The Lesson of Enron: Regulation Isn't a Dirty Word
By Robert Kuttner
In the wake of the Enron (ENE ) collapse, defenders of deregulation are mounting a heroic effort to insist that the debacle was merely a business model gone bad, not an impeachment of freer markets. But the claim won't wash. In fact, Enron suggests the need for tougher regulation in three distinct areas.
The first is financial standards. Enron could bilk investors because, despite the razzle-dazzle, nobody outside the company could figure out Enron's game. Demands for greater financial transparency were resisted at every turn. The more we rely on markets to achieve efficiencies, the more we need transparent reporting. Otherwise, a deregulated environment becomes too tempting an arena for scams. Only regulators (and their proxies, such as the Financial Accounting Standards Board) can force corporations to disgorge potentially embarrassing information. They didn't with Enron. In this respect, the Enron collapse is reminiscent of Long-Term Capital Management: financial geniuses with a formula that couldn't fail (but did), operating beyond the purview of regulators and taking investors and banks down with them.
It also recalls an earlier sordid chapter in the electric utility industry: the utility holding-company bubble of the 1920s. Those parent companies held controlling interests in local utilities. Like Enron, they operated beyond the reach of effective regulation. They turned out to be nothing but complex variations of old-fashioned pyramid schemes, watering stock and soaking investors. When the pyramids collapsed, helping to trigger the Great Depression, Congress ordered tougher regulation of both securities and utilities.
SHARK CIRCUIT. The second area inviting reregulation is electric power. As California's recent power disaster proved, demand for electricity is relatively inelastic. Spare generating capacity is needed for peak periods. Traditionally, regulated power coexisted with adequate supply and fair prices because the system included both capacity for peak demands and prohibitions on price-manipulation and windfall profits. But deregulation signals entrepreneurs both to shed spare capacity (since nobody wants to pay for it) and to amass the sort of market power that brings price manipulation.
In this climate, it was guaranteed that sharks such as Enron would emerge to cream profits by manipulating supply. And--just as in the 1920s--no regulator could probe what Enron was up to. Ironically, these markets proved too byzantine for the company itself.
Even in a capitalist economy, some major sectors of the economy demand regulation. Clearly, electricity is one of them. In principle, an efficient regime of electricity regulation could be built on regulated competition that retains trading markets but tightens the rules and cracks down on abuses. However, the regulatory acumen needed to housebreak future Enrons and keep them honest would require the wisdom and incorruptibility of a philosopher king. The Federal Energy Regulatory Commission, a friend of competition, has lately been issuing price cap orders and exploring the cause and cure of market power, something that competition by definition is supposed to minimize. That's a good start.
But this is a game of catch-up. Better to regulate electric power directly, by regulating price and supply, or generate it publicly. It is hardly accidental that the one oasis of stability immune from the California electric power disaster was the Los Angeles public power district. The power plants were municipally owned, and there were no profit opportunities--hence, no games to be played with supply or price.
RELENTLESS. A final failure of regulation involves the pension system. Enron employees were coerced or compelled to put the bulk of their tax-subsidized retirement savings into--guess what?--Enron stock. When the stock collapsed, so did their retirement dreams. Diversification is the first rule of prudent investment. It is unconscionable for a corporation to force its employees to put all their retirement eggs in one basket. That, too, should be illegal.
The theorists of deregulation have contended that competition is inherently more efficient because government intervention is corrupted by politics, while markets are cleanly accountable to investors. However, all markets are structured by rules. And the process of setting rules for deregulation, as clearly illustrated by Enron's example, is as politicized as the process of regulation.
Enron was the ultimate politically engaged company. Its chairman, Kenneth L. Lay, was an intimate of the Bush family and was wired to Democrats as well. Enron's operatives relentlessly lobbied state legislatures to provide a lax climate in which to pursue its market manipulation. The corporation resisted demands for data, and it was not clear who had the power to extract the information. It is emblematic that Marc Racicot, the Republican Party's new national chairman, was, and is, a lobbyist for--well, you know who.
Robert Kuttner is co-editor of The American Prospect and author of Everything for Sale.