Why Enron Always Happens


THERE’S AN OLD JOKE ABOUT A COMPANY’S NEEDING TO hire a new accounting firm. The chief executive invites the heads of eight firms to come in for interviews and he hires one right away. A friend asks him how he did it. “Simple,” the chief executive replies. “I just asked each of them one question. How much is two plus two?”

“That’s easy,” the friend says.

“Sure it is. Seven of them said four. So I gave the job to the eighth. He said, ‘What number do you have in mind?’”

The reputation of the accounting profession, indeed that of capitalism itself, is in a bad way these days for sometimes letting the need for a good number on the bottom line dictate the numbers above it, rather than the other way around. One of the great American accounting firms of the twentieth century, Arthur Andersen, is almost certainly at the end of its existence thanks to scandal after scandal. Enron, once the seventh-largest company in the country as measured by gross revenue, has been found to be a tissue of accounting deceptions and has plunged into bankruptcy, wiping out much of the accumulated wealth of its investors and employees. WorldCom, the second-largest long-distance provider and by far the largest carrier of Internet traffic, counted $7 billion worth of routine maintenance expenses as capital investments, making the company seem profitable when it was not. Tyco’s chief executive, unchecked by a supine board of directors, turned that company into his personal piggy bank to buy real estate, paintings, and a now-infamous $6,000 shower curtain. Indictments have been handed up by the dozen, with many more undoubtedly to follow.

What is going on? Listening to much of the public commentary and political pronouncements on this issue in recent months, one might think that the crisis of capitalism, so long predicted by its enemies, is at hand. It is not. This is capitalism.

The present crisis is just a normal part of the messy, two-steps-forward-one-step-back way in which capitalism evolves and progresses—in the long term—to ever-greater capacity for wealth production and ever-wider distribution of that wealth. But why is the capitalist system so messy? The answer is almost as simple as that to the question about two plus two.

Capitalism, unlike socialism and all the other economic isms dreamed up by economists, politicians, and social philosophers over the years, is not a system at all. Rather, its ways are determined by two ineluctable facts. First, capitalism is an artifact of human nature itself and thus manifests all of that nature’s passions, genius, obsessions, and foolishness, not to mention the human weakness for the seven deadly sins. Second, capitalism is a game, no different in a mathematical sense from football or poker except for one thing. Poker is a zero-sum game that merely redistributes the wealth of the players according to their luck and skill. The game of capitalism creates wealth, sometimes in prodigious quantities. It can also, of course, destroy it.


These two facts are deeply intertwined, but let’s consider them separately. To put the fact that capitalism is an artifact of human nature another way, let’s say that it is what happens when human beings are free to pursue their own economic happiness, which is to say their self-interest. It appears spontaneously in all cultures, despite sometimes ferocious efforts to kill it. As a Vietnamese proverb has it, trying to stop a market is like trying to stop a river. Indeed, no small part of the reason for the failure of all forms of socialism—from the sort practiced in democratic Britain after World War II to the unspeakable tyrannies of various Communist regimes, including North Korea’s—is that so much political effort must be exerted just to prevent capitalism from erupting spontaneously among the citizenry. This has profound consequences and explains much about why economic history has been what it has.

Human genius inheres in individuals, for instance, but foolishness can be, and often is, a crowd phenomenon. One of the most famous books ever written about human behavior is Charles MacKay’s 1841 Memoirs of Extraordinary Popular Delusions . Many of MacKay’s examples, such as the Crusades and the Salem witch trials, have nothing to do with economic behavior. But many others, such as the tulipomania that seized the Netherlands in the early seventeenth century and the South Sea Bubble of early-eighteenth-century England, were financial in nature.

One of the most common progenitors of these financial manias is new technology. The success of the Manchester & Liverpool Railway, which opened in 1829, demonstrated the possibilities of the most important practical application of the steam engine, and in the early 1830s dozens of railroad ventures were started in America. Their stocks and bonds were soon trading on Wall Street, and investors rushed in, often with little thought other than to get aboard while the getting was good, despite the fact that most of the new railroads had yet to carry any freight, let alone turn a profit. Some people were investing in railroads merely because other people were investing in railroads.