Conspiracy of Fools (67 page)

“This is ridiculous,” Skilling said. “We’ve got to take care of this.” They took two steps quickly. First, Enron put its electricity customers back on the California grid, essentially handing them over to the utilities. That would eliminate payments owed by the utilities to Enron.

Still, that didn’t eliminate the danger from the utilities’ all-but-certain bankruptcy. If that happened with them owing Enron huge sums, all of those earnings would be put in limbo. Skilling wanted to be able to say that, no matter what, California would not affect the company. He and Causey made a decision. They would squirrel away Enron’s California profits in an accounting reserve. More than one billion dollars, never reported as income. If everything worked out, they could dip into the reserve later and report the earnings then. Enron not only would be protected from the possible bankruptcies but would be well on its way to meeting budget targets for next year.

Besides, the way Skilling figured it, Enron didn’t need the earnings now. It wasn’t like there were huge losses in the company that needed to be offset.

The hundreds of millions of dollars in losses hidden by the Raptors just kept climbing. The temporary fix from two months before—the costless collar—hadn’t solved the problem. Enron’s share price had fallen below eighty-one dollars, so now the company was funneling cash into Raptor I. Even so, the two troubled Raptors—the first and the third—were underwater, with less capital than they owed. But the other two—Raptor II and Raptor IV—were still in decent shape.

Causey and the accountants pondered the problem. If two were fine and two weren’t, could the healthy ones support the sickly ones? Fastow hated the idea. After all, profits from the strong Raptors might be available later for LJM2. But there was no time to argue. If the problem wasn’t solved, even temporarily, by December 31, Enron would have to report losses from the two sickly Raptors.

The accountants cobbled together a plan. They would allow the strong Raptors to guarantee the obligations of the weak ones—but only for forty-five days. That would carry Enron past December 31 and allow them to avoid
disclosing the festering problems. Then they would have until the end of the next quarter to find a permanent solution. But just to make sure Fastow went along with the idea, Enron paid fifty thousand dollars to LJM2 for letting the arrangement go through.

All they needed now was the go-ahead from Andersen.

“Dave, that doesn’t work at all,” Carl Bass said. “It doesn’t even make sense.”

Bass was flanked by David Duncan and Michael Odom, the practice director for Andersen’s Houston office. They had gathered in Odom’s office to discuss Enron’s request to place its forty-five-day Band-Aid on the Raptors. All three were frustrated. Duncan and Odom wanted to give the okay; Bass could barely keep from shouting at them.

An assistant walked in. “Rodney Faldyn’s on the phone. He wants to know if you’ve made any progress on this.”

Bass knew the name. Faldyn was an Enron accountant. They were really pushing hard. “I’m still talking to Carl about it,” Duncan replied. “We’ll have an answer soon.”

Bass stared at him.
We have an answer
.

“I don’t see why this can’t work, Carl,” Duncan said.

Bass set his jaw as he started to speak. “Dave, it’s just a silly gimmick,” he replied.

“But …”

“Look, suppose I default on the mortgage on my house,” Bass said. “Even if I convince the bank not to call my note for forty-five days, I can’t go tell everybody I’m okay on my mortgage. I’m not. I’m in default.”

Duncan sighed. “That’s not the same thing, Carl.”

“It
is
the same thing. They want to push off reality for forty-five days. But they can’t. It’s still reality.”

“Then what can they do?”

Bass closed his eyes, irritated. He had already been through all this with another member of the accounting team. He had been planning to cut out early this day, to take his kids ice-skating. Instead, he had to keep going over the same ground because Enron didn’t like the answers.

“The only option they have is a true cross-collateralization,” he said. “Turn the Raptors from four pools of capital into one. But that means having a substantive, binding legal agreement among the four entities, combining their obligations.”

Bass knew Enron would hate this answer, but he didn’t care. He was tired of these accounting perversions. Enron wanted to report profits it didn’t deserve, and make real losses vanish. That just couldn’t be done.

He finished his explanation of a cross-collateralization. “But who’s going to do that?” Bass asked. “Why would one Raptor give up its value to another?”

