Winners And Losers Of 2001 ; It was another tough year for investors. At least the turmoil in the markets flushed away some really bad ideas.
Fortune Magazine 

The Top 10 Business Stories ; Talk about a bad-news pileup. In one short year, the longest economic expansion in U.S. history screeched to a halt, the seventh-largest company in the nation self-destructed, and our world changed irrevocably when a few zealots stepped onto some airplanes. What follows are FORTUNE's picks for the most important business stories of an unforgettably tumultuous 2001.
Fortune Magazine 

All I Want For Christmas
Fortune Magazine 

The Geeks Who Rule The World ; There's a reason Moody's and S&P have been doing so well. Their customers can't say no.
Fortune Magazine 

Why Enron Went Bust ; Start with arrogance. Add greed, deceit, and financial chicanery. What do you get? A company that wasn't what it was cracked up to be.
Fortune Magazine 

Enron
Fortune Magazine 

Will The Economy Get Well Soon? ; The Fed has been slashing rates with a vengeance, but a credit squeeze could really hurt the recovery.
Fortune Magazine 

Enron Fallout: Wide, But Not Deep ; Enron's collapse has hurt big American banks. But not as much as a default by Argentina would.
Fortune Magazine 

Editor's Desk
Fortune Magazine 

Best & Worst 2001 ; Honest CEOs. Harebrained ad campaigns. Appalling outfits. They've all earned a place on our year-end list.
Fortune Magazine 

Power Player; Chuck Watson built Dynegy at blinding speed but was overshadowed by Enron. Now he's got the spotlight to himself.
Forbes Magazine 

THE FALL OF ENRON
AFTERSHOCKS IN EUROPE Enron's collapse will hit many markets
BusinessWeek 

THE FALL OF ENRON How ex-CEO Jeff Skilling's strategy grew so complex that even his boss couldn't get a handle on it
BusinessWeek 

ENRON: LET US COUNT THE CULPRITS
BusinessWeek 

Digging Into the Deal That Broke Enron; Behind the web of mysterious partnerships that led to the world's biggest corporate collapse. Follow the Raptors
Newsweek 



FORTUNE Advisor/Investing
Winners And Losers Of 2001 ; It was another tough year for investors. At least the turmoil in the markets flushed away some really bad ideas.
Lee Clifford

12/24/2001
Fortune Magazine 
Time Inc. 
155
(Copyright 2001) 

For an instant take on how 2001 treated investors, all you had to do was flick on your TV. Gone were the frenetic performance-touting spots of years past. In their place: dour Schwab ads in which founder Charles admonishes a mock town meeting of gray-clad investors, "You have to take the ups with the downs." 
Signs of new stock market sobriety were everywhere this year: CNBC viewership tumbled, ten rate cuts by Greenspan & Co. still couldn't stave off a recession, and highly paid analysts were not only stripped of celebrity status but also sued by investors (Mary Meeker) or humbled into accepting buyout packages (Henry Blodget). By early December the Nasdaq was down 17% for the year, the Dow had fallen 6%, and the S&P was off by 12%.
Then again, "there are so many scenarios you could have written that would have been so much worse," points out Roy Weitz, editor of FundAlarm.com. In fact, since the unprecedented four-day market shutdown and subsequent slide after the Sept. 11 attacks, the Dow has rebounded 13%. Given the year we've had--what with events like the Enron implosion, the Bass brothers' massive margin call, and the uproar over a giant diaphragm in Denver (read on for an explanation)- -it's entirely possible that the last few weeks of 2001 will bring even more surprises. Let's hope at least some of them are happy ones. 
S&P 500 standout: J.C. Penney led the pack for most of 2001 but late in the year was eclipsed by Nvidia, which makes graphics chips for Microsoft's Xbox, among other things. The company got an extra boost when it inherited Enron's spot on the S&P 500 and index fund managers raced to buy the stock. Gain for the year: 225%. 
S&P 500 laggard: Lending can be a risky business, especially if your niche is hawking credit cards to people with spotty credit histories just as the economy heads into a tailspin. Such was the fate of Providian Financial, which lost a full 95% of its value amid a spectacular run of credit card defaults. 
Best way to cash out: Selling your stake in a company you built is never easy, but if you're Tom Bailey, the company is Janus, and you have a "look back" provision in your contract allowing you to unload your shares at the 2000 price, which reaps $603 million--well, it tugs at the heartstrings a little less. 
Worst way to cash out: Margin calls are always ugly, but rarely quite as big--or as publicized--as the late-September fiasco in which longtime Disney shareholders Sid and Lee Bass (and their dad, Perry) were forced to sell 135 million shares for around $2 billion. It gets worse: Their shares fetched only $15 each in a private deal; Disney stock now trades for $22. 
Best fund: In a year marked by--at best--middling performances, the small-cap Schroder Ultra gained a stellar 62% by keeping lots of cash on hand (around 40%), using put options, and shorting stocks (like a hedge fund). The only drawback? The fund is closed to new investors. 
Best reason to manage your own money: Fund manager James McCall of the Merrill Lynch Focus Twenty. Merrill waged a bitter legal battle to lure the then-hot momentum manager from Pilgrim Baxter two years ago. It's no doubt regretting that decision now: McCall got his walking papers in November after the Focus fund, which held tech, telecom, and Enron, lost 70%. 
Worst reason to manage your own money: You may be a step ahead of McCall, but hanging on to your day job is probably a good idea, judging from the performance of so-called market-participation funds. At the IPS iFund, where shareholders nominate stock picks on a Website, collective wisdom precipitated a 37% decline for the year. The StockJungle.com Community Intelligence Fund, for its part, was put out of its misery in August after losing about 36%. 
Most awkward PR flub: When Denver fund company Invesco agreed to pay $120 million over 20 years to slap its name on the Broncos stadium, it was no doubt angling for good press. So when a Denver Post columnist wrote that Invesco's own employees had dubbed it the "Diaphragm," it had to hurt. Invesco threatened to sue but let up when it discovered that some staffers really did think the stadium bore a striking likeness to a gigantic birth-control device. 
Hottest IPO: Let's just say 2001 wasn't exactly an ideal year to take your company public. September, in fact, had the distinction of being the first month since 1975 in which there were no IPOs whatsoever. Yet there were a few success stories, including the best performer (from the date the company went public to present): a Mountain View, Calif., company called Verisity, which makes software to detect flaws in electronic systems. Since its March IPO, the stock has doubled. 
Should've stayed private: Bringing up the rear in the IPO brigade was Seattle sandwich maker Briazz: Rattled working people shunned its pricey gourmet sandwiches, and investors lost their appetite as well- -the stock is down 88% since the IPO in May. 
Nastiest boardroom battle: The acrimonious drama had more twists, turns, and 1980s-style backbiting than an episode of Dallas, but in the end Computer Associates founder and chairman Charles Wang triumphed over Texas investor Sam Wyly (who proposed a rival slate of directors, charging that Computer Associates had floundered under Wang's stewardship). 
Biggest boardroom upset: Lone shareholder Guy Adams got so fed up with Lone Star Steakhouse management that he ran against CEO Jamie Coulter for his board seat. Unbelievably, he won--by a reported 2.3 million votes. 
Most embarrassing Enron call: There was lots of competition here: bad calls, late calls, and gutless calls by analysts (not to mention the conference call in which CEO Jeffrey Skilling labeled one money manager an a--hole), but special distinction goes to Ron Barone of UBS Warburg, who lowered his rating on the stock from a strong buy to a hold--on Nov. 28, just days before Enron declared bankruptcy. Uh, thanks. 
Best makeover: The urge to merge raged this year as fund companies attempted to save face by folding hideous specialty funds into slightly less hideous tech funds. Strong Internet was merged into the Strong Technology 100 fund, and Merrill Lynch Internet Strategies was bled into the Merrill Lynch Global Technology fund. But proving yet again that it really is what's on the inside that counts, the Strong fund has so far lost 39%, and the Merrill fund is down 42%. 
Greatest career gamble: With a middling investing record on his resume, James Oberweis, dairy magnate and founder of the eponymous asset-management firm, announced he would vie for a U.S. Senate seat in Illinois. Perhaps in light of the markets' turbulence, anything looks easier than facing the Nasdaq. 
Best prediction for 2002: Finally, we wondered what investors could look forward to next year. Fund watchdog Weitz predicts that mutual fund marketing gurus are already dreaming up a spate of "new reality" funds filled with defense and biotech stocks. Not the most tasteful proposition, perhaps, but given this year's exploits, probably not far off the mark. Let's just hope it doesn't land them in the loser's circle next year. 
Feedback? investing@fortunemail.com

COLOR PHOTO: JOHN MUGGENBORG COLOR PHOTO: ANTHONY SAVIGNANO No Disney magic for the Basses, who got a margin call and had to sell COLOR PHOTO: PHOTOFEST [See caption above] COLOR PHOTO: WALTER P. CALLAHAN [See caption above] COLOR PHOTO: MARK ASNIN--CORBIS SABA Tom Bailey COLOR PHOTO: ED ANDRIESKI--AP Does this look like a diaphragm? Invesco employees think so. COLOR PHOTO COLOR PHOTO: REUTERS--TIMEPIX Charles Wang COLOR PHOTO: YVONNE BRANDWIJK Guy Adams COLOR PHOTO: SETH PERLMAN--AP James Oberweis 
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Features/The Year In Business
The Top 10 Business Stories ; Talk about a bad-news pileup. In one short year, the longest economic expansion in U.S. history screeched to a halt, the seventh-largest company in the nation self-destructed, and our world changed irrevocably when a few zealots stepped onto some airplanes. What follows are FORTUNE's picks for the most important business stories of an unforgettably tumultuous 2001.
Alynda Wheat

12/24/2001
Fortune Magazine 
Time Inc. 
113
(Copyright 2001) 

1. 9.11 That the World Trade Center attacks could leave New York City $100 billion in the red seems oddly beside the point. They destroyed thousands of lives and livelihoods, shattered our nation's sense of security, and plunged us into war. 
2. The Recession With the market melting down, consumer confidence evaporating, and joblessness rising, not even Alan Greenspan's ten rate cuts--and another expected this month--could stave off recession. At least you lived to see the biggest boom ever. Now wave bye-bye.
3. The Enron Implosion Thanks to the energy trader's dubious bookkeeping, Ken Lay went from running a $101 billion company to presiding over the biggest bankruptcy in history. 
4. California's Energy Crisis As energy became scarce, the state instituted rolling blackouts and spent $11 billion to bail out PG&E and SoCal Edison. While conservation stabilized soaring prices, the crisis--plus the Enron collapse--left the deregulation movement in tatters. 
5. Wall Street Analysts Henry Blodget and Mary Meeker were the poster children for Wall Street hype. But this was the year investors, burned by analysts' stock picks, stopped believing and started suing and booing. 
6. Team Bush No one expected much from the President and his advisors on foreign policy. The focus was supposed to be domestic policy, like the tax cut. Sept. 11 turned that around. Bush has emerged as a strong war leader, but his legacy could still depend upon reviving the economy. 
7. Telecom Meltdown If you think this Lucent office looks empty, ask one of the company's employees about his 401(k). The entire industry suffered stupefying losses thanks to bad investments and wishful thinking. 
8. China Being selected to host the 2008 Summer Olympics wasn't the country's only big win. After years of tense negotiation, China gained entry to the World Trade Organization. 
9. Microsoft Why is Bill Gates smiling? Maybe because his Teflon tech firm slipped a Justice Department noose, shook an avalanche of bad press, launched the XP operating system, and unveiled the coveted Xbox game console. 
10.Ford Chairman Bill Ford ousted bare-knuckled CEO Jacques Nasser after a year of nightmarish PR, pricey foreign investments that left the company scrounging for cash, and lawsuits that ended the nearly century-old relationship between Ford and Firestone. The scion has a tough road ahead.

