are telling you to buy the company stock don't know how it makes money.

Sarah: Like the day you’d have a credit analyst laughing. It's like, oh, we really are. This is the situation.

Mike: The sentence of this article that I love the most. She says, “ask for the details about how it makes money, Enron says that's proprietary information, sort of like Coca-Cola's secret formula.”

Sarah: It's not. 

Mike: This is how the company makes money. It shouldn't be that hard. Three executives from the company take a corporate jet to New York and have a three-hour long meeting with her where they try to break down what the company does. And you can just imagine, like, she says this later, that she's a 30-year-old woman, these are all dude oil executives in their forties and they're like, now, darlin, I know you can't understand what we do. This whole thing is super condescending, essentially a switch back and forth between you wouldn't understand and it's a secret.

Sarah: They give her the wall of good old boy. 

Mike: That's the beginning of people being like, yeah, how does this company make money? This is a little bit weird. 

Sarah: I have to add Bethany McLean to the mural I'm planning of all of our heroic, not whistleblowers even cause that's sort of a specific term just like people who notice things. 

Mike: Just basic question askers.

Sarah: People who go, hey

Mike: Yes. So then the dogs really start sniffing around. In August 2001, four months after the article comes out, Jeffrey Skilling resigns.

Sarah: He skateboards away for the last time. 

Mike: Yeah. And he says that he wants to spend more time with his family. 

Sarah: Which means you've been caught with your hand in the cookie jar. 

Mike: Which is just like awooga, this is the month when the company reaches its highest ever stock price. People in that situation do not resign to like to help their kids do their seventh-grade homework.

Sarah: Yes. But like Joe Pesci in Casino, he's skipping town to try and evade the people who want to whack him in a corn field. 

Mike: Then in October, the company then announces, oh we actually lost money this quarter for like the first time, I think it was four years that they're losing money for a quarter. And then two weeks after that, they announce that they are restating their financial statements for 1997 through 2000. And they're just like, oh, by the way, over the last four years, we actually earned $500 million less than we said we did. We're sorry. 

Sarah: Why did they do that? 

Mike: Well, because they had to. The theory now is that Jeff Skilling knew that it was all going to come crashing down, but there was a level of deception that they couldn't maintain that now that people were asking questions, you know, even on calls like investors were like, oh, this doesn't add up to us. 

Sarah: If the junkies start asking questions, you’re in trouble as a pusher. 

Mike: And then also in October of that year, the SEC announces that they've begun an inquiry into potential conflict of interest between the company and these shell companies. 

Sarah: How seriously do people take an SEC investigation? 

Mike: There so rare actually that people take them pretty seriously. Like you have to really fuck up to get the SEC investigating you.

Sarah: Really.

Mike: And between the CEO resigning, the restatement that we actually made hella money less than we said we did. Selling off a bunch of assets and the SEC opening an investigation. 

Sarah: Four chickens come home to roost all of a sudden, and then you look up and you're like, that's a lot of chickens. 

Mike: What is totally amazing is October 5th, the stock is at $90 and then by December, the stock is at $0.75. 

Sarah: Oh, my God, by the way, like, we've talked about how big Enron is in terms of monies or fake monies, but how many people are working for Enron? How many people, you know, have converted some or all of their 401ks into Enron stock?

Mike: A lot, dude. The way it happens is the whole time the stock is plummeting. They're updating their online system, whatever they're like, sorry, our website is down. So employees can't sell their own stock. 

Sarah: Oh God.

Mike: So, all these poor, you know, HR people and receptionists, and even people on the trading floor that didn't know about the scale of this had no way of pulling their money out of the company. And of course, we find out later that all the top executives are pulling out like tens of millions of dollars in stock at this time, because they see the writing on the wall. 

Sarah: Of course, and the people who cleaned the toilets are the ones who get fucked.

Mike: Totally. I mean, you know, this whole time they're saying, oh, it's just a blip. It's not that big of a deal.

Sarah: This plane will write itself and resume chorus and not plow into that field. 

Mike: Executives are trying to get the stock price back up, pulling out their own money while telling their employees to keep the investments in, and then they just say you have half an hour to pack up your things.

Sarah: Oh my God.

Mike: They just come in one morning and by 9:30, you have to get all your stuff and bounce. Like that's it, it ended up being 4,000 lost jobs, 15,000 employees and former employees that had Enron stock as part of their retirement plan. 

