Paul Jorion, Ph.D., has more than a decade of experience in derivatives trading, financial risk management, and deferred compensation. Dr. Jorion has been a professor at Cambridge University and Paris University and a regents' lecturer at the University of California, Irvine.
If our point in this book is to think through the implications of being an investor in the post-Enron (post-WorldCom, post-Adelphia, post-etc.) world, it makes good sense to take a close look at what actually happened to Enron, and why.
But my goal in "Enron 101" is not to make you an expert in the enormously complex scheme that was Enron. (I m not sure anyone other than a few insiders grasps that entire picture, or needs to.) Instead, it s to give you a feel for how a business model that had some interesting, innovative, and maybe even sustainable components evolved into a beast that deserved to die.
When a cascade of debt-related woes knocked Enron off its feet, the company s innards were exposed to the light, for all the world to see. It was only at this point that it became clear that the Houston energy-trading giant had been playing the bubble game. When things turned sour -- when the company s debt load became overwhelming -- there was only one strategy left to play: turn the machine into what I call a stock-price pump, and hope that the company could stay at least one step ahead of the posse.
Enron didn t invent the speculative bubble. Nor was it the first company to turn itself into a stock-price pump, manipulating its numbers to artificially inflate its appeal to The Street. It was unlucky to get caught in the spotlight, held up to intense scrutiny, and be numbered among the vanquished. Perhaps Enron and its legacy will quickly be forgotten. Or perhaps "Enron" will enter the annals of corporate greed and excess like "Teapot Dome," for instance, or "ITT" in the Nixon era -- and be remembered the company that made the investor understand bubbles and stock-price pumps, and forced corporate America to leave the casino and go back to creating value.
Lessons for investors
Caveat emptor. If the nation s 7th-largest public company the darling of analysts and business school professors and Wall Street alike can engage in deception and trickery, you need to watch out for your own interests.
Do your homework. It s no longer enough for investors to believe what analysts tell them and certainly what corporations tell them.
Be prepared to be baffled. Sometimes, even the brightest and most experienced people, working full-time, can t figure out what s going on with the likes of Enron. You can t ever know everything, or even enough. If you can t get comfortable with that, stay out of the pool.
Rising tides may not float all boats equally. High-flying companies can make serious mistakes and implode, even in booming economic times. Don t assume that your favorite company s escalator will always go up.
Beware of fads. For several years, all the gurus agreed that "asset-light" was the place to be. Now The Wall Street Journal advocates investing in "boring" companies. The best policy is to avoid the fads altogether.
Diversify. As an investor, and certainly as an employee with a employer-heavy 401(k), you must make sure that your portfolio reflects the very real risks of doing business. Cutting-edge businesses carry enormous risks. Why did Enron s stock plummet from $70 a share to 26 cents a share? In part because of chicanery but also because Enron was involved in highly risky sectors.
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