COLOR PHOTO: MIKE KEPKA--SFC/CORBIS SABA California's energy crisis--one of the top ten business stories of 2001--inspired Rick and Karen Dorantes to cut their energy use in half by running appliances off car batteries. [T of C] COLOR PHOTO: PHOTOGRAPH BY JAMES NACHTWEY--VII ELEVEN COLOR PHOTOS: MARTIN SIMON--CORBIS SABA COLOR PHOTO: GREG SMITH--CORBIS SABA B/W PHOTO: MICHAEL LLEWELLYN COLOR PHOTO: ANNE KATRINE SENSTAD COLOR PHOTO: MICHELE ASSELIN COLOR PHOTO: J. SCOTT APPLEWHITE--AP COLOR PHOTO: SERGIO FERNANDEZ COLOR PHOTO: PHOTOGRAPH BY CHIEN-MIN CHUNG--REUTERS-TIMEPIX COLOR PHOTO: JEFF CHRISTENSEN--REUTERS-TIMEPIX COLOR PHOTO: JOHN HILLERY--REUTERS-TIMEPIX 
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First; While You Were Out
All I Want For Christmas
Stanley Bing

12/24/2001
Fortune Magazine 
Time Inc. 
55
(Copyright 2001) 

Dear Santa, 
I can't believe it's that time of year again. I hope this letter finds you in the best of health. I think I speak for everybody when I tell you that we've been very, very good this time around, so this is going to be a rather long list. Grab something wet, pull up a Barcalounger, and pay attention.
At the outset, let me say I consider it a miracle that this letter reached you at all. I figure you have security up the wazoo, what with all the wackos sending stuff through the snail mail. That whole drill has to make your job a lot tougher. Be patient, Santa, and don't cut corners. Don't get complacent. There's more than one evildoer who would love to take the blush out of the cheeks of a symbol of Western hedonism like you. But don't worry about this letter, of course! If there's any white powder on the envelope, it came from one of the freshly baked doughnuts I have waiting on the mantle for your upcoming visit! 
Anyhow, this year it's clear that many, many people are a lot more needy than I am, so in the spirit of the season I'm gonna ask for their presents first. 
I should start, I guess, with the poor folks at Andersen, the accounting and consulting firm. Boy, Santa, do those guys need some new calculators! Please get a whole bunch for them. They approved the books for the fellows over at Enron, whose earnings didn't turn out to really be what they said they were at first. Then they had to restate them. Was their collective face red! I'm sure if the Andersen people had better equipment, they wouldn't have screwed up like that with Enron, or with all the other corporations they seemingly permitted to wank around with their numbers in exchange for hefty consulting fees. 
While we're at it, I suppose we can't ignore the senior management that used to run Enron either. What a bunch of boneheads! But this is the holiday time of year, Santa, the season of forgiveness and giving, so why not make their executive homes your first stop? They need a lot, Santa. To start with, they're gonna want, like, thousands of hours of legal time from expensive firms, so give them that. And why not throw in a couple of files they can bake into cakes for later on? 
On your way out of town, forget about toys and games and stuff like that and just please leave a ton of money under the tree of every Enron employee, particularly the fired ones, and of course the older ones who thought they were going to have something to retire on. And as for the financial planners who allowed employees' 401(k)s to hold solely the company's stock, I suppose you should bring very special presents for them too...I can't think of what, though...How about we let the Enron work force figure that one out? 
There are so many business executives to think about this year too. Most of them you could make happy with fractional growth in Ebitda for the quarter. That would be a huge surprise, and you know how much executives like pleasant surprises! 
Bill Gates? You don't need to bring anything for him, Santa. He has just about everything, you know, and what he doesn't have, he can certainly take over and repackage as part of his operating system. But I guess you should try to make sure that there's an Xbox under every American child's tree this year, and a couple of games too, particularly the one where those buff girls in tiny Spandex outfits throw each other around. Just knowing he was making so many children happy would bring a seasonal smile to Bill's Microface. 
Oh. Make a very special trip to Carly Fiorina too. She's the woman who runs Hewlett-Packard, you know. She worked so hard this year and had so much aggravation, Santa, so...could you please make Walter Hewlett go away? He's the son of the founder, and he's being a real party pooper! He thinks that the merger is bad for a lot of stupid reasons...like something about how it will draw the company away from its core competencies in printing and focus it on the low-margin computer-manufacturing side of the business, but when you get right down to it, he's simply being a bummer, that's all. Please, Santa. Bring Carly her merger. She's staked her whole reputation--and her bonus next year--on the outcome, and, you know, any CEO who is willing to risk compensation on something must want it really, really bad. 
While you're at it, please bring John Chambers, the head of Cisco, a good stock price right away. The poor fellow has six million options riding on it. Four million of them are underwater, but more recently the company gave him two million more at a strike price of $18.50, and they should be worth something, don't you think? If you don't, Mr. Chambers will really feel that $268,131 he gave up in salary to show he knows that corporations should pay for performance and nothing less. 
Gee, this is getting kind of long, and I haven't even gotten to myself yet! So, just briefly, bring Alan Greenspan something nice but healthy, Santa--very, very healthy, no cigars or liquor. Vitamins! Yeah! And let's see...oh, yes, bring the Internet some genuine advertising revenue, will you? It could really use it. And don't forget to leave the folks over at the New York Times business section some Prozac. Or Viagra, maybe. Anything to cheer them up. 
For myself, now...well, I guess I have just about everything a man could want, so I'll just mention a few of the things I could do without. Bring me no cutbacks in my stocking, Santa, for me or my friends, and no smallpox, and no anthrax, and no particular reasons to travel anywhere by plane, at least for a while. And most of all please do not bring a suitcase with a nuclear weapon in it for anybody I know, and even the people I don't. Other than that, I could always use a new car. Anything will do, as long as the top goes down. And a phone even tinier than the one I have, to show I'm getting more powerful. And hey, keep this global warming going on. It's great! 
Now get busy, my man! You're gonna need plenty of time before takeoff this year, you know, to interview all the reindeer twice after conducting extensive background checks on all of them, especially Rudolph, whose nose always looked a little red to me, and to X-ray all those packages, no matter how small they might be, while making sure nothing has been placed in the baggage compartments underneath your sleigh by the grinches who want to steal a whole lot more than Christmas. Fly safe, Santa! We need you more than ever this year! 
Oh--and while you're over Iraq, if you happen to spot a suspicious factory or laboratory of any sort, don't forget to pop a nice little present down its chimney, from--and for--all of us. 
Feliz Navidad, baby! 
By day, STANLEY BING is a real executive at a real FORTUNE 500 company he'd rather not name. He can be reached at stanleybing@aol.com.

COLOR ILLUSTRATION: MILAN TRENC 
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Features/The Credit Watchers
The Geeks Who Rule The World ; There's a reason Moody's and S&P have been doing so well. Their customers can't say no.
Bethany McLean; Reporter Associate Doris Burke

12/24/2001
Fortune Magazine 
Time Inc. 
93
(Copyright 2001) 

On Nov. 28, when Standard & Poor's and then Moody's downgraded Enron's debt below the all-important status "investment grade," the company's bankruptcy became a foregone conclusion. The downgrades confirmed that Enron would no longer be able to support its trading operations by accessing the capital markets, and they triggered the repayment of billions of dollars of debt. 
But the one-two credit punches pointed not just to a TKO of Enron. They were also a reminder of the immense and seemingly ever- increasing power of the agencies themselves. A much-coveted triple-A rating (the highest grade) is the grease in an otherwise squeaky engine. It makes every aspect of doing business easier, from raising money to convincing customers that operations are solid. In contrast, an S&P or Moody's downgrade is a fearsome event that can dramatically increase a company's cost of capital, perhaps even destroy its ability to raise money. As one critic put it decades ago, they retain an "almost biblical authority."
That's because the rating agencies--private, for-profit companies that are privy to insider information--have come to play a quasi- regulatory role in the market. Many big investors, from pension funds to insur-ance companies to money market funds, are prohibited from owning more than a set amount of lower-rated debt, for instance. 
But while the Enron debacle is evidence of the agencies' power, it also brings some long-simmering criticism--think back to 1975, when the agencies failed to downgrade New York City's debt until the city's fiscal crisis was obvious--to a frothy boil. Critics say that the credit czars, for all their inside access, didn't identify this borrower's woes any earlier than the rest of us did--and they didn't downgrade the debt even after the severity of the problems was well known. Indeed, prior to the downgrades, Enron's debt was trading at around 50 cents on the dollar, a sign that the market had already dismissed the company's investment-grade status as farce. "The rating agencies are always late," grouses one portfolio manager. 
Of course, neither John Rutherfurd, the CEO of Moody's, nor Leo O'Neill, S&P's president, see things that way. "We communicated our view [that Enron's rating was dependent on its merger with Dynegy] clearly and frequently," says O'Neill. Adds Rutherford: "We do not want to rush to judgment nor do we delay in informing investors when we believe fundamentals have changed." 
How can the same entities be all-powerful and strangely after-the- fact at the same time? That is one of the more puzzling conundrums in today's capital markets. The nearly regulatory function of the agencies and the weight their opinions carry make their judgments critical--but also complicated. The agencies can be not just observers but active participants in the course of events. That's because a downgrade can become a self-fulfilling prophecy: If the rating agencies act too rashly, they could be accused of causing a bankruptcy. Yet if they deliberate too long, they'll simply be stating what everyone already knows--especially since today, unlike in the '70s, there is an army of outside fixed-income analysts that both challenge the rating agencies' judgments and profit from anticipating their actions. 
True, this debate rarely reaches Enron-esque proportions. And it's worth emphasizing that corporate debt is just a small part of these agencies' purviews. They analyze almost every fixed-income instrument out there, from the debt of China to the complex bonds backed by cash flows from, say, the Mississippi tobacco settlement. Their power, in fact, is very much entwined with that omnipresence. Moody's alone claims that it rates more than $30 trillion of the world's debt from over 100 countries, 4,200 corporations, and 68,000 public finance obligations. 
What's more, the agencies appear, in the wide lens of history, to be fairly accurate in their judgments: As both O'Neill and Rutherfurd note, it's rare that investment- grade credits go kaput. Both agencies have statistics showing that less than 1% of bonds rated A- or better default over a five-year period. In addition, around 85% of the credits in the domestic A class still hold the rating at year- end, implying stability in higher-rated bonds. 
But by its sheer size the Enron implosion challenges that perception of stability. And it draws attention to the agencies at a particularly interesting time--for Moody's especially. Until recently the actual businesses of Moody's and S&P were hidden away inside much larger companies. S&P is still buried within McGraw-Hill. But in October 2000, Dun & Bradstreet spun Moody's out as a separate company. For the first time ever, outsiders can perform a credit check on a rating agency. 
Combing through Moody's financials makes one thing perfectly clear: Credit rating is a fabulous business. Since its spinoff, Moody's stock has climbed--yes, climbed--some 40%, giving Moody's the same market value as Bear Stearns. This year the rating agency is expected to generate about $770 million in revenues (less than a tenth of Bear's revenues) and an astounding $382 million in operating income. And Moody's does this with just 1,600 employees. Perhaps it's not surprising that Warren Buffett's Berkshire Hathaway is the company's largest shareholder, owning just about 15% of the stock. Henry Berghoef of Harris Associates, another large Moody's holder, says that the biggest challenge facing CEO Rutherfurd is the proper management of the company's immense free cash flow. Rutherfurd himself, a scholarly, white-haired 62-year-old, has few complaints. "It's a big thrill," he says. 
Indeed, what's not to like? For one thing, Moody's potential customers almost can't say no. As Merrill analyst Joanne Park wrote in a recent report, "In many cases, a Moody's rating is practically a prerequisite for coming to market with a new issue of fixed-income securities." Like an investment bank, Moody's is a big beneficiary of the long-term growth in the capital markets--without even having to risk its own capital. Kevin Gruneich, an analyst at Bear Stearns, calculates that over the past 20 years Moody's revenue and profits grew at compound annual rates of 16% and 15%, respectively--a growth trend he terms "incredible." (Rutherfurd adds that in the past 20 years, profits have fallen only once, in 1994.) In recent years Moody's has stabilized its revenue still further, basically creating an annuity stream by instituting what it calls "relationship pricing." Instead of hiring Moody's on a transactional basis, some of its customers now pay an annual fee; in return, Moody's rates every bond issue they do. "Relationship pricing" now accounts for 36% of Moody's revenues. 
Both Moody's and S&P have also done a remarkable job of keeping pace with innovations in the capital markets. Witness the explosion of a new type of debt known as "structured finance"--a bond, for instance, backed by the cash flow from residential mortgages. Here the rating is everything: It measures the level of risk in an extremely complicated security and determines the yield that must be paid to attract investors. "The rating agencies play an integral role in distributing paper into the marketplace," says Kevin Rigby, head of Deutsche Bank's rating advisory business, which helps Deutsche's clients argue their cases to the rating agencies. (In yet another indication of the agencies' power, many of the major investment banks have entire departments that do this.) Structured finance is now Moody's largest business, accounting for one-third of its revenues, up from almost nothing in the late 1980s. 
As Moody's pushes aggressively into new markets, it has expanded its power base as well. Rutherfurd is especially excited about Europe, which currently accounts for about 20% of the company's sales. He notes happily that there are about 1,500 unrated companies with revenues greater than one billion euros. "Money coming out of banking and into the capital markets should propel growth in ratings for the next decade," he says, quickly adding, "But we love banks too." Indeed. Recently the Basel Committee on Banking Supervision proposed that ratings be used globally to determine banks' capital adequacy. (The proposal seems to be on hold for now.) 
This is certainly not a state of affairs that John Moody would have imagined when he began providing statistics on railroad bonds back in 1909. In the beginning it was all very simple: Investors paid for Moody's research, which helped disseminate important information to the market. Some two decades later the government was mandating that banks use ratings to determine the values of their investment portfolios. Then, in the second half of the century, the SEC began to rely on ratings to determine what sort of securities insurance companies, pension plans, broker-dealers, and money market funds could own. Both Moody's and S&P resisted those developments for a number of reasons--but they didn't say no. "I don't think that ratings should be used to determine investment policy," O'Neill maintains today; Moody's has written a number of letters protesting the use of ratings in regulatory policy. 
Another substantial change occurred around 1970. Prior to that time Moody's and S&P had always earned their keep from investor subscriptions. Given the growing volume of work, however, those economics no longer made sense. So first Moody's and then S&P began to charge issuers instead. There's a constant worry that this poses a conflict of interest. But unlike equity analysts, the credit analysts don't have to worry about buying business with favorable ratings. Companies simply don't have a lot of choice. 
The most controversial development came in 1975 when the SEC, worried that fly-by-night rating agencies could wreak havoc on the market, initiated a mouthful of a designation, the "nationally recognized statistical rating organization," or NSRSO. To comply with various SEC regulations, a company's rating had to come from an NSRSO- -essentially, Moody's, S&P, or Fitch, a smaller competitor that is a subsidiary of French concern Fimalac. The designation has become the subject of intense debate. "The SEC has enveloped [the agencies] in a very protective webbing that keeps anyone else from challenging them," says Lawrence White, an economics professor at NYU. "There they are, a 2 1/2-firm industry, sitting pretty." But no one has a better idea. Says Rick Roberts, a former SEC commissioner who is now an attorney at Thelen Reid & Priest: "It's a very uncomfortable situation, but it's impractical to take out what is already there." 
There have been other complaints about the clout the agencies have- -Moody's in particular. In the early 1990s allegations began to swirl that Moody's bullied municipalities into hiring it by issuing unsolicited (and negative) ratings to those that declined the offer. One Colorado school district sued the rater after it made negative comments about a pending bond sale, claiming that investors used the pan to demand a higher interest rate, resulting in a net loss of $769,000. The court ruled that Moody's ratings were opinions, not facts--and therefore the company was protected under the First Amendment. 
But that hardly settles the broader issue: In the capital markets the ratings can function as facts even if they aren't. That's because of the numerous regulations that are built around them. The Continental Divide is between investment-grade securities and non- investment-grade securities, because many investors, like pension funds and insurance companies, are permitted to own only a certain quantity of lower-quality bonds. And many money market funds are allowed to have just 5% of their assets in commercial paper that doesn't carry a top rating. So when Moody's and S&P downgraded Ford Motor's debt in October, Gary Zeltzer, head of investment-grade fixed income at J.W. Seligman, had no choice but to sell. (While Ford's debt sold off on the downgrade, it now trades at a better price than it did before.) 
And that brings us back to the Enron question: How much should credit ratings anticipate the verdict of the stock market? O'Neill insists that his firm cannot afford to rush to judgment; it doesn't bother him at all, he says, if a bond trades at a different level than its rating implies: "The market tends to be much more near-term focused. We need to be diligent and make sure we do our work." Richard Waugh, an analyst at the Principal Financial Group, agrees. "What [the agencies] do moves markets and affects the flow of capital. So they have to make very sure that they're right, and they lean over backward to accomplish that." 
But Moody's Rutherfurd has a different point of view. "If a credit is deteriorating, we want to be the first to spot it," he says. He jumps up to an easel, looking very professorial, to talk about the "Merton model"--basically, a way of incorporating the judgment of the equity market into ratings. In his view, that's important, because the equity market is forward-looking, whereas accounting data are reflective of the past. "We think we're way ahead of S&P in doing this," he boasts. Nor does Rutherfurd seem to bristle at the recent criticism. "I hate the word 'optimal,' " he says. "But we do the best we can, and we think it's pretty good." 
That "pretty good" is likely to be as good as it gets--barring a few more Enron-caliber events, the credit-rating system isn't likely to change. As First Union analyst Asa Graves says of Moody's, "They would have to really shoot themselves in the foot to lose serious market position." 
REPORTER ASSOCIATE Doris Burke 
FEEDBACK: bmclean@fortunemail.com