Sarah: 15,000 people is like a flourishing Midwestern town. 

Mike: Yeah.

Sarah: That is a lot of human beings. 

Mike: And there is this super infuriating footage of Ken Lay, like the week that all of this is happening, where he's at a news conference and he's talking about, you know, my net worth has gone from hundreds of millions to tens of millions. And my liquid net worth is less than a million dollars.

Sarah: I bet he had to sell some of his wine. I bet his wife, sadly took off her earrings. 

Mike: Yeah. I mean, the guy owns like six houses. Like it's hard to have any sympathy. 

Sarah: Well, super rich people are people who've been able to buy their way out of the human condition artificially for whoever knows how long and now they're human again. And they're like, oh no, this is terrible and it's like, yes, we know. 

Mike: And then of course, I mean, what interesting looking back on this is nobody knows any of this at the time. Like all this stuff about fraud, all this stuff about faking the books, nobody knew the extent of all this and one of the first things that happens is the FBI assigns a task force, which is run by Robert Mueller. This is like a weird little fun fact. It's seen as a, an example of a very good investigation. You know, it takes a couple of years, they aggressively get people to flip. So, Andrew Fastow the guy that was running all the shell corporations, they threatened to charge his wife with tax evasion as leverage to get him to flip, it works. He then agrees to testify against Skilling and Lay. 

Sarah: You attack people through their loved ones, that's a great strong-arm tactic. It works so well for organized crime of all strikes.

Mike: Yeah. And you know, his wife ends up doing one year of time because she knew about the tax evasion that he was doing.

Sarah: Wow. 

Mike: So Fastow ends up doing 10 years because he gets a shorter sentence for agreeing to testify. Skilling gets 24 years, but he somehow rich people, justice, technicality, something, something, he gets the sentence reduced to 10 years and I think he's getting out this year. 

Sarah: I think that people who commit financial crimes like that should have to live a life of service among the poor and be like janitors at charity hospitals or something like that, like they should have to live in the world that they created. 

Mike: Yeah. And he's done a couple interviews from jail, and he says that he was a patsy, and it was Fastow, he was the mastermind behind it all. 

Sarah: Everyone's a patsy. 

Mike: Ken Lay actually never gets sentenced. He gets convicted, but before his sentencing hearing he dies of a heart attack at his chateau in Aspen, Colorado. Which just shows you like his net worth, Kenneth Lay was fine. He was going to do 45 years. 

Sarah: This is really significant time. 

Mike: Yeah. 

Sarah: It's surprising. These are racketeering numbers.

Mike: I mean, this is the last time we did this. I mean, one of the things that's really sad about this is that, you know, white collar crime prosecutions are way down. 

Sarah: Yeah. Tell me about white color crime prosecutions generally.

Mike: I mean, one of the things that happens in one of the things I didn't mention is this is fall of 2001, what happened in fall of 2001? September.

Sarah: 11th.

Mike: Yes.

Sarah: Yes.

Mike: One of the things that happens is this is basically the last FBI major investigation of white-collar crime because they all shift over to doing terrorism after this.

Sarah: Oh, when the cat is away, the mice will play.

Mike: I mean, Enron is it's like the last gasp of a way of prosecuting white-collar crime that we just don't do anymore. But then, I mean, what's amazing is, you know, 16 people go to jail for all this Enron stuff. 

A really interesting thing is Arthur Andersen, this auditing company that's supposed to be the independent auditor but was signing off on these super fraudulent statements, gets driven out of business. So 85,000 employees lost their jobs.

Sarah: Oh my God. 

Mike: Which is way more than Enron. I mean, it's a huge deal and what's interesting and totally forgotten about all this is eventually the Supreme court actually overturns the conviction and says it was the instructions to the jury were wrong, whatever. But Arthur Andersen's reputation is so damaged by that point and all of their executives have already moved on that the company just never comes up again. 

Sarah: I really think the extent to which Americans generally are attached to corporations is interesting, do we love them? Like, do we love Coca Cola? Do we want Coca-Cola to be happy? 

Mike: Clearly. 

Sarah: I guess. 

Mike: The biggest missed opportunity of the aftermath of Enron is the narrative that forms is about fraud. It's essentially a bad apples story and as we've discussed on the show, many times the bad apples explanation is usually not the complete story. 

