The Enron Disaster Was the Product of Poor Business Journalism. A Word to the Wise Is Sufficient.
The media were on Enron like a dog on a bone. The reporters had one assignment from editors: to expose dirt. They wanted workers’ empty retirement fund dirt, payoffs to top Republicans dirt, and insider trading dirt. Dirt attracts viewers. Dirt gets the ratings up. Higher ratings allow the media to charge more money to advertisers.
This media feeding frenzy basically reported on an empty barn from which the thoroughbred horses have all escaped. The horses that were left behind — nags, mostly — are not topics for public discussion.
Enron’s empty barn is not the important story. The story is the breed of departed thoroughbreds: derivatives. They are a temperamental breed. They run like the wind when spooked, taking men’s dreams and capital with them. They are easily spooked. They are not understood by business journalists. They are surely beyond comprehension by the general public, whose eyes would glaze over 60 seconds into the “Special Report: Why Enron Failed.” Congress hasn’t a clue. They were also beyond Arthur Anderson Company’s powers of comprehension. This is what scares me. The professional monitors did not see this coming, did not sound a warning in time.
Derivatives are everywhere: $100 trillion worth, minimum. They have become business as usual. On them, the employment, retirement portfolios, and dreams of tens of millions of employees depend, but derivatives are so complex that Kenneth Lay and his associates did not see that they were creating a monster that would consume the company and their careers. Derivatives made Enron look good; then they made Enron look bad; but at no point did a journalist ask Kenneth Lay: “Are derivatives the main source of Enron’s above-average profits?” There had to be some reason why Enron was abnormally profitable. It wasn’t efficiency; they were hiring too many new people too fast. There are not that many innovative people on the market, at least not of the kind who produce above-average profits long term.
LOCK-STEP JOURNALISM
For years, business journalists marched lock-step to assure their readers that Enron was the greatest horse barn around. A good example is this document: a press release from Enron dated February 6, 2001.
ENRON NAMED MOST INNOVATIVE FOR SIXTH YEAR
FOR IMMEDIATE RELEASE: Tuesday, Feb. 06, 2001
HOUSTON — Enron Corp. was named today the “Most Innovative Company in America” for the sixth consecutive year by Fortune magazine. “Our world-class employees and their commitment to innovative ideas continue to drive our success in today’s fast-paced business environment,” said Kenneth L. Lay, Enron chairman and CEO. “We are proud to receive this accolade for a sixth year. It reflects our corporate culture which is driven by smart employees who continually come up with new ways to grow our business.”
Enron placed No.18 overall on Fortune’s list of the nation’s 535 “Most Admired Companies,” up from No. 36 last year. Enron also ranked among the top five in “Quality of Management,” “Quality of Products/Services” and “Employee Talent.”
Corporations are judged primarily from feedback contained in confidential questionnaires submitted by approximately 10,000 executives, directors and securities analysts who were asked to rate the companies by industry on eight attributes.
Enron is one of the world’s leading electricity, natural gas and communications companies. The company, with revenues of $101 billion in 2000, markets electricity and natural gas, delivers physical commodities and financial and risk management services to customers around the world, and has developed an intelligent network platform to facilitate online business.
[2005 Note: This document was still on-line on Enron’s website in 2002. It is gone today. It is kept alive here:]
I suspect — just a guess, of course — that this example of breakthrough financial journalism will not be featured in future direct-mail solicitations for subscriptions to FORTUNE.
When one company is said to be the most innovative company in the nation for the sixth time, there is something amiss. Reporters should dig deeper. If any company maintains first place for six years, the free market is not responding as the textbooks say. There should be imitators and raiders who hire away the company’s innovative geniuses.
This especially caught my attention:
Corporations are judged primarily from feedback contained in confidential questionnaires submitted by approximately 10,000 executives, directors and securities analysts who were asked to rate the companies by industry on eight attributes.
So, the “best and the brightest” one year ago thought that Enron was #18 among all large American corporations. A year ago, you could have bought a share of Enron stock for $80. What a deal!
This brings me to a consideration of the academic economists’ theory of efficient markets.
EFFICIENT MARKETS AND INEFFICIENT MANIAS
Investors want to believe that the market is as smart as the efficient market theory says. It isn’t. The market is no wiser than the fund managers who decide where to put their clients’ money. These are bright people, but they run in packs. There are more stock mutual funds than there are New York Stack Exchange stocks. They have to do something with all that money. Pension fund managers see money rolling in, month after month. What to do with all this money?