COLOR PHOTO: PHOTOGRAPH BY MATTHEW SALACUSE Creditworthy John Rutherfurd, Moody's CEO, in his New York office COLOR CHART: FORTUNE CHART Moody's Big Move Stock price index Nov. 30, 2000 = 100 Moody's S&P 500 B/W PHOTO John Moody, the founding father COLOR PHOTO: MICHELE ASSELIN Leo O'Neill is content with S&P's role. 
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Features/Cover Stories
Why Enron Went Bust ; Start with arrogance. Add greed, deceit, and financial chicanery. What do you get? A company that wasn't what it was cracked up to be.
Bethany McLean; Additional Reporting by Nicholas Varchaver, John Helyar, ; Janice Revell, and Jessica Sung

12/24/2001
Fortune Magazine 
Time Inc. 
58
(Copyright 2001) 

"Our business is not a black box. It's very simple to model. People who raise questions are people who have not gone through it in detail. We have explicit answers, but people want to throw rocks at us." 
So said Enron's then-CEO, Jeff Skilling, in an interview I had with him last February. At the time--less than ten months ago, let's recall--Enron's market capitalization was around $60 billion, just a shade below its all-time high, and its status as a Wall Street darling had not yet begun to crumble. I was working on a story that would ultimately raise questions about Enron's valuation, and I'd called with what I considered fairly standard queries in an effort to understand its nearly incomprehensible financial statements. The response from Enron was anything but standard. Skilling quickly became frustrated, said that the line of inquiry was "unethical," and hung up the phone. A short time later Enron spokesperson Mark Palmer called and offered to come to FORTUNE's New York City office with then-CFO Andy Fastow and investor-relations head Mark Koenig. "We want to make sure we've answered your questions completely and accurately," he said.
Now, in the wake of Enron's stunning collapse, it looks as if the company's critics didn't throw enough rocks. The world is clamoring for those "explicit answers," but Skilling, long gone from Enron-- and avoiding the press on the advice of his lawyers--is in no position to provide them. As for "completely and accurately," many would argue that the men running Enron never understood either concept. "One way to hide a log is to put it in the woods," says Michigan Democrat John Dingell, who is calling for a congressional investigation. "What we're looking at here is an example of superbly complex financial reports. They didn't have to lie. All they had to do was to obfuscate it with sheer complexity--although they probably lied too." 
Until recently Enron would kick and scream at the notion that its business or financial statements were complicated; its attitude, expressed with barely concealed disdain, was that anyone who couldn't understand its business just didn't "get it." Many Wall Street analysts who followed the company were content to go along. Bulls, including David Fleischer of Goldman Sachs, admitted that they had to take the company's word on its numbers--but it wasn't a problem, you see, because Enron delivered what the Street most cared about: smoothly growing earnings. Of course, now that it's clear that those earnings weren't what they appeared, the new cliche is that Enron's business was incredibly complicated--perhaps even too complicated for founder Ken Lay to understand (something Lay has implied since retaking the CEO title from Skilling last summer). Which leads to a basic question: Why were so many people willing to believe in something that so few actually understood? 
Of course, since the Enron collapse, there are other basic questions as well--questions for which there are still no adequate answers. Even today, with creditors wrangling over Enron's skeletal remains while the company tries desperately to find a backer willing to keep its trading operations in business, outsiders still don't know what went wrong. Neither do Enron's employees, many of whom expressed complete shock as their world cratered. Was Enron's ultimate collapse caused by a crisis of confidence in an otherwise solid company? Or were the sleazy financial dealings that precipitated that crisis--including mysterious off-balance-sheet partnerships run by Enron executives--the company's method of covering up even deeper issues in an effort to keep the stock price rising? And then there's the question that's been swirling around the business community and in Enron's hometown of Houston: Given the extent to which financial chicanery appears to have take place, is someone going to jail? 
A CULTURE OF ARROGANCE 
If you believe the old saying that "those whom the gods would destroy they first make proud," perhaps this saga isn't so surprising. "Arrogant" is the word everyone uses to describe Enron. It was an attitude epitomized by the banner in Enron's lobby: THE WORLD'S LEADING COMPANY. There was the company's powerful belief that older, stodgier competitors had no chance against the sleek, modern Enron juggernaut. "These big companies will topple over from their own weight," Skilling said last year, referring to old-economy behemoths like Exxon Mobil. A few years ago at a conference of utility executives, "Skilling told all the folks he was going to eat their lunch," recalls Southern Co. executive Dwight Evans. ("People find that amusing today," adds Evans.) Or how about Skilling's insistence last winter that the company's stock--then about $80 a share--should sell for $126 a share? Jim Alexander, the former CFO of Enron Global Power & Pipelines, which was spun off in 1994, once worked at Drexel Burnham Lambert and sees similarities. "The common theme is hubris, an overweening pride, which led people to believe they can handle increasingly exotic risk without danger." 
To be sure, for a long time it seemed as though Enron had much to be arrogant about. The company, which Ken Lay helped create in 1985 from the merger of two gas pipelines, really was a pioneer in trading natural gas and electricity. It really did build new markets for the trading of, say, weather futures. For six years running, it was voted Most Innovative among FORTUNE's Most Admired Companies. Led by Skilling, who had joined the company in 1990 from consulting firm McKinsey (he succeeded Lay as CEO in February 2001), Enron operated under the belief that it could commoditize and monetize anything, from electrons to advertising space. By the end of the decade, Enron, which had once made its money from hard assets like pipelines, generated more than 80% of its earnings from a vaguer business known as "wholesale energy operations and services." From 1998 to 2000, Enron's revenues shot from $31 billion to more than $100 billion, making it the seventh-largest company on the FORTUNE 500. And in early 2000, just as broadband was becoming a buzzword worth billions in market value, Enron announced plans to trade that too. 
But that culture had a negative side beyond the inbred arrogance. Greed was evident, even in the early days. "More than anywhere else, they talked about how much money we would make," says someone who worked for Skilling. Compensation plans often seemed oriented toward enriching executives rather than generating profits for shareholders. For instance, in Enron's energy services division, which managed the energy needs of large companies like Eli Lilly, executives were compensated based on a market valuation formula that relied on internal estimates. As a result, says one former executive, there was pressure to, in effect, inflate the value of the contracts--even though it had no impact on the actual cash that was generated. 
Because Enron believed it was leading a revolution, it encouraged flouting the rules. There was constant gossip that this rule breaking extended to executives' personal lives--rumors of sexual high jinks in the executive ranks ran rampant. Enron also developed a reputation for ruthlessness, both external and internal. Skilling is usually credited with creating a system of forced rankings for employees, in which those rated in the bottom 20% would leave the company. Thus, employees attempted to crush not just outsiders but each other. "Enron was built to maximize value by maximizing the individual parts," says an executive at a competing energy firm. Enron traders, he adds, were afraid to go to the bathroom because the guy sitting next to them might use information off their screen to trade against them. And because delivering bad news had career-wrecking potential, problems got papered over--especially, says one former employee, in the trading operation. "People perpetuated this myth that there were never any mistakes. It was astounding to me." 
TRADING SECRETS 
"We're not a trading company," said Fastow during that February visit. "We are not in the business of making money by speculating." He also pointed out that over the past five years, Enron had reported 20 straight quarters of increasing income. "There's not a trading company in the world that has that kind of consistency," he said. "That's the check at the end of the day." 
In fact, it's next to impossible to find someone outside Enron who agrees with Fastow's contention. "They were not an energy company that used trading as a part of their strategy, but a company that traded for trading's sake," says Austin Ramzy, research director of Principal Capital Income Investors. "Enron is dominated by pure trading," says one competitor. Indeed, Enron had a reputation for taking more risk than other companies, especially in longer-term contracts, in which there is far less liquidity. "Enron swung for the fences," says another trader. And it's no secret that among non- investment banks, Enron was an active and extremely aggressive player in complex financial instruments such as credit derivatives. Because Enron didn't have as strong a balance sheet as the investment banks that dominate that world, it had to offer better prices to get business. "Funky" is a word that is used to describe its trades. 
But there's an obvious explanation for why Enron didn't want to disclose the extent to which it was a trading company. For Enron, it was all about the price of the stock, and trading companies, with their inherently volatile earnings, simply aren't rewarded with rich valuations. Look at Goldman Sachs: One of the best trading outfits in the world, its stock rarely sells for more than 20 times earnings, vs. the 70 or so multiple that Enron shares commanded at their peak. You'll never hear Goldman's management predicting the precise amount it will earn next year--yet Enron's management predicted earnings practically to the penny. The odd mismatch between what Enron's management said and what others say isn't just an academic debate. The question goes to the heart of Enron's valuation, which was based on its ability to generate predictable earnings. 
Why didn't that disconnect seem to matter? Because like Enron's management, investors cared only about the stock price too. And as long as Enron posted the earnings it promised (and talked up big ideas like broadband), the stock price was supposed to keep on rising- -as, indeed, it did for a while. Institutions like Janus, Fidelity, and Alliance Capital piled in. Of course, earnings growth isn't the entire explanation for Wall Street's attitude. There were also the enormous investment-banking fees Enron generated. Nor was asking questions easy. Wall Streeters find it hard to admit that they don't understand something. And Skilling was notoriously short with those who didn't immediately concur with the Enron world-view. "If you didn't act like a light bulb came on pretty quick, Skilling would dismiss you," says one portfolio manager. "They had Wall Street beaten into submission," he adds. 
WHERE ARE THE PROFITS? 
Although it's hard to pinpoint the exact moment the tide began to turn against Enron, it's not hard to find the person who first said that the emperor had no clothes. In early 2001, Jim Chanos, who runs Kynikos Associates, a highly regarded firm that specializes in short- selling, said publicly what now seems obvious: No one could explain how Enron actually made money. Chanos also pointed out that while Enron's business seemed to resemble nothing so much as a hedge fund-- "a giant hedge fund sitting on top of a pipeline," in the memorable words of Doug Millett, Kynikos' chief operating officer--it simply didn't make very much money. Enron's operating margin had plunged from around 5% in early 2000 to under 2% by early 2001, and its return on invested capital hovered at 7%--a figure that does not include Enron's off-balance-sheet debt, which, as we now know, was substantial. "I wouldn't put my money in a hedge fund earning a 7% return," scoffed Chanos, who also pointed out that Skilling was aggressively selling shares--hardly the behavior of someone who believed his $80 stock was really worth $126. 
Not only was Enron surprisingly unprofitable, but its cash flow from operations seemed to bear little relationship to reported earnings. Because much of Enron's business was booked on a "mark to market" basis, in which a company estimates the fair value of a contract and runs quarterly fluctuations through the income statement, reported earnings didn't correspond to the actual cash coming in the door. That isn't necessarily bad--as long as the cash shows up at some point. But over time Enron's operations seemed to consume a lot of cash; on-balance-sheet debt climbed from $3.5 billion in 1996 to $13 billion at last report. 
