He found his solace in work. Soon after moving to Aurora, he got a job at a start-up local TV station. His first duties were cleaning out 40-odd years of accumulated debris from the old Moose Lodge, where the new station was housed. He painted the walls. Then, as each piece of equipment arrived, Skilling learned to operate it. When the production director quit, Skilling took his job. He was 14 years old. After school, his mother would drive him to the TV station, where he would stay until midnight. Throughout his high school years, he worked upward of 50 hours a week.
When Skilling was applying to college, his father took him to see his alma mater, Lehigh University, in Bethlehem, Pennsylvania. From the school, Skilling could stare down into the valley upon acre after acre of aging, decrepit steel mills, many of them boarded up and abandoned. Skilling had an immediate visceral reaction to the sight: this, he thought, was what he was trying to get away from. Not long afterward, he visited Southern Methodist University in Dallas, which dangled the prospect of an engineering scholarship in front of the young midwesterner. The sun was shining, the campus was neat, and the girls were out in their bathing suits. Perhaps most important, there were no aging steel mills anywhere. “They’re going to pay me to go here?” he thought. At a place like SMU, a person could start fresh. Though he was only 17, that’s what Jeff Skilling wanted to do.
Even though he had a scholarship, Skilling still had to work in college;
despite all the money he’d made in high school, he was flat broke. The problem wasn’t that he’d spent it; no, he’d lost it playing the stock market. Today, of course, that’s hardly likely to raise eyebrows. Lots of people, including teen-
agers, got caught up in the market in the late 1990s and lost money as the bull market soured. But it was different in the 1960s and early 1970s. The stock market had not yet become part of daily life in America, and a teenager putting his money in the market was almost unheard of. Skilling, though, poured all the money he’d made at the TV station—more than $15,000—into shares of his father’s employer, a company called Henry Pratt. He got in at $8 to $9 a share, and for a while, the stock was a winner, going as high as $25 a share. Convinced that the stock was headed even higher, Skilling borrowed thousands against his stake to buy a car. But then came the bear market of the 1970s, and before long Henry Pratt was at $2; and because he’d borrowed against the stock, Skilling had to liquidate his holdings to pay off the loan. He was soon wiped out.
Most kids would have been chastened by such an experience. Not Skilling. The summer between his freshman and sophomore years, he had a bad accident while working a summer job: a truckload of heavy equipment fell on him, crushing his back. He was in a full body cast for three months, but he came out of it with a $3,500 workers’ compensation check. And once again, he plunged the money into the market, this time the bond market. But he didn’t buy low-risk bonds. Instead, he leveraged his money almost three to one and bought $10,000 worth of deep-discount bonds. Interest rates were sky-high, and Skilling was betting that they’d soon drop. Instead, they kept going up. Skilling started getting margin calls and finally had to sell just two weeks before the rates began to fall. For the second time in less than a year, he was wiped out.
Despite the losses, Skilling’s interest in the market did have one benefit: it led him to business classes. That’s when the lightbulb switched on; once he discovered business, Skilling knew he’d found his intellectual passion. Though he’d dutifully taken his engineering classes, he found them “mind-numbing.” By contrast, business was fun, engaging, even creative. He also thought his engineering background could help him: he could apply scientific logic to business and thereby gain an edge. His GPA in engineering was 2.6. In his senior year, he concentrated on business and got a 4.0. For his entrepreneurship class, he had to read a thesis written by a Ph.D. candidate at the University of Chicago on the subject of converting commodities contracts into tradable securities. To Skilling, it was a thrilling idea, and he never forgot the paper.
Skilling graduated in 1975 but skipped the ceremony to drive to Chicago to marry Susan Long, a fellow midwesterner who was his college sweetheart. Three days later, he returned to Texas and began a job at First City National Bank in Houston. Assigned to the bank’s operations center, he was soon moved to corporate planning. His starting salary at the bank was $800 a month. By the time he left First City, he was making $22,000 a year and was the youngest officer at the bank.