The dot-com mania is the best example of an irrational stock market in our generation. Wynn Quon of Canada’s NATIONAL POST puts it well:
Here’s the simple bottom line of what happened in the tech boom and bust: Most of the dot-coms, the telecom startups, the Linux companies simply didn’t make any money. It’s as black and white as that. This meant that any large upward movement in prices would be unsustainable. The key to understanding how things got out of hand doesn’t lie in interest rates but in mass psychology. As a species, humans just don’t behave very well in crowds. There is a tuning fork inside each one of us which, when struck the right way, makes us move together in tragicomic formation. All it takes is some technological novelty and the jingle of profit and the crowds hum in manic earnestness. In the 1990s, investors got the sweetest siren call of the century. Investing in the Internet made our portfolios sing and our tuning forks resonate. It didn’t take long for behavioral feedback loops to kick in. (“I bought at $20, it’s now at $40, hey this is easy, I’ll buy more”). Add in plenty of leverage and we were on a rocket ride to NASDAQ 5000.
Here is the reality: the market is no wiser than investors are. The best-informed investors are still people. They get caught up in manias and panics. The economists’ assertion that the stock market uses the best information out there is true. It uses it; it even maximizes it; but it does not pay much attention to it when mania-driven lemmings are telling their brokers to buy. The brokers respond to “buy” orders, and the feedback loop continues. Until it ends.
In any case, during manias and panics, most of the best and the brightest are caught up in the same public psychology. They go with the flow. They add their confirmations to the lemmings. This is especially true in manias. The greed factor is the stuff of direct-mail packages and interviews by the media. When panic hits, the media try to avoid giving space and air time to prophets of doom because their message hurts advertising revenues. “If things are this bad, may we had better not spend money,” thinks the businessman. In manias, prophets of boom sell advertising.
Deep inside all of us, there is a Ponzi-scheme button waiting for some crook to press. This is the reality that the efficient-market hypothesis never quite gets around to dealing with.
Enron is the post-dot-com era’s best example of fund- driven mania. Fund managers should have known something was wrong, just by looking at the chart of Enron’s price history.
There should be reasons — solid, documented, third- party-verified reasons — why a stock that was worth $30 in early January 1999 was worth $90 in mid-2000. If the stock market was smart in 1999, it should have been equally smart in mid-2001. The rise in price was achieved in the face of collapsing NASDAQ prices and falling S&P 500 prices. There should have been a horde of journalists asking “Why?” But all we got was press releases dressed up as financial reporting. When the stick started down, we got more press releases disguised as straight reporting. Here is an example from the HOUSTON BUSINESS JOURNAL:
November 24, 2000
Enron puts down profit warning rumors
Energy and communications giant Enron Corp. has dispelled rumors of a potential profit warning.
“All of our business are performing extremely well, and we are very comfortable with consensus analyst earnings estimates of 35 cents per share in the fourth quarter and $1.65 for the full year 2001,” says Jeff Skilling, Enron president and chief operating officer. . . .
Enron shares closed at $77 3/4, up $2 3/16, in Friday’s abbreviated trading day on the New York Stock Exchange. The shares had fallen to $75 9/16 on Wednesday, down from $80 last week and a high of $90 Aug. 23.
Enron had revenues of $40 billion in 1999 and $60 billion for the first nine months of 2000.
The fact was this: Enron’s profits were based on derivatives, which in fact were producing massive losses. How could this be? For details, read Prof. Partnoy’s testimony.
WHY JOURNALISM FAILED
What went wrong in the media? Skepticism had failed. The press refused to look at the numbers: rising insider trading and falling share prices. They took as gospel the reassurances of senior officials who were bailing out. So did the investors who held onto the stock.
Where was journalism’s vaunted skepticism? It’s long gone. The press sees itself as an extension of the brokerage houses. If the press starts telling the truth, reporters will lose their access to senior officials, or even lose their jobs. The press lives on advertising. Anything that reduces investors’ confidence is seen by publishers as a threat to advertising revenues. They act as though they believe that the stock market maintains the economy rather than merely forecasting it.
The press must preserve the public’s illusion of access by the press, when in fact access is an informational liability. Any reporter who has easy access to anyone in high places should be aware that he is being given access in order to get management’s line to the investors. Access is the bone that management throws to reporters.
The first master of this screening process in American history was Teddy Roosevelt, who kept critical reporters away from his chummy sessions with “his” reporters. The Soviet Union played the same game with the entire press corps from the West in the 1820’s and 1930’s. Censors monitored in advance every story sent out of the country. Malcolm Muggridge describes the system in his autobiography, THE GREEN STICK. (This is the best autobiography I have ever read.) Everyone involved knew what was expected. The West’s newspaper editors preferred running false with a byline from Moscow rather than being cut off completely. Their readers wanted those bylines. This is the “eyewitness news” syndrome. It is alive and well today. The most notorious example of false reporting from the USSR was Walter Duranty of the NEW YORK TIMES.
Reporters should allow management to tell its story. But reporters should know that anything less than detailed, expensive investigations will not get to the truth, if the truth is bad news.
This is another reason why most financial reporting is filled with good news. It is mainly puff journalism. Puff journalism is low-cost journalism. It is also low-risk journalism. No newspaper ever gets sued for running puff journalism, not even after the entire market collapses. This is the dot-com collapse’s message to reporters.
From Gary North, here.