Sarah: I think we've discussed that on this show at pretty much every episode. Yeah. 

Mike: And so, what happens is Congress passes a series of laws in response to Enron. So they want to prevent another Enron from happening again. They pass Sarbanes-Oxley and what's really interesting about this law and about the approach to this generally is that it's all about protecting investors. So this is the reason why the California chicanery doesn't end up in any of the indictments because investors didn't lose any money.

Sarah: Oh God no.

Mike: Basically, this is seen as a problem of Enron executives, defrauding investors. So, this is from one of the law review articles, I actually interviewed the author of this because I was so curious about how all this worked, but he says the task facing government in the wake of scandals like Enron was to restore confidence in the markets. And that was the guiding principle of all of the response to Enron was that we have to make it safe to invest again. Sarbanes-Oxley includes things like there's an independent accounting board and when you have an auditor, the auditor has to rotate every six months so that he doesn't get too involved in your business or something.

I mean, there's these little things that make it easier for independent outsiders to figure out what's really going on in the company, right? So that if you're trying to lie, it is harder to lie to your investors and one of the super fucked up things is that after all of this years later, the employees of Enron sue, they sue for $2 billion, all of their wealth that was wiped out of their accounts. So these are people that lost their entire retirement savings. They get $85 million, which ends up working out to about $3,000 a person. 

Sarah: Oh, my God. 

Mike: Meanwhile, investors also sue the company, and they get $7 billion. Employees get $85 million shareholders get $7 billion. So that is who we are making whole after this entire process.

Sarah: Well, yeah, because it's not about justice. It's about preserving the myth of the economy. 

Mike: Yes. 

Sarah: Right. Because here comes along this thing that's like, hello, guess what? The infrastructure of our lives is crooked and full of all these weaknesses and incredibly vulnerable to the random and self-fulfilling egos of a few dicks and in order to, I guess, perpetuate itself, which a lot of people seem to find completely unnecessary. We have to administer quote unquote justice in a way that makes the whole situation feel stable again, but doesn't alter it in any way, like doesn't change any of the things that led to this being possible, right?

Mike: Yeah. I mean, one of the articles on Sarbanes-Oxley like lessons learned from Enron that I found talks about how a lot of these provisions in Sarbanes-Oxley have never been used. No one has ever been prosecuted under them and a lot of the law just requires disclosure. It's like if you're going to use the same auditor, you know, whatever 50 years in a row, you have to disclose it to your investors. Like it's all just like, make it easier for investors to decide whether this is a healthy investment or not. One of the senators that ends up voting against it points out that there's no protection for whistleblowers. So it's still in a lot of states legal to retaliate against whistleblowers. There's nothing in there that really makes it easier for this sort of thing to come to light. It's like, oh, you just have to tell your investors that you are doing shady stuff. 

Sarah: Well, it's also legal to fire people for their weight. So why not whistleblowing? This is America tra-la-la, see previous episode.

Mike: Yeah. But then so, you know, again, it's not necessarily that the fraud explanation or the original explanation is wrong. It's just that it's incomplete. We learned the wrong lessons again and I think the way to think about this is Enron really isn't about a couple people doing illegal things. It's about hundreds of people doing legal things. That's the best way to interpret this, that it's not about abnormal practices, it's about normal practices. One of the things that happens is in these congressional hearings, because there's all these investigations that happen Enron, the former head of the SEC, Arthur Levitt comes and testifies and he says, this is going to be a long quote, but I love this guy.

“Enron's collapse did not occur in a vacuum. Its backdrop is obsessive zeal by too many American corporations to project greater earnings from year to year. When I was at the SEC, I referred to this as a culture of gamesmanship, a gamesmanship that says it's okay to bend the rules, tweak the numbers and let obvious and important discrepancies slide.”

And this is the great untold story of the 1990s that wrongdoing became normal. Then one of the things that this law professor that I interviewed, John Coffee, one of the things that he mentions is throughout the 1990s, all of Wall Street, the entire Wall Street culture becomes organized around, making it safe for businesses to report higher quarterly earnings. And they get more and more extreme in allowing companies to bend the rules, to get their stock price up. So one of the things remember how I mentioned that Enron had to restate its earnings.

Sarah: Yeah. 