What changed the course of his life—and Enron’s history—was Skilling’s next big gamble. He decided to apply to the country’s most prestigious business finishing school: Harvard Business School. The gamble wasn’t so much that he’d set his sights on Harvard but that he applied nowhere else. It was going to be Harvard or nothing; if he didn’t get in, he thought, he’d just stay in his job and get his MBA at the University of Houston at night. Despite his middling college grades, though, he did get in—because he acted like Jeff Skilling. An interview at Houston’s Hyatt Hotel with the dean, who was meeting candidates about whom the school was on the fence, was going nowhere fast. Then the dean asked, “Skilling, are you smart?” “I’m fucking smart,” he replied. Skilling rented a U-Haul truck, drove to Cambridge, and entered the business school in the fall of 1977.
Here at last Skilling was in his element. At Harvard he became a star. He stood out in part because of his brilliance and in part because of his harshly libertarian view of business and markets. The markets, he believed, were the ultimate judge of right and wrong. Social policies designed to temper the market’s Darwinian judgments were wrongheaded and counterproductive. And that wasn’t all. John LeBoutillier, a Skilling classmate (and later a one-term congressman), remembers one class in which the students were discussing a product that might be—but wasn’t definitively—harmful to consumers. The question for the class: what should the CEO do? “I’d keep making and selling the product,” replied Skilling. “My job as a businessman is to be a profit center and to maximize return to the shareholders. It’s the government’s job to step in if a product is dangerous.” (Skilling has always denied this story.)
Skilling graduated a Baker Scholar, a coveted honor bestowed upon the top 5 percent of the class. He decided that his talent was “pattern recognition,” which meant that he thought he was good at seeing how the techniques used in one industry could be applied to another. Degree in hand, Skilling did one of the appropriately prestigious things that Baker Scholars often do, probably the one thing that best matched his mental proclivities. He joined the nation’s bluest-chip consulting firm, McKinsey & Company.
McKinsey was founded in 1926 by a University of Chicago accounting professor named James McKinsey, and the firm has dominated the business of corporate strategic consulting ever since. McKinsey has always had a special aura about it, a sense that it employs only the best of the best, that its management advice is smarter and better than anyone else’s, and that its theories are a little akin to tablets handed down from on high. It’s a coveted place to work—overachievers who go to work at McKinsey can be comfortable that they will continue to overachieve—and it can also be a stepping stone to other enviable perches. Lou Gerstner, the recently retired CEO of IBM, is one of many former McKinseyites who went on to lead major corporations. The 1982 book In Search of Excel-
lence, perhaps the best-selling management tome of all time, was written by two McKinsey partners.
Operating on the belief that intellectual brawn is more important than practical experience, McKinsey prefers to hire new consultants straight out of places like Harvard Business School rather than from industry itself. In fact, it’s hard to think of a place that believes in the value of brainpower more than McKinsey. The firm spends a great deal of time sorting out stars from the merely superbright; perhaps not surprisingly, those who prosper there often develop a smug superiority. A McKinsey partner once told Forbes: “We don’t learn from clients. Their standards aren’t high enough. We learn from other McKinsey partners.” A McKinsey al
um described the firm to a new recruit as a place where “the smartest people in business tackle the most important and challenging issues of the world’s leading corporations.” Indeed, the firm likes to think of itself as bringing enlightenment to the business world. McKinsey ideas often sound incredibly compelling, even pure, in a way that makes it impossible to believe they could ever be corrupted. But like Skilling himself, McKinsey partners tend to be designers of ditches, not diggers of ditches. When it comes to executing their lofty theories, well, consultants lean toward leaving those messy realities to the companies themselves.
Even by McKinsey standards, Skilling was phenomenally successful, rising through the extremely competitive ranks with almost surreal speed. He started his career in Dallas. Six months later he moved to the Houston office, where he was the third employee. (The Houston office is now one of McKinsey’s biggest.) It normally took a successful McKinsey consultant seven years to become a partner and another dozen or more to become a director. Skilling made partner in five years and director in ten; by 1989, he was overseeing the worldwide energy and North American chemical practices. He is still proud of the fact that only a handful of people (they include Lou Gerstner) rose through the ranks faster than he did.
