Friday, January 05, 2007

Gladwell on Enron

I just yesterday found Malcom Gladwell's "semi-defense" of Enron in the New Yorker, and I think it's pretty awful. It wasn't just reading the piece itself that brought me to that conclusion, but also reading his related blog post and the ensuing comments there. His basic thesis is that Enron's accounting practices were so complex that the entire scandal itself is an unsolvable mystery. Underpinning his argument is a discernment between puzzles and mysteries, the former of which can be solved by searching for and finding new facts, by adding information, and the latter of which involve uncertainty and cannot be solved just by adding new information. Gladwell basically thinks that Enron's accounting was so complex and opaque that it is impossible to disentangle and to confidently bring criminal charges against the executives.

At his blog, Gladwell gave readers a challenge:
Can anyone explain—in plain language—what it is Jeff Skilling and Co. did wrong?

I’m not asking for an explanation for what they did wrong as businessmen. That’s plain. They did a mountain of stupid and arrogant things. Nor is this about what Skilling and company did that was unethical or in bad faith. There’s a mountain of evidence on that too. The question is strictly a legal one: according to the way the accounting rules were written at the time, what specific transgressions were Skilling guilty of that merited twenty-four years in prison? For the sake of argument, let’s stipulate that summaries must be three sentences or less.

He's asking if anyone can concisely explain what crime Skilling and Lay committed, regardless of whether their actions were unethical. As an analogy, he refers to a former colleague of his who asked 20 Nobel physicists to explain the Higgs Boson particle in simple language, with the result being that apparently none of them were able to - which I have a hard time believing, but that's another story. Luckily Gladwell has some astute readers, because concise explanations of Skilling and Lay's criminal actions started pouring in. For example:

Fastow had set up a series of partnerships that ran afoul of SEC regulations and served to prop up the value of Enron stock while masking the huge losses. Fastow testified that Skilling had knowledge of and authorized these transactions. Enron energy traders during the summer of 2000 encouraged producers of energy to go off line, to go into maintenance, to generally cease to provide needed energy to the grid thus escalating prices and forcing purchasers to purchase at greatly inflated prices. The collusion between trader and producer defrauded the public and caused the state of California to lose billions of dollars in order to forstall a crisis. This fabricated energy crisis was criminal. Skilling either authorized it or supported and encouraged it. The link between Enron and the deregulated bill that passed in CA was clear. Enough or do I not understand the question?


Treating debt as revenue, or anything that is not revenue as revenue, is accounting fraud. If nobody gets hurt, it doesn't perhaps matter. If it runs up the stock, you should go to jail.

Plain example: If I own two companies, and CO1 loans money to CO2, and CO2 treats the cash infusion as revenue, that's a mis-characterization, even if both CO1 and CO2 are legal businesses engaged in otherwise legal activities.

The debt they treated as revenue, by the way, was pretty obviously not revenue. Fails the smell test. Lock them up.

It does seem to be uncertain as to whether or not their use of "special purpose entities" was illegal at that time, but there is no lack of other criminal doings. Thankfully, Berkeley economics professor Brad DeLong stopped by to make things even more concise:
Jeff Skilling and his co-conspirators falsified the accounts of ENRON for 1998, 1999, 2000, and 2001 in order to persuade investors it was a well-run, profitable company and so boost its stock price.

Gladwell comments essentially that there could've been wrong-doings, who knows, but it's all murky and no one can explain it well, despite the fact that his readers are doing exactly that. DeLong comments again:
Malcolm, you've gotten yourself into a hole and you are digging yourself in deeper. I'd recommend that you'd stop.

Gladwell insists it's all a big grey area and that he's not saying Skilling was necessarily innocent, just that it's impossible to tell. DeLong stops by again:
I do not acknowledge that there is grey here. Enron did its accounts in ways that misled, and that were criminal accounting fraud. No grey about whether they were misleading. No grey about whether they were fraudulent. That there is a grey area in which accounts are misleading but not fraudulent does not mean that Enron was in that grey area. It wasn't.

Robert Jennings has it right when he writes: "For practitioners (and Enron was a practitioner) none of this was vague or confusing or difficult to understand and if you lied to the accountants then you were committing fraud."
You're in a hole. Stop digging.

Now, it would be one thing if Gladwell had merely been asking, via his blog, for an explanation of what Skilling and Lay had done wrong. But in fact he had just published a piece in The New Yorker that was very sympathetic to Skilling. The introduction of the piece focuses on Skilling's harsh sentence and seems to imply that he was treated unfairly. Gladwell's article basically says that it's too complicated to understand and therefore Skilling should have been treated better. "What a big unsolvable mystery!" This is just shoddy journalism and he should've done his homework before he wrote the piece, not in light of the piece. Why didn't he ask someone like DeLong for an explanation while he was writing it? The whole thing just stinks to high heaven.

Update: I see that DeLong has posted a longer response here.

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