Enron Redefines the 'New Economy'

by Bruce Silver

As the Enron story ascends along the now-familiar arc of the Incomprehensible Washington Scandal — who knew what, when did they know it and what did they do about it — the meaning of Enron's demise for the so-called New Economy has escaped notice.

In my view, Enron was not only the New Economy's biggest success story, but through its extraordinary political influence, the company actually created much of the freewheeling economic environment supposedly needed for new electronic marketplaces to flourish.

Enron started out inauspiciously in the mid-1980s as a thoroughly Old Economy gas pipeline company forced to embrace innovation to survive in the suddenly deregulated world of natural gas. As the price of gas fluctuated wildly, with supply perpetually careening between glut and shortage, there was no credit available to stabilize the marketplace. Enron's innovation was a marketplace that allowed gas suppliers and customers to contract for a guaranteed volume at a locked-in price, trading gas "futures" like any other commodity. In this new marketplace Enron would be not just a broker/trader but an investment banker as well, buying and selling the gas itself, and taking a banker's share of the transaction.

Enron quickly came to dominate the new marketplace it had created, giving the company superior knowledge of where the price of gas was headed. That knowledge meant fantastic profits. By 1990, Enron was the first to see that energy had become a "knowledge-based business."

Fast-forward to 1995, when Enron decided to apply the same strategy they had used with gas to the electricity market. Following heavy lobbying to encourage deregulation of the electrical power industry, Enron in two years became the nation's largest wholesale buyer and seller of electricity. The company came to believe that its banker/trader model would work for any commodity, even those that had never before been thought of as tradable commodities, like fiber-optic bandwidth, and Enron wanted to play in all of them.

In the New Economy, preached Enron, superior knowledge and speed were the keys to success, while hard assets just slow you down. The company began to sell off its power plants and pipelines, while expanding its trading operations in commodities and commodity-based financial derivatives.

By the late 1990s, Wall Street had jumped on the New Economy bandwagon, and Enron's stock soared. In October 1999 the company launched online commodity trading with Enron Online, which in 2000 handled an astounding first-year trading volume of $335 billion. In early 2000, Enron launched its bandwidth trading business and announced deals with Blockbuster and Microsoft Network for video movies on demand, catapulting the stock from $40 a share to $90 a share. To investors — not to mention Wall Street analysts, regulators, auditors and lawyers — Enron could do no wrong.

When the dot-coms and B2B net markets imploded in 2000, Enron still looked to be on cruise control. After all, it had $100 billion of real revenue, and what looked like real profits. In truth Enron had reached its high-water mark, too. The bandwidth business was the first to go south. In 2001, Blockbuster backed out of the deal, claiming Enron had never delivered the technology it promised. Microsoft later followed Blockbuster. In the summer of 2001, Enron quietly folded its bandwidth trading business.

Nobody looked too closely to see why the losses from the failed bandwidth ventures — Allan Sloan of Newsweek puts the figure at $2 billion — didn't figure more prominently in Enron's financial statements. The reason, as we know now, is that the costs were hidden in an "off-balance-sheet" partnership, one of hundreds created by Enron to hide debt obligations, inflate profits and reduce taxes. In fact, behind all the "knowledge economy" rhetoric resides the stark fact that Enron's commodity marketplaces tied up huge amounts of capital — more than $10 billion — yet generated little real profit. To maintain its apparent growth, Enron had to make more deals and create more markets by piling on increasing debt and hiding it in more off-balance-sheet arrangements. That debt, secured by Enron stock, could remain hidden from investors and other creditors as long as the stock price didn't decline.

By 2001, Enron's financial structure had truly become a house of cards. Its auditor, Arthur Andersen, had until then gone along with keeping the investment partnerships off the books — technically that is legal if the other party assumes as little as 3 percent of the investment and risk. In the third quarter, Andersen insisted that losses from some of the partnerships be consolidated in Enron's earnings statement. The house of cards came down all at once; within a month the company was in bankruptcy, its debt an astounding $31 billion.

While the public debate will likely swirl around Enron's political influence and the regulators that didn't regulate, we shouldn't forget that in this case we had auditors that didn't fairly represent the company's financial position, Wall Street analysts that didn't analyze and a board of directors that didn't direct.

All these failures, I believe, are related to the "magic" we still attach to New Economy ventures: A new business model is created out of thin air. It's not really clear how the profits are made, but it seems to be working. It's the New New Thing, so everyone suspends judgment. The board of directors doesn't really get it. The auditor doesn't really get it, either. Nor does Wall Street, nor the regulators. But everybody's making money, and nobody wants to spoil the party.

We want to believe in the tenets of the New Economy that Enron preached so fervently: that the transparency and efficiency of global electronic marketplaces are good things and make us all more productive and prosperous. But for Enron, "transparency" really meant a one-way mirror into global supply and demand. Its real strategy, as revealed by an Enron executive last November, was "to be the first mover in a market and make money in the initial chaos and lack of transparency." The strategy was simply not sustainable long-term. If Enron was the model for the New Economy, I guess it's back to the drawing board.

Bruce Silver (brsilver@earthlink.net) is president of Bruce Silver Associates, Aptos, CA, 831-685-8803. Reports are available at www.brsilver.com.