Nick Glunt | Staff Writer
Though Fortune magazine had named Enron its most innovative company for seven years, Enron stock short-seller Jim Chanos couldn’t figure out how it earned all its money. Chanos called up Fortune writer Bethany McLean.
“Can you explain how Enron makes its money?” Chanos asked her.
As a former investment banker at Goldman Sachs, McLean had the skills to produce investment spreadsheets. She discovered the “very basic question” Chanos had asked was unanswerable.
As most Americans probably know, Enron was revealed in October 2001 to have been hiding billions of dollars in debt for several years.
The company, allegedly producing $101 billion in 2000, watched in horror as its stocks dropped from about $35 a share in October 2001 to almost nothing in November. Stockholders lost almost $11 billion as Enron went bankrupt.
Chanos thought it was humorous that Fortune had awarded Enron with the title, despite McLean’s inability to decipher its revenue. McLean, though, disagreed.
“I like to defend my old magazine (Fortune) by pointing out that Enron (really) was the most innovative company in corporate America,” McLean said; the audience responded with laughter.
McLean shared what she learned as a business reporter during the Enron scandal as part of her lecture at 10:45 a.m. Wednesday in the Amphitheater. As a reporter who later covered the 2008 financial crisis, though, she said she could not offer any ways out — instead, she could offer only advice: Take responsibility.
McLean was the third speaker for Week Seven’s topic, titled “The U.S. Economy: Beyond a Quick Fix.” McLean currently is a contributing editor to Vanity Fair and to Slate, as well as a nonfiction author.
“If you would have asked me after Enron if we were going to have another financial crisis,” McLean said, “I would have said, ‘No. I’ve seen the big one in my lifetime.’”
She knows now that she was wrong.
She said some people try to pin all the blame on the government’s home-ownership policies — specifically on Freddie Mac and Fannie Mae. This is not the case, she said.
Responsibility for the financial crisis lies with many people, a point she covers in All the Devils Are Here: The Hidden History of the Financial Crisis, a book she co-wrote with Joe Nocera, a columnist for The New York Times. Banks could see the crisis coming, she wrote, but continued with bad practices — thus, it’s inaccurate to call the crisis an accident.
Perhaps one of the biggest lessons she’s learned, she said, is that events look different later on, when everything is out in the open.
To business executives, she offered one special bit of advice: “If you don’t want to see something on the front page of the paper or the home page of your favorite blog, then don’t do it.”
She spent a short time detailing the people she covered in Devils who were most influential in bringing about the financial crisis.
“None of what I’m saying now is to defend what Angelo Mozilo (former CEO of Countrywide Financial) or Dick Fuld (former CEO of Lehman Brothers) or what any of the other big players — the “devils” in our book — did in the financial crisis,” McLean said, “but there is a difference in the unethical and the illegal.”
Even Enron executives, she said, were “only narrowly prosecutable.”
She said this may be a good thing, but she also said her co-author Nocera thinks there should be laws to prosecute people for such “rampant criminality.”
What’s more frightening to McLean than “outright criminality” is incompetence, she said.
A perfect example of such incompetence, she said, is the credit rating agencies. As these agencies swiped in money, she said, they began to appear as if they had “sold their souls.” AAA ratings were in high demand to sell securities; providing incentives to agents became the best way to achieve that rating, McLean said.
However, these same agencies became more and more incompetent, she added, thanks to investment bankers. After the fact, McLean discovered credit agencies were required to confirm very little in their reports.
The financial industry — especially Merrill Lynch — is just as incompetent, she said. One Merrill Lynch executive said in Devils, “We fell for our own scam.”
Every firm on Wall Street, McLean said, put special pride in the phrase “risk management.” That phrase, she added, is one of the “most utterly meaningless pair of words in existence.”
She said a major lesson she learned in the Enron scandal was to listen to skeptics like Joshua Rosner, author of Housing in the New Millennium: A Home without Equity is Just a Rental with Debt. Rosner warned of a possible market collapse as far back as 2001, when the book was published. Though skeptics can be crazy and awkward, she said, they’re sometimes right.
Another discovery of hers, she said, is that the U.S. is too busy trying to fix problems of the past instead of avoiding future ones. Furthermore, she added that ideology shouldn’t cloud the facts. Both of these criticisms could aid the future, she said.
“If there’s one critical thing, I think it’s that we all have a real duty to be honest about the past,” McLean said. “My biggest fear today is that there’s a real attempt to rewrite history — even recent history.”
She said she recently read a column that blamed President Barack Obama for the government bailout, even though it was a Republican decision. Similarly, Democrats say it’s the fault of greed and unregulated financial systems. The crisis, she said, is a result of all of these.
“To be perfectly honest, I don’t have a great fix for this,” McLean said. “One of the great luxuries of being a journalist is that I get to be an armchair critic, and I get to criticize after the fact without coming up with solutions. But I do have a moral point in all of this, which is that everybody needs to have a sense of responsibility.”
