Enron: The Fallout
Enron is probably still too new to draw final conclusions about what it all means. There is still too much of the tale yet to be told. Like drinking a wine that has not yet been properly aged, we risk missing the full range of flavor by rushing to pass judgment on the Enron debacle.
Over time, our view of this event may be quite different from what it is now. History is the result of complex forces and requires context to be fully understood, a context that the passage of time admirably fills. Nonetheless, there are a couple of early conclusions that the mainstream media tends to neglect in favor of the more glitzy public witch-hunt.
The mainstream media has pilloried former Enron executives as predatory and greedy villains, and they have focused more on the self-dealings and deceit of the men in charge. That story plays well on television or in print; it is a sort of real life Greek tragedy, where men once held in high esteem become pitiful figures after a spectacular fall. All the elements of great literature are on display--greed, hubris, status, and power. The losses of Enron employees, cast as victims, have also gotten a share of the spotlight. Meanwhile, congressmen fall all over each other trying to get in the best sound bites for the folks back home.
As with most popular judgments on economic events, more durable conclusions are likely to found by venturing into deeper waters. The first of these has to do with the investors of Enron themselves; their innocence is less than has often been portrayed. The second is that the role of governmental and monetary authorities is much more than has been acknowledged, in that they have created an economic environment where financial disasters like Enron are almost assured. These may be the more enduring lessons gleaned from Enron’s implosion, once all the emotion washes out and people begin to look again with a more disinterested eye.
Investors: Take Thy Blame
In the stock market, there are literally thousands of stocks. And when you consider the possible combinations and allocations that can be cooked up, the resulting possibilities are virtually limitless. The investor is a painter before an empty canvas. Stocks are individual colors on his palette, where they are mixed and matched in an effort to create a profitable portfolio.
Investing is a skill. It is a skill that involves some element of chance, but like poker or baseball, the best players will win over the long haul. The idea is to buy something today for less than you can sell it for later. The difference is your return, and the wider the better.
Deciding what a business is worth is not an exact science. Appraising the value of a stock, for example, is as much an art as anything. Nonetheless, by certain telltale measures, Enron was an expensive stock. During its peak, it had a price/earnings ratio as high as 81. It traded for a multiple as high as 12 times book and 221 times sales. By most measures, Enron was richly priced and thus a risky bet on an uncertain future.
As investment writer Lynn Carpenter noted in the March issue of The Fleet Street Letter, many of the greatest investors of today avoided the Enron mess. There was no Enron in Warren Buffett’s portfolio at Berkshire Hathaway. The notable investment firm of Tweedy Browne didn’t own it, nor did famed value investor Bill Nygren put it in his Oakmark Select fund. Bill Ruane, a Ben Graham disciple, didn’t invest in it for his Sequoia fund, nor did superstar portfolio manager Bill Miller, who avoided Enron entirely for his Legg Mason clients.
Lucky? Maybe. But not likely. As Lynn Carpenter notes, "Contrary to what the media hint, it was not that hard to discover something was wrong at Enron." Investors who had done their homework might have also seen some of these signs--the obscure references to off-balance-sheet partnerships and the lack of disclosure--if they were not entirely scared off by the valuation. In fact, the market’s policemen, the short-sellers, were all over Enron for quite a while. Short-seller James Chanos finally got recognition well after the fact. Barron’s put him on one of its covers as "The Man Who Called Enron." Now he is a hero, but no one wanted to listen to his message before.
In a political and social milieu where personal responsibility and self-reliance are increasingly viewed as quaint notions of an older Victorian age, perhaps it is not surprising that investors would quickly find scapegoats to shoulder the blame. Greedy self-dealing capitalists have always proven a juicy target. The view often expressed in the national media outlets is one that seeks its answers from government, as lambs seek to be led by the shepherd’s crook.
As Garet Garrett once observed many years ago, "formerly government was the responsibility of the people; now people are the responsibility of government." It seems that many Americans have become domesticated, their resourcefulness dulled, their vibrant individualist traditions replaced by the dim passivity of collectivist dependence.
Bubble Economy, Bubble Market
Investors should take responsibility for what they lost, as other skilled investors avoided Enron and still others warned their fellows of irregularities and dangers. But what may be the more important factor in manufacturing future Enrons is the role of government in fostering the boom-bust cycle. Enron, then, is just one casualty of many--albeit the largest so far--of massive credit expansion and of manipulation of interest rates.
As professor Antony Mueller wrote in his paper Financial Cycles, Business Activity, and the Stock Market (QJAE, Vol. 4, No. 1), "Economic and stock-market bubbles go hand in hand." They are created by a monetary policy that manipulates interest rates and provides fresh liquidity and bailout money during times of crisis. Overall risk perception diminishes and capital values rise as a result of this false confidence.
The expansion of money and credit is a well-documented fact that need not be recounted here. All of this money and credit must find a home somewhere, and why not in the stock market? As James Grant observes in the March 29 edition of Grant’s,
"A fast expanding central bank is a dream machine. By pushing down the bank rate, it can . . . reduce the cost of borrowing. . . . Lower borrowing costs imply higher P/E ratios, and higher P/E ratios induce greater optimism. Greater optimism stills the small persistent voice in the back of the head that asks, ‘Can this really last?’ Before you know it, Enron is the nation’s most admired corporation."
The persistent bailouts, the protectionist measures, fiscal stimulus . . . all contribute to an environment where the normal market signals are not able to function properly. Instead they are muted or blocked, thereby slowing the market’s response time and efficiency, as one who has imbibed too much alcohol begins to stumble and slur. Mueller, in the aforementioned paper, recognizes that "individual errors are quite common" but importantly notes that "neither the emergence of a bubble nor its breakdown implies market failure; boom-and-bust cycles rest on policies that have destroyed the proper market process by explicit or implicit bailout guarantees and easy money."
The fundamental condition of scarcity is understated with the arrival of all this fresh money. In the words of Mueller, "fundamental scarcity gets neglected in favor of expectations about future wealth that seem justified by the appearance of new areas of commerce, technological breakthroughs, income growth, and full employment."
However, the expectations are illusory and the pattern of production in the economy becomes distorted from what it would otherwise be if it were solely under the direction of the wishes of consumers. Credit expansion cannot go on forever, and the mistakes of the credit-induced boom become apparent. The bust part of the cycle is, in the eyes of Austrians, a time where the economy is brought back in alignment with the desires of consumers. The bust is a period of convalescence.
Is it that difficult to place Enron in the context of the larger bubble? Is it so much a stretch to see Enron as yet another consequence of easy money? In the last two years many of the malinvestments of the last boom have become manifest--the telecom sector and the Internet craze, among others. Enron was just another misshapen product of an unhealthy and unstable economic system, too heavily burdened with governmental interventions and too awash in fiat money.
Many more news stories about Enron are undoubtedly in the cards. Few of these are likely to blame investors themselves, and fewer still will invoke Austrian business cycle theory in attempting to make sense of the rubble. Yet, if we look for lessons in Enron that can help us in the future, these two issues should receive greater consideration.