A Kind Word for Arthur Andersen Jude Wanniski January 22, 2002

To: Tim Russert, Meet the Press
From: Jude Wanniski
Re: Enron’s Business Model

You did your usual good job of hammering at a controversial guest on Sunday’s Meet the Press. It was the first time I had a chance to see Arthur Andersen’s CEO, Joseph F. Berardino, give his side of the Enron story. And I see he made news. Buried in a long story about Enron’s Ken Lay, Monday’s New York Times reported on P. A13 that on your show Berardino said that Enron had collapsed because “its business model failed.” Nothing else. That was the news -- four words the Times chose out of almost a half hour of grilling. But this was really important to me. It was the first time I’d heard any reporter get someone involved in this business scandal to explain that Enron went bankrupt because its “business model failed.” Next, it would be interesting if the financial and business press would tell us what its business model was and why it failed. In other words, what strategic decisions did it make in the last few years that caused it to implode. That’s something I still don’t see in the media’s blanket coverage of this juicy story.

After all, Ken Lay and his whiz kids did not decide to destroy Enron. They had high hopes it would grow even bigger and more profitable than they had already made it. As an energy trading company, they must have made some dreadful mistakes to put the entire enterprise on a slippery slope. And Arthur Andersen would have no knowledge of those decisions. My outside accountant, Jim Giordano of Florham Park, N.J., has been checking Polyconomics’ books for 23 years and he has only the vaguest idea of what we do on a day-to-day basis. He has never seen our business model, from when we began in 1978 to its transformation today. Jim Berardino was absolutely correct when he pointed out to you that Arthur Andersen does not get involved in that kind of stuff either, and that he undoubtedly knew nothing of the irregularities in the internal decision-making process. Did you see the other NYT story Monday about the Houston stock analyst who is now “the toast of the town” because he had been predicting for years that Enron was way overvalued? You have to get to the end of the story, which I did, to find out that John Olson, the only wizard in town, finally put out a BUY recommendation last September when Enron hit $26 a share. Now Olson was in a much better position to understand Enron’s market value than Berardino, wouldn’t you think? That’s his business and Arthur Andersen is only supposed to make sure the company is keeping its books with generally accepted accounting practices and that the numbers add up.

What I think really happened, Tim, is that Enron became the flip side of the Savings and Loan Scandals. Remember the Keating Five? It is what happens when a corporation believes it can double its speed when it loses sight of its business goals. What do I mean by a “flip side”? I mean the S&L debacle was the result of the dollar inflation of the 1970s and Enron was the result of the dollar deflation of the 1990s. And NEITHER OF THEM WOULD HAVE HAPPENED if we had remained on a gold standard. I once tried to explain the S&L link to Larry Lindsey, when he was a Federal Reserve governor, but I think it went right over his head. I think you would get it, Tim, not having gotten an advanced degree in economics from an Ivy League university.

You see, it is good to be a debtor when your country’s money is about to inflate. You borrow sound dollars and you only have to pay back cheap dollars. But put “money” aside and you will see what is really going on is that you are “borrowing a big house” from the economic system, financed with the help of an intermediary known as an S&L. Then because of the inflation, you only have to pay back “a small house.” In fact, if the dollar inflates by a factor of 10, you are really a lucky fellow and only have to pay back a garage. The folks who originally built that big house you borrowed from the economy have gotten paid for their work. But the S&L has the house on its books at $100,000 and it now costs $1 million to replace it. It is getting paid 10 cents on the dollar, is how you must look at it. Even though Arthur Andersen has its best accountants on the case, the S&L is going to go bankrupt at that rate unless it starts doubling its bets, taking in Savings and making riskier Loans. When those don’t work out, you double the bets again, sending your chief financial officer to the racetrack and Las Vegas casinos, altering your business plan in hopes of recouping.

Did you ever stop and wonder why the USA had an S&L industry and other countries did not? It is because we had the best record going back two centuries for keeping our dollar as good as gold. Other countries have banks that take in deposits and make loans against an extremely wide array of assets, from soup to nuts. But an S&L borrowed ONLY houses in the short term and lent them out for 20 or 30 years. It borrowed short and lent long. In order to do that, Tim, the value of the house has to be the same, minus depreciation, at the end of the loan as it is at the beginning. That’s what a gold standard does. Gold is just a proxy for all goods that come out of the earth with human labor. You can still have an economy without a dollar as good as gold, but when you do, you will have corporations and industries that either boom or bust simply because they made bad bets on what the dollar will be worth over a given span of years.

Enron is a different kind of company than an S&L. It has been set up to trade commodities in the form of British Thermal Units -- in a word, energy. It did just fine in the years from 1985 to 1995, when the price of gold was more or less stable. This meant the Federal Reserve was keeping the dollar roughly as good as gold, more or less by accident. It was in late 1996 that I began warning of a monetary deflation as I watched the price of gold decline. As it slid from $385 per ounce to $330 per ounce and then as low last year to $250 per ounce, I ran around like a “whistle blower,” warning there would soon be a decline in the price of oil and other commodities. I warned the Clinton White House and the Rubin/Summers Treasury and all the Republicans I know. But nobody listened.

Then the price of oil nosedived from $25 a barrel to $10 a barrel, and all the other commodities in the book nosedived as well. But still nobody listened. When the 1997 tax cuts kicked in and the U.S. economy began to grow smartly, the demand for BTU’s grew even faster. The world BTU industry was happy to get rid of its surplus, but it was not about to invest more in new capacity with oil at $10 a barrel. By 2000, economic growth had used up all the surplus, though, and prices of energy began to shoot up, as Polyconomics had warned. Indeed, California was unable to buy enough energy and in 2001 had to pay incredible prices for BTU contracts. Oil was back from $10 to more than $30!!! Polyconomics warned that either the price of gold had to rise to equate with oil, in an economic expansion, or oil had to fall in the recession we warned was otherwise inevitable. But nobody listened.

This is why I take the trouble to say a kind word for Arthur Andersen. The accounting firm had nothing to do with these gyrations in the energy market that were the undoing of Enron, which was undoubtedly whipsawed by the convulsions in the global BTU markets. Enron could have used Polyconomics’ services back when they were spinning in circles, doubling their bets again and again in vain attempts to recoup. They simply did not understand the deflation. It is even hard to blame Ken Lay, if you come to think of it. The big newspapers knew about the deflation warnings and said nothing about them. Why should Ken Lay have been aware of it? He went out and hired as consultants the two BEST economists in the USA!!! The best REPUBLICAN economist, Larry Lindsey, who must be good because Texas Governor George W. Bush hired him as his chief economist. And the best DEMOCRATIC economist, Paul Krugman, who the NYTimes not only believes is “arguably the best trade theorist” in the world, but also retains him as its twice-weekly economic columnist. And why wouldn’t the Times? He awarded himself a Nobel Prize in economic science before the ink was dry on his diploma!! WOW!! What a team!!! I wonder what Lindsey and Krugman were telling Ken Lay for the $50,000 he paid them each per year. With the two arguably BEST economists in the world advising him, how could he go wrong? How about it Tim? How about a kind word for Arthur Andersen?