I recently saw the documentary about the Enron scandal, Enron: The Smartest Guys in the Room. Why? In part, curiosity, just to get a better understanding of what had actually happened. But mainly to see how it stacked up against current events. I was struck by the glaring similarities between then and now, so much so, that I am a little outraged.
Here's a quick Enron scandal recap. Enron was an energy company whose executives schemed a system to generate false profits and growth until the company's ultimate downfall in 2001. At the time, it was the largest bankruptcy in U.S. History, somewhere around $63 Billion in assets. It is especially notorious due to many executives cashing out and letting the rest of the company hold the bag. The most responsible executives involved were Kenneth Lay, Founder, former Chairman and CEO and Jeffrey Skilling, former President, CEO and COO.
The key thing about Enron's scandal was that the company could not have done it alone. To achieve the levels of fraud committed, Enron received the support of its accounting firm, Arthur Andersen, law firm, and investment partners, i.e. Wall Street.
That's right, many of the key participants in the current recession, J.P. Morgan Chase, Citigroup, Credit Suisse First Boston, Merrill Lynch, and Wachovia were already knowingly involved in fraudulent activity since 2001. How did their reputations remain intact? Large billion dollar settlements, which at the time seemed like a lot, but, as we all now know, is chump change compared to their losses over the last year and a half.
Many other parallels exist between Enron and the current meltdown:
- Overvaluation– Enron had been cooking the books for years, using mark-to-market accounting to present profits when the company was actually in debt. The stock price soared until reality struck. The same can be said for the Countrywide's and Citigroup's whose toxic assets were not so toxic back in 2005.
- No one questions the good times - Most of the analysts and speculators never questioned Enron's growth or means of growth. Fortune named Enron "America's Most Innovative Company" for six consecutive years (source: http://en.wikipedia.org/wiki/Enron). Not until a business reporter, Bethany Mclean (who worked for Fortune no less), started digging deeper did the truth start to unravel. People continued to invest in Madoff because he delivered returns, same with the housing market, until they both crashed.
- Taking advantage of people - Enron charged Californians exorbitant energy prices because they could. Banks used predatory lending practices. Bernie used his connections, heritage, and reputation to enroll people in his scheme.
- Culture promoting greed and risk – Enron's traders were able to run a muck, deliberately causing power outages for profits. Financial companies today promote risk taking which have led to serious consequences from Societe Generale to AIG.
- Taking off with the money - Enron's executives were cashing out while freezing their own employees' retirement accounts. Today's CEO's enjoy similar rides in their golden parachutes.
- Government ties - Enron had strong ties with President George W. Bush, while the Treasury Secretary Paulson (a past Goldman Sachs CEO) concocted the bailout plan for Wall Street.
So how far have we come as a society since Enron? Well taking a quick glance at the facts, not far. Many of these bad practices continue to exist and some have been taken to larger extremes. Instead of Ken Lay, we now have Bernie Madoff as our scapegoat. Instead of one company going under, there are several. I think many of these corporate scandals stem from society's stance on white collar crime.
Here are some inciting questions:
- Why does Ken Lay have his trial start over 3 years after Enron's bankruptcy? In fact, by the time the individual trials of the Enron executives ended, the housing bubble that set off the 2007-2009 financial meltdown had just burst.
- Why is there a 3 month window between the conviction and sentencing of Ken Lay?
- Why is Ken Lay allowed to go on vacation after being convicted, to “conveniently” have a heart attack before serving any prison time?
- When is the last time a murderer's been given 2 months of freedom before going to prison?
Put aside the access to high powered lawyers and political protection. The simple fact that white collar defendants are allowed to wear suits shows the justice system's inequality towards certain classes of defendants.
In my opinion, white collar crimes are usually much more destructive than their blue collar cousins. A murder affects a relatively small range of people, mainly the lives of the victim, friends, and family. In the case of Enron 20,000 employees not only lost their jobs, but also lost their retirement savings. The net economic impact is much greater, not to mention the future crimes induced by such economic devastation.
Here's the paradox. It seems that society is much tougher on physical crimes (i.e. murder) than monetary crimes (i.e. insider trading). One is measured in lives, the other, in dollars. But the value of life is not easily measured, whereas there is no ambiguity with money. So how does society justify its stricter assessment of the less quantifiable and looser assessment of the more quantifiable?
The answer lies in the ability to at least roughly measure the value of life to have some basis for comparison. Although it may seem callous, I shouldn't have to apologize for suggesting a measurement that is already in use by government and private industry. The measurement is known as a Quality-Adjusted Life Year, or QALY for short; a great New York Times Magazine article goes into great depth about its usefulness for health care programs. The main idea is that your quality of life depends on your state of being. So my quality of life as a healthy adult is worth more than me with a debilitating disease. Hence a QALY is the value of life for one year. The average estimate of a QALY is around $50,000, but more recent studies have shown it to be as high as $129,000.
We can use this number to measure the average value of life and then calculate the damage done by Enron. If we use the highest QALY estimate and account for the average U.S. Life expectancy rounded up to 80 years, the average value of life is around $10 Million (Keep in mind that government agencies making life or death decisions estimate the value of life to be around ~$5-6million). Enron's bankruptcy was estimated to have lost investors $40 Billion. So that is roughly 4,000 lives that were lost due to corporate greed.
Society can't afford to be soft on white collar crime anymore.