Q: Do you think (Ben) Bernanke may be creating a Federal Reserve bubble if he proceeds with QE3?
A: There are a lot of people who think that’s the case. The only reason not to think it is that everybody thinks it, and often what everybody thinks turns out not to be right, but that’s not very optimistic. If I had to look at the facts that I know right now, I would say: absolutely. The trade most Wall Streeters talk about is “risk on,” by which they mean that because of the Federal Reserve’s policies to push interest rates low, you are pushed into riskier and riskier assets in search of a return, which means, “Pile into risky assets.” And that’s why you saw the stock market perform so well until recently. That’s why you saw risky asset classes — like junk bonds — perform well. I do not see how that ends in a pretty fashion.
Q: There are lots of questions here around “too big to fail.” I guess one question says, “Do you feel that there are tools in place are being developed that are critical of large companies and address the real ‘too big to fail’ issue?”
A: I don’t, and I think that’s one of the real failings of the Dodd-Frank financial reform bill, is that it does not solve “too big to fail.” In fact, it enshrines “too big to fail” firms as part of our global financial system. I don’t think there is any way to unwind a “too big to fail” firm, because the decision will always become political if you can’t simply allow the firm to fail. And once it becomes political, all bets are off. I think one of the biggest mistakes that was made of the financial crisis was not forcing big firms, big banks to break up. Because, I think the only way to have companies that aren’t too big to fail is for them not to be “too big to fail.” I think that’s a really scary thing. All of the regulation in the world and all the best attempts on the part of regulators to give people tools to unwind firms, it is still going to become a political question the next time one of these firms gets into trouble.
Q: There are a bunch of questions — makes me a little nervous standing here — about the next danger zone, whatever that is. But there are questions … I think they kind of circle around the financial industry and the state of the global banking system. Where do you think that stands today?
A: I will preface my remarks by saying that I am much better at investigating the events of the past than I am at predicting the future, so take whatever I say with a grain of salt. I don’t think that the financial crisis is over yet. I think that, for a bunch of reasons, the banks are still obviously saddled with the bad decisions they made during the financial crisis. In particular, Bank of America’s purchase of Countrywide is, if you believe some people, threatening to take down Bank of America. Banks still have hundreds of billions of second-lien mortgages on their books that haven’t been written down. The notion that we’ve put this behind us and the banking system has moved on, I think, is false. There is the “too big to fail” issue, which we discussed. I also think — what I worry about — is that there is a fundamental disconnect between how banks see the world and how consumers see the world. It’s sort of “banks are from Venus; consumers are from Mars” — something like that. But I don’t think that’s healthy for any of us, going forward. Banks have treated consumers with an astounding lack of respect, both during the financial crisis, and they’ve continued to. Not only did they sell people loans they couldn’t pay back, but they haven’t even been able to kick people out of their homes following the appropriate rules. And the banks say, “Well, it doesn’t matter; these people deserve to be kicked out of their homes anyway.” But in every other sphere of American life, laws prevail. Things are supposed to be done according to process and procedure, and when they’re not, that betrays a lack of respect. And so, I think that whole mindset, somehow, needs to change. I think that’s a very dangerous thing for all of us.
Q: There are a lot of questions here — quite a few — on the subject of bubbles. One of them is, “I learned this week that the next bubble will be commodity prices.” “Is there a student loan bubble?” “What do you think of the so-called bubble in social network stocks?” But I guess maybe the question might be, given that you have written about and investigated bubbles, are there predictive things that might help us better understand these perceived bubbles?
A: I think the one quality that all bubbles have in common is that everybody has bought into the bubble. And so, it’s become an article of faith. It became an article of faith in the late 1990s that Internet stocks could only go up. It became an article of faith that Enron was the most brilliant firm the universe had ever seen. Blue chip consultants from McKinsey (& Company) used to run around the globe, preaching to other companies how they could make their companies more like Enron. It became an article of faith that home prices could never go down. I don’t think we’re quite to that … judged by that standard; I don’t think we’re quite there in any of these other things yet. There is a lot of belief in social networking stocks, but there are also some questions about, “Is this really warranted? Are these valuations really warranted?” The same is true of other things. There may be a bubble in commodity prices, but people are asking about it and people are wondering. I guess, on that note, I’d like to make a point about a difference: There are different types of bubbles, too. I think that there are productive bubbles and unproductive bubbles. Maybe an economist could quibble with me on this. But what I mean is: The dot-com crash, for all of the wreckage that it left, was in the end, in some ways, a productive bubble. We got out of it Amazon; we got out of it eBay; we got out of it real companies, real change, real innovation. The railroad bubble, back in the early years of this country, was a productive bubble. There was some wreckage, but we got out of it a railroad system. What is different about the housing crisis, and what scares me, is that it was an unproductive bubble. Nothing was created. It was just purely a financial bubble and an asset-price bubble, but it didn’t leave anything in its wake. I think bubbles are a part of financial markets, and probably, in some ways, a good part, if they are productive bubbles. What scares me about the housing-price bubble is that it was an unproductive bubble. I don’t know if that is somehow linked to the seemingly inexorable rise of finance as part of our economy over the last decades.