The assistant returned. “Dave, Rodney Faldyn’s on the phone again.”

Days later, Duncan printed out a draft memo for the files about Raptor. He reviewed its three pages carefully. The second-to-last paragraph was the most important. It described a negotiated agreement allowing the forty-five-day cross-guarantee among the Raptors. Andersen, the memo said, concluded that the arrangement worked.

“We discussed this conclusion with the Professional Standards Group (PSG),” the memo read, “who concurred with our conclusion.”

It wasn’t true. Carl Bass and other members of the PSG had told the Enron team in no uncertain terms that the arrangement couldn’t be done. But Duncan and the practice directors in Houston had simply overruled them.

In a meeting room down from his Washington office, Alan Greenspan, the Federal Reserve chairman, took a seat at the head of the conference table. To his left sat Lawrence Summers, the Treasury Secretary, and a few staffers. On the right was Gray Davis, the California Governor who had flown in that day, December 26, to discuss his state’s power crisis with the country’s two most influential economists.

“Mr. Chairman, Mr. Secretary, thank you for meeting with me. I’m hoping that we can find some solutions to the troubles facing my state. The thing is, if deregulation fails in California, it will fail in the United States.”

Greenspan placed his hand on a thick briefing book in front of him. He and Summers had met privately minutes before and decided to throw a splash of cold water on Davis. The man needed to understand there were limited answers to California’s problems, all of them unpleasant.

“Truthfully, Governor, California hasn’t deregulated,” Greenspan said. “The state simply replaced one form of regulation with another. It’s become a system of central planning run amok.”

Summers joined in. “You have a fixed price set by the state for selling electricity to the public. But you have a variable, floating price when you buy electricity.”

“That’s not sustainable,” Greenspan said. “The problem is your regulatory system. And there are a very limited number of solutions. But the first step is that prices for consumers are going to have to go up.”

Davis showed no emotion. “I really feel the problem is the energy producers,” he said. “They’re manipulating the markets and forcing up prices.”

“They may be,” Greenspan said. “But that’s beside the point. That’s not
causing
the problem; that’s making it worse. The real problem is a supply-and-demand imbalance.”

Davis objected. There was plenty evidence, he said, that energy producers were withholding power from the market. Greenspan and Summers didn’t argue the point, stressing that it made economic sense for power to be withheld. The utilities weren’t making good on their bills already. With the utilities now careening toward bankruptcy, it would be folly for power companies to keep pumping electricity into the state without limits. It would just increase their exposure to the likely bankruptcies.

Gently, the two economists suggested that the state government hadn’t helped matters. By attacking power companies, accusing them of crimes and refusing to meet with them, Davis and other politicians had signaled an unwillingness to deal with the structural problems. In a market, perceptions could be as important as reality. Until California took a more realistic approach, power companies would continue to be reluctant to do business with the state.

“Governor,” Summers said, “this is classic supply and demand. The only way to fix this is ultimately by allowing retail prices to go wherever they have to go.”

Davis’s face hardened. He didn’t like being lectured from the ivory tower. “Fine,” he said. “You two live in your world of economics, supply and demand and pricing.”

He leaned in. “Let me tell you about my world,” he said. “About California politics. About referendums, where anybody with enough signatures can take a ballot initiative to the voters and overrule anything that we’re doing.”

Greenspan and Summers listened as Davis laid out his political dilemma. The words made it obvious that the power problems in California would become much worse. Economics and politics were in conflict. And for now, politics would rule.

Two days later, a black sedan pulled to the front of the Ronald Reagan State Office Building in downtown Los Angeles. Ken Lay emerged from the back, followed by Steve Kean, his chief of staff and Enron’s government-relations specialist. They had interrupted their vacations for this quick trip to California to meet with Gray Davis.

Lay and Kean headed to the fifteenth floor and were taken to the Governor’s conference room. After a couple of minutes, Davis came in and walked to Lay, who put out a hand.

“Governor, I’m Ken Lay.”

“Good to meet you, Ken.”