Skilling and Fastow had a simple explanation for Enron's low returns. The "distorting factor," in Fastow's words, was Enron's huge investments in international pipelines and plants reaching from India to Brazil. Skilling told analysts that Enron was shedding those underperforming old-line assets as quickly as it could and that the returns in Enron's newer businesses were much, much higher. It's undeniable that Enron did make a number of big, bad bets on overseas projects--in fact, India and Brazil are two good examples. But in truth, no one on the outside (and few people inside Enron) can independently measure how profitable--or more to the point, how consistently profitable--Enron's trading operations really were. A former employee says that Skilling and his circle refused to detail the return on capital that the trading business generated, instead pointing to reported earnings, just as Fastow did. By the late 1990s much of Enron's asset portfolio had been lumped in with its trading operations for reporting purposes. Chanos noted that Enron was selling those assets and booking them as recurring revenue. In addition, Enron took equity stakes in all kinds of companies and included results from those investments in the figures it reported. 
Chanos was also the first person to pay attention to the infamous partnerships. In poring over Enron documents, he took note of an odd and opaque mention of transactions that Enron and other "Entities" had done with a "Related Party" that was run by "a senior officer of Enron." Not only was it impossible to understand what that meant, but it also raised a conflict-of-interest issue, given that an Enron senior executive--CFO Fastow, as it turns out--ran the "Related Party" entities. These, we now know, refer to the LJM partnerships. 
When it came to the "Related Party" transactions, Enron didn't even pretend to be willing to answer questions. Back in February, Fastow (who at the time didn't admit his involvement) said that the details were "confidential" because Enron "didn't want information to get into the market." Then he explained that the partnerships were used for "unbundling and reassembling" the various components of a contract. "We strip out price risk, we strip out interest rate risk, we strip out all the risks," he said. "What's left may not be something that we want." The obvious question is, Why would anyone else want whatever was left either? But perhaps that didn't matter, because the partnerships were supported with Enron stock--which, you remember, wasn't supposed to decline in value. 
SKILLING SENDS A SIGNAL 
By mid-August enough questions had been raised about Enron's credibility that the stock had begun falling; it had dropped from $80 at the beginning of the year to the low 40s. And then came what should have been the clearest signal yet of serious problems: Jeff Skilling's shocking announcement that he was leaving the company. Though Skilling never gave a plausible reason for his departure, Enron dismissed any suggestion that his departure was related to possible problems with the company. Now, however, there are those who speculate that Skilling knew the falling stock price would wreak havoc on the partnerships--and cause their exposure. "He saw what was coming, and he didn't have the emotional fortitude to deal with it," says a former employee. 
What's astonishing is that even in the face of this dramatic--and largely inexplicable--event, people were still willing to take Enron at its word. Ken Lay, who stepped back into his former role as CEO, retained immense credibility on Wall Street and with Enron's older employees, who gave him a standing ovation at a meeting announcing his return. He said there were no "accounting issues, trading issues, or reserve issues" at Enron, and people believed him. Lay promised to restore Enron's credibility by improving its disclosure practices, which he finally admitted had been less than adequate. 
Did Lay have any idea of what he was talking about? Or was he as clueless as Enron's shareholders? Most people believe the latter. But even when Lay clearly did know an important piece of information, he seemed to be more inclined to bury it, Enron-style, than to divulge it. After all, Enron's now infamous Oct. 16 press release--the one that really marked the beginning of the end, in which it announced a $618 million loss but failed to mention that it had written down shareholders' equity by a stunning $1.2 billion--went out under Lay's watch. And Lay failed to mention a critical fact on the subsequent conference call: that Moody's was considering a downgrade of Enron's debt. (Although Skilling said last February that Enron's off-balance- sheet debt was "non-recourse" to Enron, it turns out that that wasn't quite true either. Under certain circumstances, including a downgrade of Enron's on-balance-sheet debt below investment grade, Enron could be forced to repay it.) 
Indeed, facing a now nearly constant barrage of criticism, Enron seemed to retreat further and further from Lay's promises of full disclosure. The rather vague reason that Enron first gave for that huge reduction in shareholders' equity was the "early termination" of the LJM partnerships. That was far from enough to satisfy investors, especially as the Wall Street Journal began to ferret out pieces of information related to the partnerships, including the fact that Fastow had been paid millions for his role at the LJMs. As recently as Oct. 23, Lay insisted that Enron had access to cash, that the business was "performing very well," and that Fastow was a standup guy who was being unnecessarily smeared. The very next day Enron announced that Fastow would take a leave of absence. 
We now know, of course, that Enron's dealings with its various related parties had a huge impact on the earnings it reported. On Nov. 8, an eye-popping document told investors that Enron was restating its earnings for the past 4 3/4 years because "three unconsolidated entities should have been consolidated in the financial statements pursuant to generally accepted accounting principles." The restatement reduced earnings by almost $600 million, or about 15%, and contained a warning that Enron could still find "additional or different information." 
And sophisticated investors who have scrutinized the list of selected transactions between Enron and its various partnerships are still left with more questions than answers. The speculation is that the partnerships were used to even out Enron's earnings. Which leads to another set of questions: If Enron had ceased its game playing and come completely clean, would the company have survived? Or did Enron fail to come clean precisely because the real story would have been even more scandalous? 
THE LAST GASP 
On the surface, the facts that led to Enron's Dec. 2 bankruptcy filing are quite straightforward. For a few weeks it looked as if Dynegy (which had long prided itself on being the anti-Enron) would bail out its flailing rival by injecting it with an immediate $1.5 billion in cash, secured by an option on Enron's key pipeline, Northern Natural Gas, and then purchasing all of Enron for roughly $10 billion (not including debt). But by Nov. 28 the deal had fallen apart. On that day Standard & Poor's downgraded Enron's debt below investment grade, triggering the immediate repayment of almost $4 billion in off-balance-sheet debt--which Enron couldn't pay. 
But even this denouement comes with its own set of plot twists. Both companies are suing each other: Enron claims that Dynegy wrongfully terminated the deal, "consistently took advantage of Enron's precarious state to further its own business goals," and as a result has no right to Enron's Northern Natural pipeline. Dynegy calls Enron's suit "one more example of Enron's failure to take responsibility for its demise." No one can predict how the suits will pan out, but one irony is clear: Enron, that new-economy superstar, is battling to hang on to its very old-economy pipeline. 
To hear Dynegy tell it, a central rationale for abandoning the deal was what might be called the mystery of the missing cash. General counsel Ken Randolph says that Dynegy expected Enron to have some $3 billion in cash--but an Enron filing revealed just over $1 billion. "We went back to Enron and we asked, 'Where did the cash go? Where did the cash go?' " says CEO Chuck Watson. "Perhaps their core business was not as strong as they had led us to believe," speculates Randolph. Dynegy also claims that Enron tried to keep secrets to the last. Enron's lack of cash was revealed to the world in a filing on the afternoon of Monday, Nov. 19. Watson says he got the document only a few hours earlier--but that Lay had a copy on Friday. "I was not happy," says Watson. "It's not good form to surprise your partner." 
Sagas like this one inevitably wind up in the courts--and Enron's is no exception. Given that credit-rating agency Fitch estimates that even senior unsecured-debt holders will get only 20% to 40% of their money back, the battles among Enron's various creditors are likely to be fierce. Nor has Enron itself conceded yet. The company's biggest lenders, J.P. Morgan Chase and Citigroup, have extended $1.5 billion of "debtor in possession" financing to Enron, which will enable it to continue to operate at least for a while. And Enron is still searching for a bank that will back it in restarting its trading business. 
In the meantime, the courts will also be trying to answer a key question: Who should pay? Enron's Chapter 11 filing automatically freezes all suits against the company itself while the bankruptcy is resolved. But while Enron may seek the same protection for its executives, lawyers predict that the attempt will fail and that the individuals will have to fend off a raft of suits. Some think that criminal charges are a possibility for former executives like Skilling and Fastow. But such cases require proof of "knowing, willful, intentional misconduct," says well-known defense attorney Ira Sorkin. And a criminal case requires a much higher standard of proof than a civil case: proof beyond a reasonable doubt rather than a preponderance of the evidence. That's a high bar, especially since Enron executives will probably claim that they had Enron's auditor, Arthur Andersen, approving their every move. With Enron in bankruptcy, Arthur Andersen is now the deepest available pocket, and the shareholder suits are already piling up. 
In any conversation about Enron, the comparison with Long-Term Capital Management invariably crops up. In some ways, it looks as if the cost of the Enron debacle is far less than that of LTCM--far less than anyone would have thought possible, in fact (see next story). But in other ways the cost is far greater. Enron was a public company with employees and shareholders who counted on management, the board, and the auditors to protect them. That's why one senior Wall Streeter says of the Enron saga, "It disgusts me, and it frightens me." And that's why, regardless of how the litigation plays out, it feels as though a crime has been committed. 
FEEDBACK: bmclean@fortunemail.com 
Additional reporting by Nicholas Varchaver, John Helyar, Janice Revell, and Jessica Sung 
Quote: Among the still unanswered questions swirling around Enron is this one: Is someone going to wind up in jail? A Wall Street exec says of the Enron saga: "It disgusts me, and it frightens me."

COLOR PHOTO: PHOTOGRAPH BY PAUL HOWELL--GETTY IMAGES COVER The Enron Disaster Lies. Arrogance. Betrayal. How Ken Lay and his team destroyed America's seventh-largest corporation COLOR PHOTO: PHOTOGRAPH BY GREG SMITH--CORBIS SABA After the collapse: Stunned employees leave Enron's Houston headquarters. COLOR PHOTO: GREG SMITH--CORBIS SABA When Dynegy's Chuck Watson (right) abandoned the deal he'd struck with Ken Lay, Enron's bankruptcy was assured. COLOR PHOTO: JENNIFER BINDER When Jeff Skilling bailed out in August, it was a clear signal that something was wrong. COLOR CHART: FORTUNE CHART It took Enron four years to add $50 billion in market cap... ...and only ten months to destroy it all COLOR PHOTO: DERON NEBLETT Lay insisted that CFO Fastow was being smeared. The next day he was gone. 
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First
Enron
Jason Tanz

12/24/2001
Fortune Magazine 
Time Inc. 
28
(Copyright 2001) 

Maybe Enron's downfall shouldn't have come as such a big surprise after all. In September the bankrupt energy concern paid $10,000 to sponsor this sculpture as part of CowParade Houston 2001, the latest iteration of the fundraiser-cum-public-art-project. The cow--called Moost Imoovative and created by Jason C. Alkire--sat in front of Enron headquarters through early November. In retrospect it could be seen as a warning: The bovine, like its sponsor, is a house of mirrors, reflecting the viewer but offering no insight into its content. On Dec. 6 the cow was sold at a charity auction for $8,000. Heck, is the whole company even worth that much? 
--Jason Tanz


COLOR PHOTO 
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Features/The Recovery
Will The Economy Get Well Soon? ; The Fed has been slashing rates with a vengeance, but a credit squeeze could really hurt the recovery.
Anna Bernasek

12/24/2001
Fortune Magazine 
Time Inc. 
89
(Copyright 2001) 