It would be hard to imagine a place that suited Skilling more perfectly. The McKinsey thought process reduced a chaotic world to a series of coolly clinical, logical observations. That’s precisely how Skilling thought. McKinsey valued sheer brainpower; he had it to spare. It favored people who were quick on their feet and who could “present well.” That was Skilling through and through. He had a way of turning practical disagreements into abstract arguments and could outdebate just about anyone. “It was difficult to disagree with Jeff because he would elevate the disagreement to an intellectual disagreement, and it was hard to outsmart him,” says a former partner who worked with him.
But McKinsey also played to his weaknesses. Working at McKinsey only heightened his natural arrogance. McKinsey could be a cold place, ruthless in sorting out the stars from the also-rans. Skilling embraced that ruthlessness. The culture rewarded individual achievement, as opposed to teamwork. Skilling was never much of a team player. If he thought he was smarter than someone—and he usually did—he would treat him harshly if he had the temerity to disagree with him. Other McKinsey partners began saying of Skilling, “Sometimes wrong, but never in doubt.”
Ultimately, though, McKinsey was the formative experience of Jeff Skilling’s business life. Though McKinsey has since sought to distance itself from Skilling and Enron, much of what he brought to Enron—not only ideas about how to reshape the natural gas industry but ideas about what companies should value and how they should be run—came out of his experience at McKinsey.
His first goal, upon arriving in Houston as an up-and-coming consultant, was to start a financial services practice. But within a few years, the price of oil, which had skyrocketed during the energy crisis of the 1970s, began to decline, hurting not only the companies that drilled for oil but all the big Texas banks that had loaned them money. Clearly a financial services practice was not going to fly. So he did other kinds of consulting work. According to the Houston Chronicle, a study Skilling did of the Houston Fire Department so thoroughly impressed the fire chief that he told Skilling, “You could be the best fire chief in the nation if you ever need a job.” And he did occasional consulting for InterNorth, work that continued after the company changed its name to Enron.
By the late 1980s Skilling was spending about half his time on Enron work. In the process, he was also learning about the natural-gas business; not surprisingly, he was appalled at what he saw. It was, he has said, “the screwiest business I’d ever seen in my life. All the rules were written in Washington. It was like Alice in Wonderland.” All true, of course. But it was also true that the industry had to change, and Skilling reveled in that opportunity. “It was fabulous,” he has said. “It was like starting from scratch.” By the late 1980s Skilling was convinced that he had devised an answer—nay, the answer—to the industry’s problems. He saw one of those patterns he so liked to recognize. Put simply, he believed the natural-gas business could get out of its predicament by becoming more like the financial-services industry. He called his idea the Gas Bank, and it soon catapulted Skilling into Enron for good.
The biggest single issue facing the entire natural-gas industry was astoundingly basic: the interaction between buyers and sellers. It wasn’t all that long ago, you’ll recall, that gas was sold under long-term contracts between producers, pipelines, and local utilities, with the price set by the government. But by the late 1980s, with the onset of deregulation, some 75 percent of all the natural gas sold in the country changed hands on the spot market during a frantic few days of deal doing at the end of every month.
The problem with such a system was its inherent uncertainty. A sudden cold spell in the Northeast could cause prices to rise overnight, hurting consumers. A wave of warm weather could depress prices, causing the gas producers to lose money. Even though there was a glut of natural gas, big industrial customers couldn’t be sure that they would always be able to lock up as much supply as they needed from one month to the next. And it was a risky bet for a pipeline company to guarantee a long-term supply at a fixed price to a customer because the pipeline couldn’t count on being able to secure a steady supply of gas at a price that would ensure a profit. No wonder many industrial users of natural gas were switching to oil and coal. No wonder they no longer viewed natural gas as a reliable fuel. As for the pipelines, they were struggling to make profits, because the margins on spot-market deals were so low. Indeed, by the late 1980s, Enron was trying to convince the industry to move back to longer-term contracts—just like in the old days, except the price would be negotiated between the parties rather than set by the government.