Mike: When a company has to restate its earnings from a couple of years ago, it basically means it's lying, right? Like you're saying you earned a bunch of money a couple of years ago to get your stock price up and now you're saying, oops, that was not right true.

Sarah: Right. Like how do you honestly overlook $500 million worth of losses? 

Mike: Your fucking lying. It's a measure of how much corporations align.

Sarah: It's not in your other pants.

Mike: No. Yes. And one of the things, this guy notes is that in 1990, about like 49 companies a year said, oh, whoops, we had to restate our earnings. By the end of the decade, 150 companies we're restating their earnings every year.

Sarah: Oh good. 

Mike: Bullshitting your revenues became standard practices. The article that he wrote about Enron is called “It's About the Gatekeepers, Stupid.” And essentially what really happened was a total degradation of the checks and balances that are supposed to keep companies from committing fraud. Nearly every institution on Wall Street that is supposed to stop companies from doing this ended up enabling them. 

Sarah: Good God. 

Mike: And one of the things that is totally overlooked in all of this is the extent to which the investment banks Citibank, JP Morgan, et cetera didn't just know about what Enron was doing, they encouraged Enron to do it. One of the things that comes out in the Senate hearings about Enron is that JP Morgan was helping Enron set up these shell corporations and was charging extra to make them difficult for regulators to find. 

Sarah: What?

Mike: It was charging a premium to make them even more illegal. 

Sarah: Because JP Morgan understood that what Enron was doing was making it more profitable for them.

Mike: Yeah. Some of the shell corporations are actually opened in the name of Chase Manhattan Bank, Citi group. These companies are essentially planting the idea with Enron that this is how it should do it. So, all of these loans that I mentioned of making loans look like income, this was the banks idea. This was something that the banks came up with to help Enron and so one of the articles that comes out about this in 2005 points out that 70% of the company's profits throughout the 1990s, we're from contracts with banks. And it was basically a puppet of the banks. They pumped $8 billion into this company throughout the 90s, so as early as 1993, Enron was insolvent. 

Sarah: Wow.

Mike: Enron had way more debt than revenues that never would've made it through the nineties, if it wasn't for the big banks, putting up all of this money to make it easier to fake their revenue. 

Sarah: And because all of these big banks and these big corporations are all leaning on each other, they know that if one falls, they'll all fall with it. So they all have to keep each other up. 

Mike: Exactly. And this is actually much less about Jeff Skilling being entrepreneurial than it is about the investment banks being entrepreneurial, right. We make more money when Enron goes up. Let's manipulate the stock of Enron so that we make more money. Another thing that's amazing is when you look at the auditors, right, these independent investigators that are supposed to be certifying Enron's revenues every year. The thing that this law professor points out is that there's no evidence that any other auditing firm would have behaved any differently. There's no evidence that Arthur Andersen was particularly corrupt. It's just, they got their first.  And what's really happened is, you know, the auditing business, this thing of investigating companies’ financial statements, isn't particularly profitable. So, like the grocery stores on Thanksgiving, will get you into the store with like a cheap turkey and then they'll get you on, you know, the gravy and the potatoes and all the fixes.

Sarah: They get you on gravy. 

Mike: Auditing firms will get you in the door with the audit, which is not that profitable, but then get a ton of money from you for consulting fees. What this does is it creates an incentive where the auditors can't tell you that you're doing anything wrong. The way that it's supposed to work is if you're doing shenanigans, your auditor is like, fuck you, no we're not going to certify this. But if the auditor says that now they're jeopardizing all of their consultancy contract. 

Sarah: And then the lose money and then how can they possibly jeopardize that? God, it's all so obvious.

Mike: So basically, all of these auditing firms are competing with each other to low ball companies on how much it costs for their auditing services. And then they're high balling on everything else that they're doing, that they're actually making money on.

Sarah:  Like when you fly spirit airlines and you have to pay $19 for water, they upgrade you to death. 

Mike: What you want to do as an auditor is make what the company's already doing acceptable. And that's exactly what Arthur Andersen did. I mean, this isn't a problem with Arthur Andersen. This is a problem with the auditing industry. 

Sarah: Do you feel like the civil rights that literally should have been routed to the, you know, the people who tend to show up as criminal defendants, poor people who committed really tiny pointless crimes of out necessity? You know, like check fraud that like the megawatt of doubt and due process in the eyes of the law that was supposed to go to them, got routed to a corporation because they bought it. 