When it comes to recessions, economists believe in a simple rule of thumb: Pump money and credit into an ailing economy, and before long you have a recovery. The bigger the injection, the stronger the rebound. So between Alan Greenspan's yearlong campaign to slash interest rates and the government's latest stimulus package, totaling $75 billion, we should get one mind-blowing recovery, right? After all, the last time we pumped so much money into the economy was in the early 1960s, and things turned out pretty groovy back then. 
Unfortunately, it may not be so simple this time. Eight months into this recession, consumers are still buying big-ticket items like cars and homes. While that has kept the economy from totally tanking, it leaves little pent-up consumer demand to drive a fast recovery. So it's all up to corporate America--which, you'll recall, got us into this mess in the first place. As Mark Zandi, chief economist of Economy.com, puts it, "The difference between a strong recovery and a disappointing one will depend on business investment."
And on that score, there's cause for concern, if not outright agita. Most worrying are early signs of a credit squeeze as banks tighten up on corporate lending. If that continues, the recovery may not be right around the corner, as many economists are now predicting- -or if it is, it won't feel like much of one. Here's what's going on. 
Since the terrorist attacks of Sept. 11, many banks have turned hypercautious. According to the Federal Reserve's survey of senior loan officers, the most comprehensive picture of banks' willingness to lend, 51% of domestic banks restricted their lending in October, up from 40% in August. Foreign banks became just as wary, and the tougher credit conditions are affecting firms of all sizes across the country. "We've become more conservative in our lending," admits George Andrews, president of Capitol City Bank & Trust in Atlanta. "We're turning down customers we would have lent to a year ago." 
Banks are making it tougher for business to borrow in other ways too. According to the same Fed survey, more than half of domestic banks in October raised the rate they charge on riskier corporate loans. At the same time, a growing number of banks have imposed more stringent loan covenants and collateral requirements on large and medium-sized companies. All this took place even as the Fed was slashing short-term interest rates to stimulate business investment. Indeed, as we'll see later, what should be one of the best times ever to borrow money isn't turning out that way at all for most companies. There's one notable exception--large, well-known firms have taken advantage of a bonanza in the corporate bond market--yet here, too, that borrowing window seems to be closing as the market for commercial paper, for example, has dried up. 
So what's making banks so jittery? Blame Osama. Jay Sidhu, CEO of Sovereign Bank in Pennsylvania, says Sept. 11 introduced a lot more uncertainty for corporate earnings, leading banks to worry about the quality of loans. "Suddenly a firm that expected sales of X was not going to achieve that, and it made us more cautious," he explains. "I think the majority of banks reacted in the same way." Now Sidhu is looking for tangible improvement in the economy before he's willing to lend freely. In particular, he's closely watching consumer confidence, employment, and investment in technology for signs of a sustained rebound. 
Once Sidhu becomes less squeamish, other bankers probably won't be far behind. "Bankers are herdlike in their behavior," says Zandi. "They've trained in the same way, go to the same conferences, and talk to one another, so when one bank makes a change, the others follow." The trouble is, even when banks become more optimistic, there's a lag effect before easier credit benefits the economy. Researchers at the New York Fed have found that it can take at least three months from the time banks increase the availability of credit to when firms spend the funds. 
So how bad could it get? Think back to the last time banks lost their nerve--the early 1990s. Although it's hard to remember anything negative happening at all during the 1990s nirvana, we did experience a full-blown credit crunch at the start of the decade. That's the reason the recovery from the 1990-91 recession felt so lackluster. In fact, the media dubbed it the "jobless recovery" because firms simply couldn't get the funds they needed from banks to expand operations and hire more staff. At the time, remember, banks were saddled with bad loans following a commercial property bust. Happily, that's not the case today. "Right now we don't have anything like the real estate crisis of the late '80s," says Richard Berner, Morgan Stanley's chief U.S. economist. "It's not about a problem with capital but with confidence." Still, another corporate collapse a la Enron, and banks might find their capital base isn't as strong as they thought. That's one of the things about economic slumps. Loan quality can deteriorate virtually overnight. 
While we may well avoid a Grade A credit crunch this recession, it's clear we won't return to the days of easy money that financed the boom of the '90s anytime soon. The main reason is that the conditions for business investment aren't nearly as ideal as they were in the 1990s. As the recovery got under way back then, Washington was reducing the federal budget deficit, which brought long-term interest rates down steadily. Today we face the opposite situation. The surplus has vanished, and the prospect of mounting deficits is fast becoming reality. That's one reason long-term interest rates have hardly budged this year although official short- term rates plunged from 6.5% to 2%. Since Greenspan started cutting rates in January, 30-year bond yields have edged down from 5.5% to a mere 5.35%, and ten-year yields went from 5.31% to 5%. 
While the talk on Wall Street is all about recovery, with markets staging a dramatic rally since their post-Sept. 11 lows, the business environment remains grim--profit margins are at 19-year lows, there's excess capacity at every turn, and aggressive price discounting is rampant. Not exactly the best combination to encourage firms to invest now, is it? And that's reflected in the latest figures, which show that the steep decline in business investment that began a year ago is continuing today. Real business spending on plant and equipment dropped 11.9% in the third quarter, and new orders for capital goods in November suggest a further sharp drop for the fourth quarter. "Both leading indicators and current conditions point to further declines in capital spending," says Prudential economist Richard Rippe. "We're expecting next year to be just as weak on an annual basis." 
So are we looking at a replay of the jobless recovery? One discouraging sign: The unemployment rate climbed to 5.7% in November, up from 5.4% the previous month. But that doesn't mean all is lost. After all, the anemic recovery at the start of the 1990s was followed by some pretty good times. 
FEEDBACK: abernasek@fortunemail.com

COLOR ILLUSTRATION: ILLUSTRATION BY ALISON SEIFFER TWO COLOR CHARTS: FORTUNE CHARTS/SOURCE: FEDERAL RESERVE Bank loans: more expensive and tougher to get Before Sept. 11, credit conditions were becoming easier for business. Not anymore. Net percentage of banks raising the cost of loans Net percentage of banks tightening loan standards 
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Features/Cover Stories
Enron Fallout: Wide, But Not Deep ; Enron's collapse has hurt big American banks. But not as much as a default by Argentina would.
Nelson D. Schwartz

12/24/2001
Fortune Magazine 
Time Inc. 
71
(Copyright 2001) 

In a bland suburban office park 30 minutes north of Atlanta, life after Enron is taking shape. It's a show of creative destruction that would make philosopher Joseph Schumpeter proud. Only a few months ago, the Intercontinental Exchange (ICE) was battling Enron for a slice of the online energy market. Now ICE and its CEO, Jeff Sprecher, are struggling to handle a flood of new business, as former Enron clients search for other ways to trade electricity and natural gas. Sprecher has airlifted in servers from around the country; his tech team is working 24/7 to accommodate trading volume of $2.5 billion a day--a 100% increase in two weeks. ICE's volumes climbed steadily all through November, as Enron's customers ebbed away. But now, says Sprecher, "by any measure, our business is going through the roof. Enron opened the door, and I walked through." 
ICE's success at profiting from Enron's failure illustrates just how quickly the market has moved to absorb the demise of America's seventh-largest corporation. It's not that people aren't hurting: Thousands of Enron workers are unemployed, and investors face billions of dollars in losses. Still, not a single light flickered after Enron's implosion, which had almost no impact on volatile energy prices. "It's like a great ship going down--there's a big splash, but the sea quickly fills in," says John Rowe, co-CEO of Exelon, the nation's ninth-largest utility. "The short-term effect is really not that substantial."
Among energy companies that traded with Enron, potential losses range from $100 million for Duke to $80 million for Mirant and $75 million for Dynegy. Among banks, J.P. Morgan Chase recently announced that it had $500 million in unsecured loan and derivative exposure to Enron; analysts say Citigroup could face a similar loss. Those numbers sound large, but they're unlikely to cause more than a crimp in earnings. "The fallout is a mile wide and an inch deep," says Jim Hanbury, a bank analyst with Dresdner Kleinwort Wasserstein. "One of the very good things about being a big company is that when bad things happen, it doesn't kill you." Indeed, the potential default of Argentina--a story pushed off the front pages by Enron--could actually pose a more serious threat to America's money-center banks. 
Large banks are further cushioned from Enron's failure because of the way loans are syndicated. "Literally thousands of institutions get a piece," says Hanbury--from smaller banks and Wall Street firms to insurance companies and hedge funds. That dilutes the impact of any one failure. Goldman Sachs' Richard Strauss says Enron's collapse could trim Citigroup's earnings by five cents a share, but he still expects Citi to earn $3.25 a share in 2002. He predicts J.P. Morgan will take a slightly bigger hit--15 cents a share--equivalent to a 4% reduction in earnings next year. Strauss is similarly sanguine about the impact on Wall Street. "Wall Street has had time to react, so I think the exposure of major firms is pretty minimal," he says. "Unlike Long-Term Capital's collapse or Russia's failure in 1998, people had a chance to unwind their trading positions this time." 
The fallout is likely to be felt most keenly within the energy industry itself, especially among companies that, like Enron, had moved aggressively to profit from trading and marketing electricity and natural gas. On Wall Street and in the boardrooms of energy towns like Houston and Atlanta, there's a fierce debate over whether Enron's flaws were unique. The major surviving energy traders-- including American Electric Power, Duke, Dynegy, Mirant, and Reliant- -argue that unlike Enron, they possess major physical assets like power plants and storage facilities that balance the risks inherent in trading. 
Ironically, just a year ago those companies emphasized their trading prowess; today the spin is that trading is merely a way to maximize the value of hard assets. "Our business model is fundamentally different from Enron's," says Dynegy President Steve Bergstrom. "We don't do nearly the volume of trading Enron did, and we also produce power and control natural gas. Enron had gotten out of the energy business and was essentially a financial services company that happened to make markets in electricity and natural gas." Even so, Dynegy faces more risk than its competitors. For starters, says CSFB analyst Curt Launer, Dynegy derives more of its earnings and cash flow from marketing and trading than do companies that are more akin to traditional utilities. In addition, Enron is suing Dynegy for $10 billion as a result of the failed merger. Although the suit has little chance of succeeding, any adverse legal decisions would immediately push Dynegy's stock price down. On the other hand, says Launer, Dynegy's shares have more upside potential if and when the energy sector comes back into favor. 
Mirant's CFO Ray Hill is especially eager to put some daylight between his company and Enron. "We have $22 billion in assets and 15,000 megawatts of generating power across the country," he says. "One wall of our trading floor shows the status of every plant, and almost all our trading is driven by our own assets. So if I sell power forward six months or a year, I can produce it if I need to." In addition, says Hill, Mirant's internal controls bar traders from putting more than $75 million of capital at risk each day. That's a small fraction of Mirant's shareholder equity, currently $4.7 billion, or its annual profits, projected to be nearly $700 million in 2001. "At the end of every day, the CEO and I both get a report showing exactly how much capital is at risk," Hill says. 
Still, executives from Mirant and other companies are taking great pains to tell investors just how their businesses work. Last month Mirant CEO Marce Fuller spent an hour and a half taking analysts in Atlanta and New York through each line of Mirant's balance sheet. "This isn't a topic that would have been included in an analysts' meeting in the past, but there's going to be a lot more pressure on companies like ourselves to help people understand how we make money," says Fuller. Duke Energy's group president of energy services, Harvey Padewer, agrees: "We've been very open with the Street. No one ever considered Duke a black box." 
It will be a while before energy trading companies--even those with substantial assets--regain the trust they had before the Enron debacle. Fuller says that while Mirant has already signed several profitable deals to sell gas for former Enron clients, getting fresh capital to build new power plants or make acquisitions is much harder than it was six months ago. That has caused Mirant to slow capital expenditures and delay some new investments. "There's still a lot of nervousness that something else is out there," admits Fuller. "Larger, sophisticated players with real assets like Mirant, Dynegy, and Reliant will do just fine. But the capital markets think if Enron can go down, who else has problems?" 
FEEDBACK: nschwartz@fortunemail.com 
Sharing the Pain 
These numbers look bad, but they're unlikely to have a big impact on earnings. 
Potential Enron Company exposure (in millions) J.P. Morgan Chase $500[1] Citigroup $500[2] Duke Energy $100 Reliant $80 Mirant $80 Dynegy $75 American Electric Power $50 UtiliCorp $32 [1]Unsecured exposure. [2]Wall Street estimates. 
FORTUNE TABLE

COLOR PHOTO: PHOTOGRAPH BY CHRIS STANFORD The trading floor at Mirant: Some energy companies are profiting from Enron's failure. COLOR PHOTO: PHILIP GOULD A hard asset: part of an Enron gas pipeline in Louisiana 
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Editor's Desk
Editor's Desk
Rik Kirkland/Managing Editor

12/24/2001
Fortune Magazine 
Time Inc. 
16
(Copyright 2001) 

Fearless reporting has taken senior writer Pattie Sellers to many strange but rewarding places. Name a topic, ideally something grand, hard to pin down, and yet compulsively interesting, and Pattie's written about it--Ego, Charisma, Failure, Power. (In fact, that's usually how it works; Pattie walks into my office, says something like, "How about a story on 'Revenge'?" and she's off.) What makes these high-wire acts work is that Pattie is a dogged reporter. She never settles for five examples when she can get nine, she's comfortable with numbers, and she's a people person with a knack for getting folks to open up. Which means she's a great writer of company stories as well as concept stories. Latest example: her piece on Coca- Cola, "Who's in Charge Here?" It's got everything: a great brand struggling to restore its luster, a CEO who never expected to have the top job, an ambitious heir apparent who appears more than ready to claim it, off-stage power brokers, plus lots of history, corporate culture, and insight on the beverage biz. Classic Coke meets Classic Sellers. 
Bond guys have more fun. At least they did this year. Despite the stock market's stunning post-Sept. 11 rally, returns on bonds outpaced the S&P 500 by 22 percentage points for 2001. In addition, a record year for global bond underwriting has reordered (for now) Wall Street's pecking order and left the boring bond guys rich enough to do stuff formerly reserved for the IPO underwriting crowd--like spending an average worker's annual wages on a night's wine tab. You'll learn all this and more in our lead First piece, "The Revenge of the Nerds." Written by editor-at-large Justin Fox, it's a fine example of how we approach economics and markets: Look for surprising and important insights, then deliver them with style, wit, and clarity. In that same vein, check out Cait Murphy's column on the real roots of terrorism, and Anna Bernasek's feature story on what may yet temper the coming recovery.
What's incredible, despite all the ink that's been spilled on the spectacular fall of Enron, is how much is still unclear. What did founder Ken Lay know about the company's funky accounting and off- balance-sheet machinations, and when did he know it? Why exactly did ex-CEO Jeff Skilling split in August? How leveraged was Enron--and did its vaunted trading operations ever make decent money? Truth is, we don't have all the answers yet, and neither do our competitors. But one thing's for certain: When FORTUNE senior writer Bethany McLean stood up last February and pointed out that the Emperors of Energy Trading had no clothes--or were at least wearing some rather tattered duds--(that's her piece, "Is Enron Overpriced?" at right) she was the first journalist to do so. I also know this: Her cover story, "Why Enron Went Bust," is the deepest and clearest account yet of how things came unhinged. 
Can't we get this terrible year behind us? At FORTUNE, we know how you feel. So we've decided to declare 2001 over as of mid-December. After all, we're pretty confident nothing's going to come along to change our top stories of the year--the Sept. 11 terrorist attacks (No. 1), the recession (No. 2), and Enron (No. 3). So we're delivering in this issue a preemptive package on the year that was, including our tally of the best and worst in business. Directed by assistant managing editor Jim Impoco, it captures in stunning images, fine writing by Bill Powell and Andy Serwer, and lots of short, snappy bouquets and brickbats, the tragedy, comedy, and occasional triumph of 2001. Now here's to a better 2002.

