[A-List] US legitimation crisis: Enron

["Michael Keaney" <michael.keaney@xxxxxx>]

Bad company

Its testosterone-fuelled traders were fixtures in Houston's strip clubs. One
division of the company spent $2m a year on flowers alone. And its
executives used the firm's corporate jets as taxis. In the first extract
from his remarkable new book on the rise and fall of Enron, Robert Bryce
describes the heady mix of greed, sex and arrogance that produced America's
most spectacular financial scandal

Monday November 4, 2002
The Guardian

J R Ewing never talked about pipelines. Jett Rink was interested in drilling
for oil, not shipping it through a maze of unseen steel tubes. Real men -
particularly fictional ones like Ewing and Rink - find oil and gas. Lesser
mortals navigate the maze of engineering, metallurgical and legal wrangles
that are needed to get those hydrocarbons delivered to the nearest refinery
or storage terminal. Face it, there's no sex in laying pipe.

Yet pipelines are the conduit for the American Dream. Every year, pipelines
carry some 550 billion gallons of crude and petroleum products to
refineries, airports, rail yards and other locations. Trillions of cubic
feet of natural gas are moved through some 2 million miles of interstate,
intrastate and local pipelines. Pipelines are the largely invisible,
sometimes dangerous, infrastructure that allows America to consume more
energy than any country on earth. By the early 1990s, when Jeff Skilling, a
former McKinsey consultant, began his rise to power within Enron, the
company and its leaders were, says one veteran gas man, "the kings of the
American pipeline business". Enron owned the greatest collection of tubular
steel infrastructure ever assembled in one company. It was transporting or
selling 17.5% of all the gas consumed in the United States.

Those pipelines were profitable but they were, and still are, heavily
regulated by federal authorities. With all of the federal regulations on
pricing, the pipeline business is more akin to the utility business than the
energy business. Pipelines carry a product from one spot to another, and the
owner of the pipe gets paid a fee for the service. It's a straightforward,
profitable business. As one former Houston Natural Gas executive said of
pipelines: "All they do is make money. It's boring, but it's dependable."

Perhaps that's why Skilling hated them so much. Skilling's brain was too big
for pipelines. He was always thinking big thoughts. And big thoughts have no
place in the pipeline business. Pipeline companies demand solid managerial
skills from people who show up every day and stick to their business.
Skilling was not a manager, he was a deal-maker. Exotic financing schemes
and the deals that came with them excited Skilling. Collecting nickels,
dimes and quarters from what was essentially a new-fangled toll road that no
one could even see, did not. The only thing that mattered to Skilling about
Enron's pipelines was that they kept providing him with cash that he could
use elsewhere.

For Skilling, elsewhere meant only one place: the trading business. Skilling
may have disliked pipelines, but he was an absolute genius at figuring out
how to trade the precious commodity that moved inside them.

As soon as Skilling moved on to the 50th floor, he began a hiring binge that
didn't stop until the company went bankrupt. But give him credit: he
attracted the best and the brightest. Harvard, West Point, Rice, University
of Chicago - every prestigious school in the country began feeding their
best MBAs, engineers and maths wonks to Enron. At the same time, Skilling
began raiding Wall Street, stealing traders, investment bankers, information
technology whizz kids, programmers and every other skill-set that Enron
needed.

The fleet of newly hired hotshots were never short of confidence or the
belief that they were working at the best, smartest, fastest-moving company
in the world. One longtime Enron employee (who held a PhD from the
University of Maryland) said: "There's no question that Enron people
arrogantly thought they were smarter than everybody else. There's no excuse
for that. But they were smarter than everybody else."

By mid-2000, Skilling had achieved his goal: almost all vestiges of the old
Enron, the stodgy, slow-growing pipeline-based entity that transported gas
and generated a bit of electricity, were gone. In its place, Enron had
become a trading company. And with that change came a rock-'em, sock-'em,
fast-paced trading culture in which deals and "deal flow" became the driving
forces behind everything Enron did.