Enron took the first steps in that direction by setting up a new division called Enron Gas Marketing, which tried to get customers to sign up for long-term deals. In March 1988, for example, Enron signed a 15-year contract with Brooklyn Union to supply 21 million cubic feet of gas a day to a plant being built in Bethpage, New York. The deal was a coup for several reasons. Brooklyn Union agreed to pay a hefty premium to the market price of gas because Enron was willing to guarantee the supply for so many years. Second, Brooklyn Union was not one of Enron’s old-line natural-gas customers; in fact, it wasn’t even connected to Enron’s pipeline system. Enron would have to contract with another pipeline to get the gas to Brooklyn Union. Although deregulation had mandated such “open access” a few years earlier, this was one of the first deals that took advantage of the new rules. But while such a deal diminished the uncertainty for Brooklyn Union, it actually increased Enron’s risk. If gas prices rose and the contract became unprofitable, that was Enron’s problem, not Brooklyn Union’s. And Enron was assuming the transportation risk as well; if, for some reason, the Houston company couldn’t get the gas to the New York utility, Enron would be liable.
Enter Skilling’s Gas Bank. It was nothing less than the first serious effort to diminish the level of risk for everybody involved in natural-gas transactions. The basic idea was this. Producers (acting as depositors) would contract to sell their gas to Enron. Gas customers (the borrowers) would contract to buy their gas from Enron. Enron (the bank) would capture the profits between the price at which it had acquired the gas and the price at which it had promised to sell the gas, just as a bank earns the spread between what it pays depositors and what it charges borrowers. Everybody would be happy. So long as Enron had a balanced portfolio of contracts—that is, contracts to sell gas at a specific price were matched by contracts to acquire gas at a specific price—the spot-market price of natural gas could go crazy and it wouldn’t matter. Enron would already have locked in the profits. Just as important, for both sellers and buyers, the uncertainty of the spot market would be replaced by the contractual certainty that Skilling’s Gas Bank offered. “The concept was pure intellectually,�
� Skilling has said. “It made all the sense in the world.”
In late 1987 Skilling pitched his idea to a meeting of 25 top Enron executives, including Lay and Kinder, in a conference room on the forty-ninth floor of Enron’s headquarters in downtown Houston. In classic Skilling fashion, he used just one slide in his presentation—which shocked the Enron executives, who were expecting dozens—and he spoke for less than a half hour. When he had finished, an executive named Jim Rogers declared the idea dumb, and virtually all of the others agreed. In the elevator afterward, Skilling apologized to Kinder for not explaining his concept well. Kinder, chomping on his unlit cigar, replied that when he had heard Rogers call the idea stupid, he knew it was the right move.
Later, after Skilling had become a celebrity, the Gas Bank was described as his first great triumph at Enron. But that was just part of the Enron myth. In fact, however “intellectually pure” the Gas Bank was, it didn’t work very well at first. Selling the gas wasn’t a problem; local utilities and industrial customers were eager to sign long-term contracts that guaranteed them a steady supply of gas. And they were willing to pay a price that was higher than the spot-market price—sometimes twice as much—for that security. The problem was persuading the people who controlled the supply of natural gas—the producers—to get on board. Although there were daily fluctuations on the spot market, natural-gas prices remained deeply depressed. But natural-gas producers were wildcatters at heart, and they had the wildcatter’s mentality: tomorrow will surely be better than today. And for that reason, they were reluctant to sign long-term contracts to deliver gas at a fixed price that they viewed as “too low.” Thus Enron still had to buy gas on the spot market to fulfill the terms of its Gas Bank contracts with utilities. If prices shot up, the contracts would be wildly unprofitable; indeed, a McKinsey study was predicting just such a price hike. (As it turned out, McKinsey was wrong: prices stayed low, and those initial contracts turned out to be supremely profitable.)
The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron Page 8