COLOR PHOTO: ADAM FRIEDBERG COLOR ILLUSTRATION: MARC ROSENTHAL COLOR PHOTO: SCOTT THODE COLOR PHOTO: SEAN ADAIR--REUTERS/TIMEPIX 
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Features/The Year In Business
Best & Worst 2001 ; Honest CEOs. Harebrained ad campaigns. Appalling outfits. They've all earned a place on our year-end list.
Jeremy Kahn and Brian O'Keefe

12/24/2001
Fortune Magazine 
Time Inc. 
139
(Copyright 2001) 

Corporate marriage 
Best: Smucker's and Jif Now that's synergy. On Oct. 10, No. 1 jelly maker J.M. Smucker, of Orrville, Ohio, agreed to buy Jif, the No. 1 peanut butter brand, from Procter & Gamble for $1 billion in stock (P&G threw in Crisco to grease the way). Investors decided it was the best thing since (or on) sliced bread: Smucker stock has risen 36% since the deal was announced. Fried PB&Js for everybody!
Worst: HP and Compaq It's bold (the new Hewlett-Packard would be the No. 1 player in servers and PCs). It's big (it would be an $87 billion company). But is it beautiful? Some important shareholders don't think so--namely, Hewlett and Packard. The sons of the co- founders have blasted the proposed $23 billion acquisition of rival Compaq for months. We can see why: Revenues won't grow until 2003, and the much hyped $2.5 billion in cost savings won't be realized until 2004. "We can pull this off," insists HP CEO Carly Fiorina. Maybe--but with seven operating systems and five processors to sort through, the details will be devilish. 
Business book 
Best: Fast Food Nation Eric Schlosser's immensely readable mixture of cultural history and muckraking journalism shows the big business of burgers and fries to be a "revolutionary force in American life." This supersized dose of perspective on what's involved in allowing you to "have it your way" makes you think twice about having it at all. 
Worst: DotCom Divas Elizabeth Carlassare's collection of case studies profiling sisters doin' it for themselves with IPOs and new distribution channels would have felt "last year" last year. Apparently neither Carlassare nor the nearly two dozen visionaries celebrated in the book saw the dot-bomb coming. Right, Candice Carpenter? 
Business movie 
Best: Startup.com Ambition, betrayal, shattered friendships, and broken hearts--now, that is what business is really all about! An insightful documentary chronicling the rise and fall of the nascent dot-com GovWorks, the film perfectly captured what it was like to be in the trenches during the late, great Net boom. 
Worst: Antitrust Sure, Tim Robbins made a decent Bill Gates body double, but the MGM-backed movie's hackneyed plot about a megalomaniacal software titan intent on dominating the world's communications networks through a conspiracy of theft and murder needed serious debugging. For a real antitrust thriller, try the court transcripts of U.S. v. Microsoft. 
Dresser 
Best: Bernard Arnault He earned his nickname--the "Pope of Fashion"--for the immense power he holds as CEO of French luxury juggernaut LVMH. But it applies equally well to his appearance. With brands like Louis Vuitton and Thomas Pink in his stable, the French billionaire always has something stunningly smart to wear. The key to looking cool, though, is never getting ruffled. Case in point: After losing a two-year battle for control of Gucci in September, Arnault turned around in November and completed a deal to acquire Donna Karan. Looking good! 
Worst: Steve Ballmer Clothes haven't made this man. In the Microsoft CEO's closet, the ex-jock and computer-geek worlds collide, and the result isn't pretty. Hey, Steve, "bespoke" isn't a command in Basic! You'd think $15 billion could at least buy him a decent iron. But with the antitrust case (mostly) behind him, XP on the market, and the Xbox ready to go under a bunch of Christmas trees, maybe he figures disheveled is in the eye of the beholder. 
Marketing campaign 
Best: Volkswagen People the world over are now on the lookout for colorful Beetles--"Hey, there's a blue one!"--thanks to Volkswagen's stylish print and TV ads. The company was named advertiser of the year by The Gunn Report, a publication that tracks global advertising awards. VW's ads aren't just fun to look at--they're effective too. The company sold more cars in the U.S. this year than at any time since 1973. 
Worst: Sony Pictures Film critic David Manning, of Connecticut's Ridgefield Press, loved Hollow Man. He raved about A Knight's Tale. And he called The Animal a winner. Too bad Manning didn't exist. A couple of Sony Pictures execs invented the man and his blurbs in order to hype Sony flicks. Two thumbs down. 
E-mail 
Best: Ted Waitt "Hi. That's right. It's me. I'm back." With that simple message to Gateway's employees, the beloved 38-year-old PC company founder (above) announced his return as CEO after a yearlong absence. Some straight talk from their cowboy-boot-wearing, ponytailed leader boosted workers after months of watching profits (the company lost $94 million in the first quarter) and the stock price plunge. Too bad investors have yet to share the enthusiasm. 
Worst: Neal Patterson Enraged to see the corporate parking lot of Kansas City health-care software company Cerner empty at 7:30 one March morning, CEO Patterson fired off a blistering e-mail to company managers threatening to fire loafers and stop approving employee benefits. "Hell will freeze over" before he tolerates a less than "substantially full" lot at 7:30 a.m. again, he wrote. "You have two weeks. Tick, tock." A week later the e-mail was all over the Web, prompting Cerner's stock price to sink 22% in three days. 
IPO timing 
Best: Weight Watchers As comfort-seeking Americans stuffed themselves with junk food after Sept. 11--and news of Taliban defeats invigorated the market--underwriters for the Woodbury, N.Y., weight- loss specialist were able to raise the price for Weight Watchers' mid- November IPO by 9% at the last minute. Bargain-starved investors gobbled up shares of the business (endorsed by Fergie), driving shares up 23% the first day and fattening the company's wallet by $417 million. 
Worst: Prada The Milan fashion conglomerate planned an offering on the Italian market for this summer. But the weak economy caused Prada to delay till the fall; Sept. 11 caused another postponement, this time indefinitely. That was bad news for CEO Patrizio Bertelli, husband of designer Miuccia Prada, whose recent haute couture shopping spree has him struggling to pay off some very unfashionable debt. He was recently forced to unload his 25% stake in Italian fashion house Fendi. 
Candor 
Best: Procter & Gamble The George Washington of business this year, P&G couldn't tell a lie. It admitted to rival Unilever, unprompted, that it had hired spies to gather information on Unilever's shampoo business. The P&G snoops even rooted around in Unilever's trash. When P&G CEO John Pepper learned of the operation, he fired the three executives who had authorized it and began talks with Unilever, ultimately paying about $10 million and pledging never to use any of the information gained from its spies. 
Worst: Enron Let's see: Undisclosed transactions with funds controlled, at least in part, by CFO Andrew Fastow. Misstated earnings of more than $580 million going back to 1997. Some $1.2 billion in shareholder equity vanished. Oh, and as much as $27 billion in debt that appeared nowhere on its balance sheet. One could argue that if Enron had been more candid about how it made money, it might not have ended up as the largest corporate failure in U.S. history. Of course, if Enron had been forthcoming, it wouldn't have been Enron. 
Prediction 
Best: Stanley Roach The Morgan Stanley chief economist began warning of a 2001 recession way back in September 2000--well before any of his Wall Street colleagues. 
Worst: John Chambers Where's that 30% to 50% growth you were so fond of talking about, John? Cisco's pro forma earnings per share declined by 23% this year--and that's excluding all the write-offs for unsold inventory and bad investments that you'd rather investors ignore. The only Cisco number that's even close to 50% is the decline in the company's stock, which fell from around $38 in January to near $20 in early December. 
Family values 
Best: Rupert Murdoch Promoting your kid is one thing; sticking by him when he screws up is another. But that's just what Murdoch (above right) has done. The News Corp. CEO named eldest son Lachlan, 30 (above left), deputy chief operating officer last October. This year Lachlan lost millions of Dad's money when telecom startup OneTel, in which he'd invested the dough, went bankrupt. However, Rupert has continued to show faith in his son's business acumen; Lachlan has been busy shuffling executives in Australia and installing a new editor at the New York Post. 
Worst: Florence Fang No one likes to be fired, especially after less than a year on the job. But imagine how Ted Fang felt when, following a rocky start, he was ousted as publisher of the San Francisco Examiner by his own mother. (We also hear Fang is grounded.) 
Honorable mention: Jack Smith The General Motors CEO (above left) helped push out his little brother Mike (above right) as chairman of GM subsidiary Hughes Electronics in order to pave the way for its sale. 
Layoff policy 
Best: Charles Schwab Maybe there's no such thing as a good layoff. But at least the once fast-growing discount broker made an effort. Before chopping heads, founder Charles Schwab and his co-CEO each took a 50% pay cut; 750 other execs took cuts too, and the firm encouraged employees to take Fridays off without pay. Only after those measures failed did Schwab lay off 3,400 workers, in late March, softening the blow with 60 days' notice, stock-option grants, education stipends, and a promise to pay a $7,500 bonus to any employee who returned within 18 months. 
Worst: The airlines Ever wonder why airline workers always seem to be on strike? Just days after the Sept. 11 hijackings, even as they were securing a $15 billion bailout from Congress, the airlines announced plans to lay off an estimated 100,000 people. Three major carriers--American (20,000 job cuts), Delta (13,000), and Northwest (10,000)--invoked a force majeure clause claiming that emergency circumstances allowed them to bypass customary notice, severance, and early-retirement incentives; they later backed off a bit in the face of public opinion. 
Graceful exit 
Best: Herb Kelleher The retirement of the Southwest founder and CEO this year was as smooth as a three-point landing. Kelleher (right) leaves behind a cash-rich carrier that's well positioned to weather the problems battering the airline industry. Southwest, which refused to slash schedules after Sept. 11, was the only U.S. airline to report a profit in the third quarter. 
Worst: Linda Wachner Booted without severance after 15 years as CEO of Warnaco, Wachner leaves behind a company in desperate need of a turnaround. Thanks in part to Wachner's bloated compensation package, the women's apparel maker is bankrupt, and its stock, once worth $44, trades for pennies. Not only did Wachner let down shareholders, but she also did a stellar job of alienating key customers--most notably Calvin Klein, who called her a "cancer" on his brand. But Wachner isn't leaving quietly: She's considering suing Warnaco for the golden parachute--reportedly worth $44 million-- promised in her employment contract.

COLOR PHOTO: PHOTOGRAPH BY DAVID BASHAW COLOR PHOTO: SCOTT THODE COLOR PHOTO COLOR PHOTO: JOANNE CHAN Ballmer (right) knows software, but he could stand some advice from Arnault (left) on ready-to-wear. COLOR PHOTO: A. BOLANTE--REUTERS/TIMEPIX [See caption above] COLOR PHOTO: DANIEL PEEBLES COLOR PHOTO: PAUL SCHMULBACH--GLOBE PHOTO Fergie is a fan. And now plenty of investors are too. Weight Watchers' IPO was a hit. COLOR PHOTO: SCOTT THODE COLOR PHOTO: DAVE ALLOCA--DMI/TIMEPIX COLOR PHOTO ILLUSTRATION: GRANT DELIN; DIGITAL MANIPULATION BY FORTUNE B/W PHOTO: MICHAEL O'NEILL Southwest didn't encounter any unexpected turbulence when CEO Herb Kelleher handed over the controls. 
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On the Cover
Power Player; Chuck Watson built Dynegy at blinding speed but was overshadowed by Enron. Now he's got the spotlight to himself.
Neil Weinberg and Daniel Fisher

12/24/2001
Forbes Magazine 
52
Copyright 2001 Forbes Inc. 

