From: hal@finney.org
Date: Wed Feb 06 2002 - 12:19:27 MST
> Enron, Spawn of Business Journalism
> by Gary North
It's hard for me to get past Gary North's name in judging this article.
For those who have forgotten, North was the single loudest voice in
predicting Y2K apocalypse. He predicted absolute disaster, starvation
and death throughout the entire world, with complete certainty. His web
site had thousands of documents, each with his own pessimistic commentary,
selected to drive home the point that we were headed for an inevitable
and unstoppable catastrophe. Of course he turned out to be absolutely
wrong, and he disappeared for quite a while after that, but apparently
he is now starting to show his head again.
So Gary North does not have much credibility with me. Should I bother
to read his article, given his track record of being not just wrong on an
important issue, but being flagrantly, obnoxiously, infuriatingly wrong?
Here is where the ad hominen fallacy raises its head. Usually it is
used as a debating tactic. But the real point is that it can be an
error in our own thinking. Should we reject possibly-valid analysis and
information just because of flaws in the source? On the one hand, we
do need filters; we can't read everything that is written by the entire
human race. But on the other hand, we risk filtering out useful data.
In any case, I read the article, and while it is not badly written, in
fact I don't agree with most of it. However the errors that I see are
not blatant and some of what North says seems correct. Errors include
his conclusion that Enron and the dot-com debacle disprove the efficient
market hypothesis, and that the Enron failure is largely due to government
subsidies. I agree that the story does illustrate groupthink among
journalists and investors, but IMO that is not newsworthy analysis.
I think the core of the Enron story is and will be that the people
entrusted with management defrauded the investors. This is a constant
problem in the capitalist world, at all scales. Each of us puts our
savings into other people's hands, meaning that we have to trust them.
And such trust is risky. Every day people lose money because they are
cheated by people they trusted.
In business, the issue is whether the management truly represents the
interests of the owners, the stockholders. Every company is aware
of this risk. The entire structure of the business firm is set up to
try to minimize this problem. It's similar to cancer in an organism,
where a part of the whole decides to advance its own interests at the
expense of the larger body. Biological organisms have defense in depth
against cancers, but sometimes those defenses fail. In the same way,
firms have all kinds of checks and balances to try to keep individuals
from enriching themselves at the expense of the business. But these
aren't perfect either.
In the case of Enron, I believe the evidence indicates that this is what
happened, that the managers looked after their own interests rather than
those of the company's owners whose investments they were supposed to
be protecting. The use of complex financial structures defeated the
checks and balances; no one could tell where the money was going, so it
was too tempting to direct it into their own pockets.
Enron, in fact, was killed by cancer. (Technically it's not quite dead
yet; it is dying of cancer.) It's newsworthy, because it doesn't happen
often to businesses at this scale. But the real lesson is that investors
need to be aware of this new risk. They need to make sure that their
managers are not in a position to cheat the company through the use
of complex financial instruments. The use of derivatives and swaps
can be profitable, but unless there is effective auditing in place,
the business is risking its own life in using these instruments.
Investors need to think of derivatives as carcinogenic stimulants.
They produce short term benefits but can lead to long term destruction.
IMO the Enron bankruptcy does not show the need for more government
supervision, or fewer government subsidies, or most of the other
lessons people are trying to draw. It shows the need for investors to
be more careful. It shows a failure of one of the main limits against
corruption, the use of independenet auditors. Investors will want to
protect themselves by insisting that their employees, the managers,
hire auditors who have no financial incentive to cheat the investors
whom they are supposedly protecting.
These are the kinds of lessons which Enron teaches, and they are exactly
the kinds of lessons which the capitalist system excels at learning.
Even without any regulatory changes, Enron will lead to a new awareness
of risk, and new techniques to manage it. The end result will be a
system which is more robust and more able to fight the cancers which
constantly threaten business survival.
Hal
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