Traders ran the place. All of the company's top executives - particularly
those close to Skilling - were either traders or had helped run trading
operations. And all of them believed in Skilling's vision of Enron as a
trading company. Chief financial officer Andy Fastow (who was last week
charged with 78 counts of fraud and money-laundering) had learned the
trading business while in Skilling's group in the early 90s. Greg Whalley,
the president of Enron Wholesale Services, the entity that ran the company's
trading operations, had worked in Europe as one of Enron's chief power
marketers. Mark Frevert, the chairman and CEO of Enron Europe, had overseen
the company's European trading operations. Other top execs, such as Lou Pai,
had been involved in trading for years.

Pai, who owned a 14,000ft mountain in Colorado, had two passions in life:
money and watching young women take their clothes off - but not necessarily
in that order. At Enron, he was able to gorge on both. Stories of Pai's
fascination with strippers were legion. One executive recalled getting an
expense report from Pai in 1990, shortly after Pai began working for him.
"It was $757 [£484] for one lunch. He and two or three co-workers had gone
to Rick's [a Houston strip club]. I said, 'I'm not approving this. You are
going to have to take care of this yourself.' You just don't do that in
business."

But Pai's attitude to women and sex was far from exceptional at Enron.
Several women who worked at Enron said that Skilling and the young traders
who dominated the company viewed women as a commodity that could be bought
and sold just like gas, electricity, or any of the other products Enron was
trading. And since Houston's strip clubs are among the best in the country,
it was only natural that Enron's boy geniuses visited them regularly.

Sex and extramarital affairs are not, by themselves, a problem for
companies. But at Enron, the sexual misconduct happened at such high levels
that it became a part of the company's culture. The sex, said one executive,
"set the tone for the rest of the company. And you couldn't get away from
it. It was like a humidifier. It was in the air."

Enron's massive new edifice to itself, a 40-storey, 1.2 million sq ft
building was going to be a monument to trading. The building, designed by
acclaimed architect Cesar Pelli, would have four trading floors - each big
enough for 500 "transaction desks" - with state-of-the-art communications
systems. Chairman Ken Lay and Skilling would move their offices from the
50th floor of the old building down to the seventh floor of the new one.
Instead of overlooking all of Houston, their new offices would be on a
balcony overlooking the new trading floors. And they wouldn't have to take
elevators to get to the traders: two snazzy, curved stairways were going to
connect their floor with the trading area.

The new tower had been under construction for nearly a year and was costing
Enron a fortune. Pelli's design, which would mimic the glass-sheathed oval
tower Enron already occupied, was going to give Enron the most expensive
building in downtown Houston. The final bill would be about $300m.

Enron was wasting even more money in Europe. The company's European trading
operations were located in an impressive new building named Enron House,
located at 40 Grosvenor Place, in the heart of London, on land owned by the
Duke of Westminster. Although the building cost $74m to construct, Enron
spent another $30m in bringing it up to the company's lofty standards. When
it moved into Enron House in November 1999, the top executives, including
Frevert, could sit in their top-floor offices and look down on rear gardens
of Buckingham Palace. The rent for the new digs? A bargain at a mere £8m a
year.

And if the Pelli-designed building was going to make a statement, it had to
be decorated. It needed art. Expensive, trendy art. And Andy Fastow and his
wife Lea - modern-day de Medicis - were just the ones to make sure Enron
made the right decisions. Beginning in the summer of 2000 and continuing
right through until the autumn of 2001, as Enron began to spiral downward,
the Fastows were the driving force behind an amazing art-buying binge. They
spent $575,000 on a soft sculpture by Claes Oldenburg. They paid $690,000
for a wooden sculpture by Martin Puryear, a record amount for his work sold
at auction. The committee also bought works by the sculptor Donald Judd, the
painter-printmaker Vic Muniz, the video artist Nam June Paik, the
photographer Julie Moos and the painter Bridget Riley. By August and
September 2001, the company had spent about $4m on 20 different pieces.