On a cool day in Houston early last month, Dynegy chief Charles Watson announced the boldest deal of his career. In 15 years he had built the natural-gas producer into a powerhouse, but he chafed in the shadow of his far bigger hometown rival, Enron Corp., and its chairman, the silver-tongued Kenneth Lay. Lay's swagger personified the freewheeling energy-trading markets, and Enron dominated the action, but now the titan was reeling from allegations of dirty self-dealing, a raft of sudden resignations and an SEC investigation. Valued at $70 billion only months before, Enron was teetering on the brink of collapse. 
So Chuck Watson declared he would rescue his rival, at an especially sweet price: just $9 billion in Dynegy stock. Watson was sure the skeptics on Enron were wrong and that with a few problems solved Enron was still a rock-solid money machine. Its revenue grew 57% in the third quarter to $47 billion--more than one and a half times what Dynegy generated in all of 2000. For a fire-sale price, he boasted, Dynegy would suddenly expand sixfold into a $200 billion-a-year giant with $90 billion in assets. The supercharged firm would handle as much as one-quarter of U.S. energy trading. After operating in obscurity for years, Dynegy suddenly would become the second-largest corporation in America in sales--"a world-class energy merchant by anyone's definition," Watson proclaimed.
Two weeks later Watson's triumph ended in epic failure. He scuttled his dream deal after getting surprised by a string of horrifying financial revelations at Enron. The big rival's market cap had continued to plunge, falling to a level so low--less than $270 million--as to make Watson look like a sucker for ever offering $9 billion. Enron clearly was headed for Chapter 11, or even liquidation. The merger was off, and the recriminations and lawsuits were just beginning. 
"I was very disappointed," Watson says in characteristic, laconic understatement. He also was furious: Enron had tumbled into turmoil by misleading investors, and now it was misrepresenting its finances yet again--so says Watson--and laying the blame on Dynegy. "I just hope the other side doesn't think all this spinning, which got them into trouble to begin with, is going to get them out of it," he fumes. 
In the fallout, Enron struggles to stay alive, and Watson can count his blessings. In retreating, he has dodged Enron's $12 billion in debt, the dark cloud of the investigation now under way by the Securities & Exchange Commission, the devastated trading floor and a thicket of lawsuits and liabilities so massive and murky that they could end up burying everyone in sight. Instead, Watson is setting up the next chapter at Dynegy. He took it over in 1985 with a $600 investment and a 10% stake for himself, building it into a firm with a $10 billion market value (as of Nov. 30). With 5% now he's worth half a billion. 
Watson vows to make Dynegy even bigger, even better, and an undisputed leader in a gun-shy industry that has lost the stability and swagger of its once-dominant progenitor, Enron. Dynegy says it can grow at least 20% next year, to $35 billion in revenue. 
The death of Enron is a mixed blessing for Chuck Watson. Some of Enron's business and some of its brightest people will wind up at his firm; if he gets his way in court Watson will also get Enron's valuable pipeline system, Northern Natural Gas, in return for the $1.5 billion he poured into Enron in the course of the merger plans. The negative: litigation. Enron is threatening to sue Dynegy for backing out of the merger, and Enron's creditors are sure to pile on at some point. 
Even without swallowing the bigger Enron, Dynegy is a leading processor of natural gas and one of the top three transporters on every interstate pipeline in North America. Its power plants generate 19,000 megawatts of electricity, enough for a city of 8 million. In the commodity derivatives markets, where suppliers and utilities lock in future prices, Dynegy is a top trader in natural gas, power, coal, emission credits and weather derivatives. But these volatile trading businesses, which contributed 80% of Enron's alleged earnings but ultimately could not make up for its blunders elsewhere, are merely a healthy sideline at Dynegy, contributing only 20% of earnings. 
And Watson may yet have a multibillion-dollar merger in his future. Big rivals such as American Electric Power, Duke Energy and Reliant outmuscle Dynegy in some markets, making them attractive partners. He expresses keen interest in doing more deals, having made nine acquisitions since 1995, which has kept Dynegy's top line growing a hefty 45% a year. Last year its stock jumped 218%, the second-best performance in the S&P 500. Even on the day Watson bailed out of buying Enron, he inked a $600 million purchase of another outfit, BG Storage. He's a gambler whose winning streak might not have ended. 
Enron and Dynegy were born the same year--1985--but took very different paths. Ken Lay started out with $10 billion in revenues from the merger of two energy companies, Houston Natural Gas and InterNorth. Then he won fame and accolades for transforming a stodgy old gas business into a sexy wheeler-dealer, doing for energy what Nasdaq did for stocks: creating a highly liquid, over-the-counter market for all kinds of contracts. In the process, he slapped Enron's name on a new sports stadium and hobnobbed with the likes of Dick Cheney and George W. Bush. 
Chuck Watson started out with far less. Dynegy began life under the unpromising name of the U.S. Natural Gas Clearinghouse, a marketing arm jointly owned by six pipeline companies, Morgan Stanley and the law firm Akin Gump. Nor was Watson some headhunter's superstar: He began his career as a lowly trainee at Conoco. Even after Dynegy hit the big leagues, Watson's aw-shucks manner kept him out of the public eye; he frequently says he'd rather let his customers talk up Dynegy than do it himself. Flashy, no, but competitive, hell yes: He is so fierce a warrior on the links that when he was recovering from an Achilles tendon injury recently, he borrowed an oversize golf shoe to fit it over his sore, swollen foot rather than miss combat in 18 holes. 
Always scrappy and still athletic at 51, Watson was born in Great Lakes, Ill., one of four children of a salesman who hawked space in industrial parks. The family moved around a lot and Watson attended 22 schools in nine states. Sports let him fit in quickly. He was driving for a college basketball scholarship until he seriously injured his back in a car wreck as a high school senior in Ft. Smith, Ark. On graduating from Oklahoma State in 1972, he took a job with Conoco in Ponca City, Okla. so he could stay close to his college sweetheart, Kim, who now has been married to him for 28 years. The summer job turned full-time, and in the next 12 years Watson worked his way up at Conoco to the middling title of sales director. 
It was 1984, natural gas was on the verge of revolution, and Watson wanted to be in the vanguard. "A lot of people in this business were scared by deregulation," he recalls. "I was excited by the opportunities." Opportunity arrived in the form of the slapped-together U.S. Natural Gas Clearinghouse. 
Watson first turned down the job. It looked unworkable. The pipeline companies might try to force the fledgling firm to do business only with their own pipelines; how would he push them aside? His suitors kept wooing him, offering a sizable raise, and finally Watson relented, with one condition: "Don't pay me a salary--give me 10% of the company." He got both, the equity initially taking the form of phantom stock--in effect, a long-term option. 
On Watson's first day on the job, only 6 of the 60 employees borrowed from the parent firms showed up. He told the no-shows not to come back. Later that year he bought out the 10% stakes from the pipelines for $100 each and then he got Akin Gump to sell, leaving Morgan as sole shareholder. His vision was clear from day one. Hundreds of brokers were jumping in, many armed with just a phone and a Rolodex. Competing with them was a losing game. Suppliers and buyers would eventually get each other's phone numbers, and one day the fat middleman spreads that Watson's shop relied on would evaporate. Then what? 
With the backing of Morgan Stanley and a surfeit of underground salt domes for gas storage, Watson figured he could buy gas at wellheads and deliver it when and where customers wanted, holding it for them when they didn't need it and serving it up when demand surged. This meant Watson would assume the risk of holding gas that might tumble in price; but any trader could handle that risk with some artful hedges. 
The startup was barely making payroll when Watson arrived, turning a sale a week and celebrating each with a round of cigars. Watson nixed the cigars and started turning multiple sales a day. He worked his contacts and had staff cold-calling corporate gas users to drum up business. 
By 1989 Morgan Stanley wanted out and sold the company for $16 million. The buyers were three energy companies (British Gas, Nova and Chevron) and employees. Morgan was happy with its tidy profit. Had it held on, its stake would be worth $10 billion. 
Meanwhile Ken Lay at Enron was discovering the same potential in gas trading. Deregulation had left producers and utilities at the mercy of volatile spot prices. Lay began writing long-term contracts to buy or sell gas at fixed prices. Business grew more stable at both ends of the pipeline. Eventually the raw trading of these contracts--rather than delivering on them--became Enron's mainstay. 
In the mid-1990s electricity joined gas on the deregulatory path. Watson wanted in but needed currency. So in 1995 he bought Trident, a publicly held ethylene producer; the reverse merger gave him new access to money in the capital markets. The following fall, Watson cut a deal with Chevron to sell the oil giant's entire North American gas output, the first such exclusive marketing deal. It was precisely what Watson had in mind all along. The gas producer receives market prices at its wells. Watson takes ownership, transports, stores and delivers the energy at a markup. He compares the approach to that of grain trader Cargill. 
Business was booming, but Watson wanted to buy a lot more gas processing plants and electric power plants. The problem was in raising the cash. Dynegy had a public currency, but 88% was now in the hands of employees and three institutions. There wasn't enough of a float to attract institutional shareholders. So Watson walked into a meeting of his owners in Scotland in 1997 with a blunt message: "We have a problem. It's in this room. Two of you have to go. I don't care which." Then he walked out. Nova and British Gas exited. The company's float went to 60% overnight. The next year Watson changed Natural Gas Clearinghouse's name to Dynegy, excising an "r" to dodge a preexisting British claim. Then he used his stock to make his boldest push yet into power. Illinova, an Illinois generating firm, was nearly insolvent. Watson bought it for a pittance. 
Enron was having a field day with deregulation, too. Instead of buying electricity from a plant and selling it elsewhere for a tiny cut, it began carving output into pieces, much as Wall Street slices Treasurys into Treasury strips. Enron would guarantee a utility running a distribution grid all the power it would need on a hot summer afternoon. An aluminum smelter would pay half as much but suffer some interruptions. 
As Enron's confidence grew, its trades got more exotic, involving derivatives on pulp, metals, pollution and the weather. In late 1999 the firm shifted much of its business to EnronOnline, basking in the dot-com craze. The site soon was handling $3 billion in trades daily. Revenues in 2000 doubled to $101 billion. Reported earnings before interest and taxes hit $2.3 billion. At a January 2001 analyst meeting, company execs suggested Enron's price of $80 a share was inadequate, notwithstanding that it was 46 times earnings. The shares should have been going for $126, said President Jeffrey Skilling. 
By then Enron and Dynegy had gone separate ways. Enron was selling assets, earning 80% of its profits from trading and 20% from energy. At Dynegy the ratios were reversed. In February Lay handed the top job to Skilling, chief advocate of Enron's asset-lite strategy. Lay became elder statesman. 
Skilling epitomized Enron's hubris. He had once said of a rival, "If Thomas Alva Edison came back from the dead and called Southern Co. he'd find nothing has changed." Of Enron: "We're on the side of angels. People want open, competitive markets .... It's the American way." To goose earnings, Skilling set up outside partnerships. They, in turn, issued Enron-backed bonds and used the proceeds to buy power plants, fiber optics and other assets from Enron. Then Enron plowed the cash into its trading business while the debt--and losses--moved off its books. 
The questions started getting prickly when Enron's stock price fell in the spring. Its business of trading fiber-optic capacity, with revenues of more than $300 million in 2000, lost $137 million in the first half of 2001 as sales plunged. In mid-August Skilling abruptly quit. Speculation was that something was seriously amiss. Then on Oct. 16 Enron set a $1 billion third-quarter charge related to a partnership linked to Chief Financial Officer Andrew Fastow, plus a $1.2 billion reduction in shareholder equity due to "accounting errors." Rumors were rampant that trading partners were avoiding Enron and that it was on the brink of a credit downgrade that would force it to immediately repay $3.9 billion in debt, pushing it into bankruptcy. 
On Oct. 25, Dynegy President Stephen Bergstrom was invited to lunch by Stanley Horton, chief of Enron's pipeline group. Horton--without first telling Ken Lay of his plans--told Bergstrom that Enron was in deep trouble and that a merger with Dynegy was the best way out. But it had to happen fast. 
Enron's desperate plea in hand, Bergstrom called Watson, who was outside an operating room in St. Louis where his mother was having heart surgery. "I was intrigued and honored they had come to us," Watson recalls. He set one demand: Ken Lay had to call him personally. Lay called him the next day, and on Saturday morning Watson and Lay chewed over a deal in Lay's kitchen. Watson offered a deal with no premium over Enron's depressed price. Lay accepted and said he would step aside. 
Dynegy was an obvious mate. The firms are right across the street from each other, and many employees have worked at both. Their traders live in the same neighborhoods--the Young Turks in West University and the superstars in River Oaks. They send their kids to ritzy St. John's School. "The press loves the rivalry between Enron and Dynegy, but on a lot of issues, we're on the same page," Bergstrom says. 
For Dynegy, Enron's crunch was sweet revenge. Dynegy execs chafed at the the dowdy image they were accorded despite fast growth and a soaring stock. Lay put Enron's name on Houston's new baseball stadium. Watson bragged about his small p.r. staff. A media search yields 91,000 mentions of Enron in five years--six times as many as for Dynegy. 
For all their folksiness, Dynegy execs were talking trash about Enron for years. Off the record, they questioned Enron's assertions it held "balanced books" of commitments to buy and sell commodities and suggested their rival was laying risky bets on the direction of gas and electricity prices. 
Investment bankers came in to do the paperwork. Dynegy merger chief Hugh Tarpley, an alum of Notre Dame, coined the de rigeur code names: Dynegy was the heroic Rockne; Enron, fittingly, was the Gipper--the dying football player. Watson, meanwhile, was hosting a week-long pro-am golf tournament for 300 clients, one of his first forays into big-time promotion. Some events he couldn't miss, like a round of golf with Tiger Woods. When guests asked where he was, underlings made excuses. On the last day of the tournament, someone noticed Watson heading toward the course in a golf cart wearing business shoes, a clue that he was headed for merger talks; he feigned forgetfulness. 
Chief Financial Officer Robert Doty, meanwhile, was poring over Enron's financials and feeling fine. "We got a lot of comfort that the core business was operating well and capable of generating great cash flow," Doty recalls. But ChevronTexaco, which owns 26% of Dynegy, scrutinized the deal and asked--why not wait for Enron to fall into bankruptcy and buy it at a distress sale? In the end Chevron put $1.5 billion into Dynegy, which used it to buy 100% of the preferred stock in the Enron unit that owns its prized Northern Natural Gas pipeline. That, along with $1 billion more at the merger's close, was expected to give Enron the liquidity it needed. 
Watson unveiled his daring rescue plan on Friday, Nov. 9, reserving the right to call off the deal if Enron's liabilities rose, or profits fell, below certain levels. His hole card: a clause stating Dynegy's $1.5 billion investment gave it the right to keep the big pipeline even if the deal was aborted. "There was a lot we didn't know," he admits, "but we thought we'd adequately protected our shareholders." Dynegy's stock had a quick 28% run-up on news of the bid. 
If Skilling is to go down in history books for his hubris, Watson should get a mention, too. J.P. Morgan Chase and Citigroup offered to inject $500 million or more in equity capital into Enron. Watson, confident that Enron's hemorrhaging was over, brushed aside the offer. 
The euphoria faded fast. On Nov. 19 Enron filed quarterly financials that held two bombshells. Recent credit downgrades to a notch above junk had put Enron on the hook to repay $690 million to a partnership in just a week--something Enron had never warned Dynegy about. What's more, Enron had $1 billion less in cash on hand than it was supposed to have. 
Watson was stunned. Enron had provided a peek at the numbers two weeks before, but none of this was disclosed (Enron has disputed this). Watson says that Dynegy got the full filing just three hours before it was made public and that only then did he know his deal was in trouble. What else had Enron failed to disclose? Negotiations went on even as Enron shares fell to $4 and lower. On Nov. 28 three credit agencies downgraded Enron to junk status. That morning Watson called Lay and killed the deal. Lay was cordial. 
The niceties ended there. Dynegy issued a press release staking its claim to Northern Natural Gas and accusing Enron of misrepresentation. Enron's chief financial officer, Jeffrey McMahon, disputed that claim and said Dynegy saw the financials in advance, hinting Dynegy may owe Enron a $350 million breakup fee. Bunk, says Watson: "It's real cute for Jeff to say we got an advance copy when it was 110 pages we received just three hours in advance." 
Even if Dynegy's biggest deal slipped through Watson's fingers there is a big world of opportunities in energy. In Europe, Dynegy has a growing presence and can play the same games it did in the U.S. as the energy industry there deregulates. 
Back at home, Watson confronts months of legal wrangling and a long struggle to reclaim legitimacy for the energy-trading business. The recent chaos in California and the collapse of Enron will make further deregulation--and Dynegy's stock--a tough sale. 
Additional reporting by Rob Wherry.