Davis sat at the head of the table, while Lay and Kean took seats on one side, across from a member of the Governor’s staff. “Governor,” Lay began, “as you know, Enron is a major participant in the California market. And clearly the state has some serious problems.”

Lay broached the next subject cautiously. He understood the politics and—Republican though he was—suggested that Davis shift the blame for all the troubles onto his Republican predecessor.

“Governor, you didn’t cause this problem; you inherited it,” he said. “But you can solve it by giving the state true competition and consumer choice.”

The advice he gave could have come out of the mouths of Greenspan and Summers. Supply had to be increased and demand cut, he said. The market had to see the state was serious. Announce plans to build power plants, with temporary waivers from environmental regulations. Allow for pricing models that would result in lower costs during nonpeak hours. Then let the consumers feel the effects of higher prices, in order to change behaviors.

“I can’t do that,” Davis said sharply. “I’m not going to raise rates.”

“Governor,” Lay said, “it’s going to be very difficult to get consumers acting rationally if they’re paying five cents a kilowatt hour for electricity that costs twenty-five cents.”

If Davis took those steps, Lay said, prices would ultimately drop. Then the state could enter into long-term fixed contracts and never face this problem again.

Couldn’t happen, Davis said. And he couldn’t suspend the environmental rules. Voters wouldn’t stand for it.

The conversation dragged on. Davis tossed out a few ideas he was considering—orchestrating state takeovers of power plants, invoking emergency powers. Lay cautioned the market would react terribly to such moves, and again stressed that he had to address supply-and-demand issues. At the meeting’s end, Lay left confident Davis was ready to act decisively, one way or the other.

Enron wanted to close the chapter on the Azurix mess. It went to the market and offered to repurchase the public shares, making Azurix an Enron division again. It was the best way to lessen the damage from shareholder lawsuits.

The company had arranged to recognize its losses in Azurix and report
them in the quarter just ended. But that question got kicked up to Carl Bass, and from what he could tell, the losses should have been reported almost a year earlier. He spoke with David Duncan, reminding him that he had been told many months before that losses had to be taken if the value of an investment fell and stayed low for two or three fiscal quarters. Now eight quarters had passed, without Enron reporting the Azurix disaster. There might be a need for a restatement of prior earnings.

That wouldn’t happen. “I never told them the original advice,” Duncan said. “I can’t go back and do it now.”

Cash flow. That was always Enron’s Achilles’ heel.

No matter how much it stitched together in mark-to-market earnings, it simply couldn’t force cash to appear. Sure, it borrowed plenty of money through the complex transactions known as prepays and reported those billions of dollars as cash from operations. But that just pumped up debt without taking care of the real shortfall.

This year, though, would be different. With energy prices in California so high, Enron’s trading partners were forced to put up huge amounts of cash as collateral—some two billion dollars by late December. The cash wasn’t really Enron’s to use; it was more like a security deposit, which the company would probably have to hand back in a few months.

Still, to the untrained eye, the collateral allowed Enron to appear flush. The company reported the two billion dollars as cash flow from operations. If Enron had to return the money when prices dropped, so be it. Its finance team would deal with that later.

In early January 2001, Skilling and Baxter stood on the ground level of an Enron parking garage, smoking. Baxter dropped the butt to the ground, crushing it with his foot. He was cranky and frustrated, like he’d been most days in the months since the end of Project Summer. Every other sales effort had bombed out.

“This is like pushing on a string, Jeff,” he said. “I’m not getting anywhere.”

“We’re going to have to keep plugging,” Skilling replied. The international projects had to be sold.

Baxter shook his head. “You don’t need
me
to do this,” he said. “I’m not having any fun doing this.”

He breathed deeply. “Jeff, I think it’s probably time for me to go,” he said. “I want to spend more time with my family, just do something new.”

This can’t be
, Skilling thought. Baxter was his go- to guy, his smoking buddy, the person he most trusted on deals.

“Cliff, look, I need you,” Skilling said. “Don’t do this to me now. Go back and rethink this thing.”