“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 it
s 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.”
“I’ll think about it,” Baxter said. “But I doubt I’m going to change my mind.”
Days later, he returned with the news. He would leave in a couple of months. Skilling was devastated.
Appearing stiff, Gray Davis stood in the Assembly chambers at the state Capitol, delivering his third State of the State address.
“We will regain control over the power that’s generated in California and commit it to the public good,” he said. “Never again can we allow out-of-state profiteers to hold California hostage.”
Davis listed a series of hard-nosed solutions: forbidding generators from conducting unscheduled maintenance, making it illegal to withhold power from the grid, expanding his emergency authority, prosecuting evildoers.
“The remedies I am proposing tonight are reasonable and necessary,” Davis said. “There are other, more drastic measures I am prepared to take if I have to.”
After all the advice from the free-market evangelists, Davis had chosen another path—all-out war.
Rick Causey’s voice was icy.
“Enron does not want Carl Bass consulting on anything involving the company anymore,” he said.
Steve Goddard, the Andersen partner who had run the Enron accounting team before Duncan, tried to sound conciliatory. “Well, Rick, why don’t you tell me what the problem is,” he said.
The problem? Bass had been an impediment in several deals. He had forced LJM2 to put more cash into Fishtail. He had argued that the video-on-demand venture wasn’t a real business yet, and then tried to use that position to stop Braveheart. The man had no creativity, Causey said.
Goddard asked for some time to think about the request. Maybe there was something they could do. Andersen had a new chief executive, Joe Berardino, the man who had forged the rules compromise with Arthur Levitt. He’d be down in Houston in a few weeks. Maybe Andersen’s new top diplomat could negotiate a solution with Causey, too.
But if Causey was insistent, there was little doubt what would have to be done. Enron was Andersen’s biggest client, paying more than forty-nine million dollars in fees that year, with thirty-five million dollars of those payments from consulting. Clients like that could expect to be kept happy. So if Enron didn’t want Carl Bass anymore, Carl Bass would have to go.
———
In Washington, Dick Cheney, the Vice President-elect, was on the telephone with Ken Lay.
Months of uncertainty had followed the November presidential elections, with the Bush and Gore campaigns fighting it out in court over the razor-thin margins of victory in Florida. Now, with Bush declared the victor, the Administration was assembling its Cabinet.
A number of candidates had already been selected—including Don Evans, the campaign’s national finance chairman and an old friend of Lay’s, to serve as Commerce Secretary. Lay himself had interest in one particular job, which was why Cheney was on the phone to Houston this day.
“Ken,” Cheney said, “I’m sure you know, we’ve been seriously considering you for Treasury Secretary.”
Lay could already tell the news wasn’t good.
“The President has decided that with he and Don Evans and I all from Texas, all from the energy business, things were getting too top-heavy. Nominating a fourth person that was in the energy business and from Houston would probably just create too many problems.”
“Well, I certainly understand, Dick,” Lay replied.
Lay wasn’t all that disappointed, though. He didn’t lust for Washington. He was happy staying Enron’s chairman.
Vince Kaminski, Enron’s top risk analyst, examined the data on the latest request out of the finance division with amusement. It was just another bit of foolishness.
For more than a year—since the troubles related to their opposition to LJM—Kaminski’s group had basically been ignored by finance. But now that Fastow and his crowd were struggling, they were coming back, trying to get somebody to bail them out of one of the messes they had created.
These silly Raptor structures were the problem. This was LJM all over again, a hedge in name only that offered no real economic protection. And now, with losses from the hedges piling up, the Raptors couldn’t cover them. Finance had asked Kaminski’s group to analyze what would happen if all of the Raptors were pooled together permanently.
The answer was pretty simple—nothing. Kaminski’s analysts concluded that the Raptors were so far underwater that combining them wouldn’t help. Plus, because three of them were capitalized with Enron stock, they all had exposure to the same risk. Kaminski contacted finance and let them know their idea wouldn’t work. Then he forgot about the Raptors. Surely the losses would just have to be recognized. There was no other logical alternative.
———
Usually, the final weeks of a presidential Administration are like the last days of high school. Nothing much gets accomplished as years of belongings are packed and people prepare for the next stage of life.
So by early January, with George Bush preparing to move into the White House, members of the Clinton Administration might have been expected to be kicking back. Instead, Treasury officials decided to take one last shot at fixing the California electricity mess. They tried to bring everybody together—the energy producers, the Secretary of the Treasury, the governor—for a final bargaining session.
But Davis refused to return to Washington and rejected efforts to meet halfway in Kansas City or
St. Louis. Everyone, Davis said, needed to come to California, but the Clinton Administration officials declined.
Instead, this crucial meeting—the last chance for the Democratic governor to obtain help from a Democratic Administration—would be handled by conference call.
On January 13, a series of officials made their way down a hallway deep in the Energy Department. They were all dressed casually, not surprising for a Saturday. Summers, the Treasury Secretary, led the pack, followed by members of his department. Clinton’s National Economic Adviser, Gene Sperling, joined the group, along with an assortment of executives from some of the nation’s leading energy companies.
They arrived in a secure room filled with flashing monitors and high-tech communications devices designed for use in a national energy emergency. The government’s conference call with Gray Davis was about to begin.
About that same time, Ken Lay, Steve Kean, and Rick Shapiro, a company lobbyist, found seats around a conference table in Davis’s Los Angeles office. Lay greeted the other industry executives in the room, including Steve Bergstrom, the president of Dynegy, a top Enron competitor.
The video hookup with Washington was switched on. Larry Summers appeared, sitting at the head of the conference table in the Energy Department’s secure room. They could see Sperling from the White House, as well as the rest of the officials, staffers, and executives.
Everyone on the call was ready to get started, but the sound was left on mute. Governor Davis hadn’t arrived.
Minutes passed.
In Washington, Summers fumed. He didn’t want to sacrifice the weekend with his family waiting around for Davis to show up. He switched on the sound.
“Do we know where the Governor is?” he asked. A voice responded. “No, but he’s expected soon.”
Lay watched Summers on the video screen. The answer from the Governor’s aide had clearly annoyed him.
He turned to chat with some of the others at the table, then glanced back at the video screen.
Summers was gone.
After five minutes out of the room, Summers walked back in and switched on the sound. “Okay, anybody know where the Governor is?” he asked. Again, no real answer.
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