Mike: Yes. 

Sarah: Because like when poor people do things to survive, we're like, oh, it's a crime. It becomes a crime, a poor person did it, it's a crime. And we never take the tack of like, oh, if people need to engage in this behavior in order to survive, maybe we shouldn't punish them as if they're a violent danger to society.

Mike: Right.

Sarah: Or like, hold them awaiting arraignment for months and months or what have you. There's no benefit of the doubt. The whip only cracks harder, but if a corporation does it, we're like, oh, is that what you need to do?

Mike: Yeah. One of the things that came up after Enron was that Ken Lay was really good friends with George W. Bush and he was a guest of honor at the inauguration. And there's like these private dinners that he had. There's a lot of smoke there, it looks bad, but what's actually much worse is all of the legal changes that happened throughout the 1990s to make it essentially impossible to prosecute individual bankers for anything that's going on. So, this law professor that I interviewed was also pointing out like the Rico Statute, you know, how they got Al Capone.

They limited the Rico Statute so that it wouldn't cover securities fraud anymore. The statute of limitations has been shortened. They redefined the Supreme court, redefined the term aiding and abetting so that it was harder to prosecute bankers. They've made it harder to do class actions, but just like redefining things, strengthening things, weakening things, all of which made it so much harder to actually put these guys in jail or notice what they're doing.

Sarah: And then they're redefining conspiracy charges in very specific ways so that they do not apply to white collar crime. 

Mike: A huge thing that I'm obsessed with is the liability standards. So, to hold a CEO liable for criminal activity in his or her company, you have to prove that they were willful, right. That they knew about it and that they didn't give a shit basically. Whereas liability, I mean, I have a friend who rented a house to a couple of college students who ended up using it to cook meth, they were cooking meth in the garage, and he did two years in jail. 

Sarah: What? 

Mike: Yes. Because it's like, oh, you should have known. But then when it comes to CEOs, it's not that he should have known it's that he did know and he didn't care, which is a really hard standard to prove. 

Sarah: Yes. 

Mike: It wouldn't actually surprise me all that much if Ken Lay didn't know how deep all of this stuff went, but I don't care, he should still go to jail. You are sitting at the head of a criminal organization that is completely fake and ruins the life savings of 4,000 people, you should go to jail. I don't actually care if you knew about it. 

Sarah: And for every person who knew exactly what was being done and how the solution of profit was being generated, I'm sure there were 10 or 20 or 50 people who looked at this and were like, you know, some kind of black magic has to be going on back there for this to be going on. And we're deriving benefit from what will be someone else's pain, if we think about it, but we won't. We're just going to look away we are just going to choose to look away, that's also really what enables so many of these schemes. 

Mike: Yeah. Another thing that I cannot get over is this whole thing about Mark to Market Accounting. The thing that plants, the seeds for this entire explosion, the SEC approved it, the company had to apply to the SEC in 1992 to use this form of accounting and the SEC said it was fine. Also with the California thing, Enron never could have been able to do this unless it owned a couple of the power producers in California, because it could take them offline and then say, oh, there's no power or buy more power from me.

That was something they needed a waiver to anti-monopoly statutes to do and the SEC was like, well, that sounds good to us. So again, another one of these checks and balances, the SEC is supposed to stop companies from doing this, but the SEC has essentially just become a stage in your career in the financial sector. The way that it works is you work at Merrill Lynch for a couple years, you get bored. You go work for the SEC for three or four years, and then you go back to Merrill Lynch. 

Sarah: This is at every level about the fact that when society is run by too few, too powerful people or entities, it's like the corporations all become friends. The corporations are friends with the regulatory bodies who are supposed to be imposing some sort of system of ethics. And then the people who are responsible for cracking down on the people, in the jobs that they want in five years, aren't going to do that because they want them those jobs. 

Mike: And this is what's so important about why we learn the wrong lessons from Enron is that it was essentially how people had betrayed insiders. It wasn't about the culture of insiders themselves. And this is all planting the seeds for the financial crisis, everything that happened in the financial crisis. Enron was a little sample platter of all of these conflicts of interest, all of the gross little tentacles stretching across government and private sector, it's all there. 