Extravagantly appointed offices were far from the company's only indulgence.
In 1997, Skilling's gas and power trading group, Enron Capital and Trade,
spent about $2m on flowers, according to an auditor who worked for the
division. "Oh yeah, we had secretaries sending their bosses flowers, bosses
sending their secretaries flowers. For a while, we were the biggest customer
for about five florists all over Houston," said the auditor. "We found out
some secretaries were sending flowers to their friends so that the
secretaries could get the pretty vases the flowers came in."

Flowers, first-class airfares, first-class hotels, limousines, new
computers, new Palm Pilots, new desks - Enron employees began to expect the
best of everything, all the time.

But cost-control was never a consideration for Skilling and Lay. After all,
EnronOnline, the company's new website, was the toast of cyberspace. In the
few months since it had been launched in November 1999, it had quickly
become the biggest e-commerce site the internet had ever seen. The trading
site had been the brainchild of a trader, of course, named Louise Kitchen, a
brash young Brit who had been Enron's head natural gas trader in Europe.
Cocky and impatient, Kitchen was emblematic of Skilling's new version of
Enron. At just 31 years old, she was young, rich (in 2001, her total pay
from Enron was $3.47m), and she believed that there was no end to what she -
and Enron - might do.

While she and her team were developing the site, Kitchen said: "I didn't
need a pat on the back from Ken Lay or Jeff Skilling. It was obvious that we
should have been doing this ages ago."

Kitchen's attitude was typical among the traders. They were the
über-Enroners, the ultimate masters of the universe. Kitchen, along with
another thirtysomething trader, a Canadian named John Lavorato, was rapidly
consolidating her power within Enron. And within a few months of
EnronOnline's debut, the pair were heading all of Enron's North American
trading operations. There were hundreds of traders, lined up with banks of
computer screens, keyboards, telephones - and adrenaline. In the first five
months of 2000 alone, the website did 110,000 transactions with a total
value exceeding $45bn. Deals could be done in seconds, rather than minutes
or hours.

Electricity, natural gas, coal, oil, refined products, bandwidth, paper,
plastics, petrochemicals, and even clean-air credits were for sale on
Enron's website. Within a few weeks of its launch in November 1999,
EnronOnline was the biggest e-commerce entity in the world. In all, the
company was selling over 800 different products.

EnronOnline was the logical outgrowth of Enron's gas trading business. What
had been done by phone and fax was now being done on the web. The company's
trading business surged, in large part, because of tremendous increases in
gas consumption in the United States. Between 1983 and 2000, demand for
natural gas in America rose by nearly 30%, to 22.5 trillion cubic ft per
year.

Enron transferred what it learned in gas to the electricity business. Once
confined to trading among utilities, Enron elbowed its way into electricity
trading in the mid-1990s. It was selling gas and power, but all the while it
was collecting still more information that provided a constant feedback
loop. Enron owned pipelines and power plants, and with EnronOnline, it could
instantly tell in which direction the market was going. It could also tell
who was buying, who was selling, and where it should be placing its own bets
in the marketplace.

In a very short time, Enron had remade itself from pipeline company to the
largest energy marketer in the country. But Skilling wasn't satisfied. He
wanted more. So in May 2000, Enron announced that it would buy the
London-based MG plc, one of the biggest metals traders in the world, for
$446m. Lay said that the deal would allow Enron to claim a major role in the
$120bn-per-year metals market. "Our business model, which we have proven in
the natural gas and electricity markets, will give us a tremendous advantage
in an industry that is undergoing fundamental change."

There it was again: Enron knew how to trade gas; it knew how to trade
electricity; now it would apply those lessons to the metals business.

Surely, Enron would succeed. The company owned pipelines and power plants,
valuable assets that gave it visibility in the gas and electricity markets
in North America, South America, Europe and Asia. It had a big trading
operation in Europe. EnronOnline was becoming the de facto standard for
traders all over the world. Commodity traders on Wall Street relied on
EnronOnline for pricing on dozens of different products and invariably had
one of their computer screens tuned to the website. And Enron had one of the
most sophisticated trading platforms ever developed. The company's traders
could assess the risk on any deal almost instantaneously. Any deal they made
was instantly processed and accounted for in the company's massive data
centre. Almost any position Enron took in the commodities market was quickly
hedged with a countervailing position. Furthermore, it had a battalion of
traders who were among the sharpest in the business. They made more money,
had bigger egos, and drove faster cars than just about anybody.