Q: There are a couple of questions on employment and incentives for people not going into the financial services world. This particular question says, “Our economy has provided golden parachutes, large paychecks for financial companies in wizardry. How can we provide incentives for young people to enter true businesses — like engineering — instead of these quick-rich opportunities?”
A: I think that is a wonderful question, and if anybody can come up with the answer, you should write an op-ed and broadcast it to the world, because I think that’s really critical. I think a big part of our problem is that the financial sector has become a more and more important part of our gross domestic product. I don’t have the numbers at my fingertips right now, but the growth is enormous. Someone in our book said that the financial sector, in a properly functioning economy, is supposed to be friction. It’s supposed to be this necessary cost that makes the real economy function, but it’s just supposed to be friction. And now, the friction has become our reality, and the friction has become one of the most lucrative fields you can go into and a huge source of apparent profits. That, to me, spells a sickness in our economy. Another friend of mine, who is a hedge fund manager, was talking about the billions of dollars he has made — and he has made billions — and he was saying, “Well, it’s weird, because all I do is allocate capital to other people who are making the real merchandise and making the things that make the economy go.” He said, “There is a layer of people on top of me who make fortunes just for investing in different hedge funds.” And he was sort of musing about the strangeness of the modern economy. I think that definitely raises interesting questions worth thinking about. Maybe one silver lining out of the downturn in the financial sector is that more talented, young people will start looking toward alternative careers and start doing things like engineering and being doctors and maybe lawyers — is that productive? Anyway…
Q: There are a couple of questions on household debt and the burden on debt and slow growth exacerbating the problem, but this comes at it a different way, I think: “Is it good or bad for the U.S. economy, in its current condition, to be making massive cuts on government spending? Can you comment on the U.K. also, maybe?”
A: Oh Lord, I wish I knew the answer to that one. I think we have this real conundrum, because we have too much debt. Developed economies around the world have too much debt. We are on an unsustainable path and we need to reduce our debt burden. I really believe that too much debt just stymies all sorts of productivity. We’re going to drown in it if we’re not careful. It puts this nation at the mercy of other nations — most notably China — in ways that are more damaging than just about any military policy could possibly do. Make no mistake: This is a huge problem; it’s something we need to fix. But the problem is that a lot of economists argue that by cutting and cutting now, we’re going to actually make our debt problem worse because that’s going to result in no GDP growth and going to shrink our economy at the very time we need it to grow. I just … I wish I knew who was right in this debate. I think if you look at the history of the stimulus that’s been tried since the financial crisis, you might say, “The stimulus hasn’t worked. All of the spending just added to our debt, and it didn’t revive our economy.” Of course, the people who advocate more spending would say, “Well, we haven’t spent enough. If we spend more, it will work.” I guess that might be right, but you can take that to a pretty illogical extreme, where every time spending doesn’t work, people say, “Well, we need to spend more.” People never acknowledge that maybe more spending isn’t the cure this time. I hear from some on Wall Street that the real problem is just debt, and until we do something about this debt overhang — at both the consumer level and the government level — we’re in trouble. I don’t know if there is a great way to have a debt reduction, yet a pro-growth policy as well, and a pro-growth policy, most importantly, for small businesses around the country that really are the engine of prosperity and the engine of American success.
Q: This is the final question, and I chose this one because I know it will keep everybody in their seats. This is a great one: “I’m looking for an investment adviser. What questions do I ask to qualify someone to manage my money?”
A: I am not a personal financial adviser. As I joked this morning, one of the great things about being a financial journalist is that I’ve never had any money to manage. I haven’t had to make those decisions. But look, I talk to a lot of people, and I get asked that question a lot, and I think it’s really tough. I guess I have two rules, at the end of the day, and they’re both clichés, but I think they’re good clichés. One is: Nobody is ever going to care about your money as much as you do. The idea that you can find somebody, hand off your money and just look the other way while they take care of everything for you … it’s just an abdication of your responsibility. You can’t do it. The second lesson … I got asked this on an NPR show, and I think I got booed by the audience because they said, “What can we do to reduce the power of the financial sector?” And I said, “Look, there’s something we can all do, which is to live within our means.” That’s hard, because the banks aggressively market their products. Back 10 years ago, you could drive down a street in any city and see, “Let your home take you on vacation. You’re stupid if you don’t cash out the equity in your homes.” The banks have to take responsibility for that, but we all have to take responsibility, too. If we don’t give the banks debt to package up and sell, then they have no debt to package up and sell. I think the best thing anybody can do for their financial health is to live within their means.