Another guy that I interviewed for this episode, named Gavin Benke, who wrote a book called Risk and Ruin about Enron. He pointed out that Enron was seen afterwards as an example of that the process working. This was a bad actor, they got nailed and we're fine. One of the things that Alan Greenspan said, because he also testified in front of Congress for this. He also said regulation would be one of the worst things to do because everything went fine in Enron and so there's no lessons to learn. We're in this new thing. It's the information economy. The business cycle is over because we have all this new information now. So, investors have all the information they need, we're never going to have a crash again.

Sarah: And we also think that if things are going well, if people are making money, it must be because the decisions we're making at that moment are the right decisions. When really, it seems like what people make money off of on the stock market more than anything are these casino and Enron type situations where it's like the thing you have to do to fly close to the sun is the thing that's going to melt your wings of wax. And defraud all of your workers and leave you marginally put out.

Mike: Yes, there was never any larger examination of what led to Enron. It was just these bad guys told them a bunch of lies, and then we all moved on. 

Sarah: Right. 

Mike: So, the last thing I want to read is from one of these congressional committees, this is one of the senators that had been in all the hearings, and this is in sort of the summary report. He says, “The evidence shows some of us financial institutions and public companies have been misusing structured finance originally designed to lower financing costs and spread investment risk to carry out sham transactions that have no legitimate business purpose and mislead investors, analysts, and regulators about company's activities, tax obligations, and true financial condition.”

So, he's basically saying the whole thing is rotten, everything is bad. Everybody's full of shit. Conflict of interest is inherent to the sector and then they just didn't do anything. 

Sarah: Isn't it funny how, like, there's this concept within the American right of the elite and the idea of like the elite are like the few people who run everything and they're controlling our lives and it's terrible. But somehow the idea of the elite that the actual elite is pushing is that the elite are people who read too much and really, it's like, no there's an elite. There's an Aluma whatever. It's just like the few hundred people who have all the money and pull all the strings and whose corporations and entities, and regulatory bodies are all friends with each other and decide who gets justice and who doesn't and that's all it is. It's just that all the money is friends with all the other money. 

Mike: Yes. And also, you know, I'm super allergic to anything that sounds like a conspiracy theory, which is why I always want to read quotes from these reports to show people that like, I'm not making this up. This is real stuff, but this is why I don't think that quote unquote, corporate greed is the lens through which to look at this. It's just everyone doing what you would expect them to do. If I got paid more for overlooking some things in an audit, I'm probably going to do that. I'm not greedy necessarily. It's just, most people want to keep their jobs and most people tell themselves stories as ways of justifying how they keep your jobs.

Sarah: Most people also are living in a society where there are extremely high incentives for keeping your job, because you know that if you lose your job, you could be bankrupted by cancer tomorrow. It's very much like the way that organized crime also operates in terms of it's like, look, we will sweeten the deal for you to go along with us. We will protect you. We will give you a cut. If you don't go with us, we will interpret that as you're making life harder for us, and we will fuck up your life. 

Mike: And also, to go out with the fake note of optimism similar to yours. 

Sarah: Mine was real. I don't do fake; I don't fake optimism. You can do a fake one if you want.

Mike: One of the things that has stuck with me from, I used to work at an anti-corruption organization and one of our guiding principles was that corruption isn't a crime of passion, it's a crime of calculation, right. That if you only earn $30 a month as a cop. Well, of course, you're going to take bribes when you pull people over for speeding, because you're calculating the benefits of that outweigh the risk.

Everything we're talking about with Enron was a crime of calculation from the auditors to the bankers, to Jeff Skilling, they were making calculations about what was going to be better for them. And the optimistic thing about that is that you can change the calculations. I don't think that Jeff Skilling is a corrupt person, I think that he was inside of a company that made it much more lucrative to commit fraud than not committing fraud. And when you change the incentives for people like auditors and SEC people and Wall Street analysts, and mid-level people that may or may not be whistleblowers, when you change their incentives, you can get a different outcome. 

The problem is the erosion of incentives over the last 20-25 years where the calculation has now tipped where wrongdoing makes more sense, but we can make wrongdoing make less sense. We can change the incentives back as far as national projects go that seems like a pretty worth wild one.

Sarah: Yeah, let's do that.

Mike: Yeah. I'm going to get started. 

Sarah: All right. Good, I'll meet you at the place.