Skilling became convinced that Enron simply couldn't lose. In the lingo of
his predecessor, Rich Kinder, Skilling began "smoking his own dope".
Skilling had made Enron into the trading company that everyone was talking
about. Enron had become the 900lb gorilla in the marketplace. It didn't just
own the casino. On any given deal, Enron could be the house, the dealer, the
oddsmaker and the guy across the table you're trying to beat in diesel-fuel
futures, gas futures, or the California electricity market. With all of
those advantages, Enron's trading business must have been a cash machine.
Right?

Wrong.

Like every business Skilling created while he was piloting Enron, the
trading business was a loser. Sure, trading was glamorous and sexy, but it
generated virtually no cash for Enron. And that was a problem. Instead,
Enron's trading operation had an insatiable appetite for cash. Unlike other
online energy marketplaces such as Altra or the consumer-goods auction site,
eBay - which matches buyers and sellers for a fee - EnronOnline was the
principal in every transaction. That's a very expensive place to be.

If a seller agreed on Enron's posted price for, say, natural gas to be
delivered on a certain date, that seller could sell it immediately to Enron.
The company would then take title to the gas and try to sell it to another
party. That may not sound like a big deal, but by mid-2000, Enron was doing
several billion dollars' worth of trades every day. And because it was in
the middle of every transaction, Enron would have to hold some of those
commodities for days or even weeks before it could get the price that it
wanted on its trades. That meant Enron had to have billions of dollars in
cash at the ready. The sort of ready cash needed to clear and fund each sale
and purchase - often called a company's "float" - can be enormously
expensive. And the bigger the float, the bigger the expense.

Every day that Enron held on to a big position in a commodity, it had to pay
interest on the money it borrowed to take that position. For instance, one
of Enron's gas traders might be betting that gas prices would rise and
therefore go "long" on gas contracts in the amount of 500 million cubic feet
of gas. At $3 per 1,000 cubic feet, the gas could be worth $1.5m. That might
not sound like much. But Enron had hundreds of traders, some going long,
others going short in gas and dozens of other commodities. Supporting all of
those positions required huge amounts of capital. And as the number of
transactions handled by Enron-Online grew, so did its appetite for capital.
The new operation had to have enough cash to keep a liquid market in 800
different products, each of which was seeing a big surge in volume.

In the first six months of 2000, Enron borrowed more than $3.4bn to finance
its operations. The company's cash flow from operations was a negative
$547m. Enron was losing money - real money, cash money - hand over fist by
just being in business. Interest expenses were surging.

By the end of June 2000, Enron was paying about $2m per day in interest to
banks and other lenders. The $376m in interest charges for the first half of
2000 was more than it paid in all of 1996. Despite EnronOnline's voracious
appetite for capital, Skilling was able to convince a nearly constant parade
of reporters that Enron's trading business was the golden goose. Other
companies were going to explode as Enron figured out how to buy and sell
every part of an individual company's traditional business. Enron was going
to intermediate everything, commoditise everything. Just as the Ford Motor
Company didn't have to own the steel mill to build cars, Enron was going to
speed the breakup of every business in the world into its individual parts.

"We believe that markets are the best way to order or organise an industrial
enterprise," Skilling told the Financial Times in June 2000. "You are going
to see the deintegration of the business systems we have all grown up with."

If Enron was going to help that "deintegration", its trading business was
going to keep growing. And that meant Enron would need more capital, lots
more capital. But there was a problem: Enron could not raise capital by
adding more debt. More debt on its balance sheet might lower the company's
credit rating, which would further increase the company's already high
interest costs. Skilling needed more cash but no more debt. Some smart
"financial engineering" was required.