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Business Week International Editions: American News: THE FALL OF ENRON
AFTERSHOCKS IN EUROPE Enron's collapse will hit many markets
By David Fairlamb in Paris

12/17/2001
BusinessWeek 
38
(Copyright 2001 McGraw-Hill, Inc.) 

Enron Corp. may be based in Houston, but its spectacular collapse has had almost as big an impact in Europe as in the U.S. The energy trader's bankruptcy has sent European banks, investors, electricity consumers, and champions of Europewide energy deregulation reeling. And it's not just the energy markets that have been thrown into confusion. Enron was active in a number of other European sectors, including metals and pulp and paper trading. It even owns a windmill manufacturer in Germany. ``This was a global company whose collapse will be felt right around the world,'' says Alessandro Profumo, CEO of UniCredito Italiano. 
Profumo should know. Over the last year, the Milan bank loaned Enron an estimated $20 million. All told, European banks have admitted to lending Enron and its subsidiaries more than $2 billion. In addition, analysts calculate, there is up to a billion dollars further exposure in the form of derivatives and trading contracts.
The European bank reported to have the largest loan exposure to Enron--between $500 million and $800 million--is Royal Bank of Scotland. RBS executives aren't talking, but their stock has taken a big hit. Other banks with sizable Enron loan exposure include Britain's Abbey National, France's Credit Lyonnais, and the Netherlands' ABN Amro (table). ``Enron isn't on the same scale as the Long-Term Credit Management collapse [in 1998],'' says Peter Luxton, global economic adviser to Standard & Poor's Corp., ``but it still has a huge effect.'' 
In recent days, the scale of that financial damage has become clearer. The result could well be tighter credit for many companies just as Europe's economy softens. Spreads in the corporate fixed income market widened by up to 40 basis points between Nov. 28 and Dec. 5. Adding to the pressure is the fear that there is more risk in the credit markets than was realized. ``We didn't know Enron, but lent on the back of its credit rating,'' says Profumo. As Enron sank, he adds, ``the first question I asked my colleagues was: `What is the value of a rating?''' Just a few months ago, the parent company had an AA rating from the main agencies. It's now rated as junk. 
Banks aren't the only ones affected. Enron stock and bonds were widely held by European mutual funds and insurers. The lucky ones offloaded their stakes as the extent of the company's problems started to come out. ``I knew I had to get out in August, when they canceled a meeting with me at the last minute--after I'd arrived in Houston,'' says a fund manager at a private German bank. He quickly dumped $50 million of Enron stock. Insurers that still held big blocks of Enron shares when it collapsed include Germany's Allianz, France's AXA, and Holland's Aegon. Analysts estimate Aegon's exposure at $200 million. 
Meanwhile, Europe's spot and futures markets for electricity are in chaos. Enron was a big electricity supplier and trader in Europe, at the height of its activity accounting for up to 20% of volume traded on the energy exchanges. Most energy and power companies already had wound down their exposure to Enron by the time its collapse became imminent. But the scale of the company's problems and the speed with which it collapsed have unsettled many traders. Not surprisingly, the price of energy futures is on the way up. Because Enron's aggressive pricing had helped bring down tariffs, businesses and domestic consumers will have to pay more for their energy this winter. Prices will probably rise fastest--up to 2.5%--in Britain's deregulated market, say analysts. Enron was a particularly large player there, producing electricity and delivering it to 2.2 million retail consumers and thousands of companies. 
Even more than in the U.S., Enron's woes are likely to increase resistance to energy deregulation. Although Germany and Britain have almost wholly liberalized their markets, progress elsewhere, especially France, has been slow. Opponents of reform will use the Enron debacle to hold up the process. ``They're going to make a real meal out of this in Paris,'' says a European Commission official in Brussels. This American bankruptcy is Europe's headache.

Indecent Exposure
Europe's banks turn out to be big Enron creditors
                              MILLION
ROYAL BANK OF SCOTLAND         $500
Britain
INTESA-BCI                      300
Italy
CREDIT LYONNAIS                 250
France
ABN AMRO                        200
Netherlands
SOCIETE GENERALE                167
France
ABBEY NATIONAL                  160
Britain
BARCLAYS                        126
Britain
DEUTSCHE BANK                    50
Germany
Data: Bank and analysts' estimates
Photograph: ENRON'S INTERESTS INCLUDE A GERMAN WINDMILL MAKER PHOTOGRAPH BY JENS DIETRICH/FOTOAGENTUR NETZHAUT 
..................................................................................................................................... 

Cover Story
THE FALL OF ENRON How ex-CEO Jeff Skilling's strategy grew so complex that even his boss couldn't get a handle on it
By Wendy Zellner and Stephanie Anderson Forest in Dallas with Emily Thornton, Peter Coy, Heather Timmons, Louis Lavelle, and David Henry in New York, and bureau reports

12/17/2001
BusinessWeek 
30
(Copyright 2001 McGraw-Hill, Inc.) 

To former Enron CEO Jeffrey K. Skilling, there were two kinds of people in the world: those who got it and those who didn't. ``It'' was Enron's complex strategy for minting rich profits and returns from a trading and risk-management business built essentially on assets owned by others. Vertically integrated behemoths like ExxonMobil Corp., whose balance sheet was rich with oil reserves, gas stations, and other assets, were dinosaurs to a contemptuous Skilling. ``In the old days, people worked for the assets,'' Skilling mused in an interview last January. ``We've turned it around--what we've said is the assets work for the people.'' 
But who looks like Tyrannosaurus Rex now? As Enron Corp. struggles to salvage something from the nation's largest bankruptcy case, filed on Dec. 2, it's clear that the real Enron was a far cry from the nimble ``asset light'' market maker that Skilling proclaimed. And the financial maneuvering and off-balance-sheet partnerships that he and ex-Chief Financial Officer Andrew S. Fastow perfected to remove everything from telecom fiber to water companies from Enron's debt-heavy balance sheet helped spark the company's implosion. ``Jeff's theory was assets were bad, intellectual capital was good,'' says one former senior executive. Employees readily embraced the rhetoric, the executive says, but they ``didn't understand how it was funded.''
Neither did many others. Bankers, stock analysts, auditors, and Enron's own board failed to comprehend the risks in this heavily leveraged trading giant. Enron's bankruptcy filings show $13.1 billion in debt for the parent company and an additional $18.1 billion for affiliates. But that doesn't include at least $20 billion more estimated to exist off the balance sheet. Kenneth L. Lay, 59, who had nurtured Skilling, 48, as his successor, sparked the first wave of panic when he revealed in an Oct. 16 conference call with analysts that deals involving partnerships run by his CFO would knock $1.2 billion off shareholder equity. Lay, who had been out of day-to-day management for years, was never able to clearly explain how the partnerships worked or why anyone shouldn't assume the worst--that they were set up to hide Enron's problems, inflate earnings, and personally benefit the executives who managed some of them. 
That uncertainty ultimately scuttled Enron's best hope for a rescue: its deal to be acquired by its smaller but healthier rival, Dynegy Inc. Now Enron is frantically seeking a rock-solid banking partner to help maintain some shred of its once-mighty trading empire. Already, 4,000 Enron workers in Houston have lost their jobs. And hundreds of creditors, from banks to telecoms to construction companies, are trying to recover part of the billions they're owed. 
From the beginning, Lay had a vision for Enron that went far beyond that of a traditional energy company. When Lay formed Enron from the merger of two pipeline companies in 1985, he understood that deregulation of the business would offer vast new opportunities. To exploit them, he turned to Skilling, then a McKinsey & Co. consultant. Skilling was the chief nuts-and-bolts-operator from 1997 until his departure last summer, and the architect of an increasingly byzantine financial structure. After he abruptly quit in August, citing personal reasons, and his right-hand financier Fastow was ousted Oct. 24, there was no one left to explain it. 
Much of the blame for Enron's collapse has focused on the partnerships, but the seeds of its destruction were planted well before the October surprises. According to former insiders and other sources close to Enron, it was already on shaky financial ground from a slew of bad investments, including overseas projects ranging from a water business in England to a power distributor in Brazil. ``You make enough billion-dollar mistakes, and they add up,'' says one source close to Enron's top executives. In June, Standard & Poor's analysts put the company on notice that its underperforming international assets were of growing concern. But S&P, which like BusinessWeek is a unit of The McGraw-Hill companies, ultimately reaffirmed the credit ratings, based on Enron's apparent willingness to sell assets and take other steps. 
Behind all the analyses of Enron was the assumption that the core energy business was thriving. It was still growing rapidly, but margins were inevitably coming down as the market matured. ``Once that growth slowed, any weakness would start becoming more apparent,'' says Standard & Poor's Corp. director Todd A. Shipman. ``They were not the best at watching their cost.'' Indeed, the tight risk controls that seemed to work well in the trading business apparently didn't apply to other parts of the company. 
Skilling's answer to growing competition in energy trading was to push Enron's innovative techniques into new arenas, everything from broadband to metals, steel, and even advertising time and space. Skilling knew he had to find a way to finance his big growth plans and manage the international problems without killing the company's critical investment-grade credit rating. Without a clever solution, trading partners would flee, or the cost of doing deals would become insurmountable. ``HE'S HEARTBROKEN.'' No one ever disputed that Skilling was clever. The Pittsburgh-born son of a sales manager for an Illinois valve company, he took over as production director at a startup Aurora (Ill.) TV station at age 13 when an older staffer quit and he was the only one who knew how to operate the equipment. Skilling landed a full-tuition scholarship to Southern Methodist University in Dallas to study engineering, but quickly changed to business. After graduation, he went to work for a Houston bank. The bank later went bust while Skilling was at Harvard Business School. Skilling said that fiasco made him determined to keep strict risk controls on Enron's trading business. He once told BusinessWeek that ``I've never not been successful in business or work, ever.'' Skilling now declines to comment, but his brother Tom, a Chicago TV weatherman, says of him: ``He's heartbroken over what's going on there.... We were not raised to look on these kinds of things absent emotion.'' 
Enron's ``intellectual capital'' was Skilling's pride and joy. He recruited more than 250 newly minted MBAs each year from the nation's top business schools. Meteorologists and PhDs in math and economics helped analyze and model the vast amounts of data that Enron used in its trading operations. A forced ranking system weeded out the poor performers. ``It was as competitive internally as it was externally,'' says one former executive. 
It was no surprise then that Skilling would turn to a bright young finance wizard, Fastow, to help him find capital for his rapidly expanding empire. Boasting an MBA from Northwestern University, Fastow was recruited to Enron in 1990 from Continental Bank, where he worked on leveraged buyouts. Articulate, handsome, and mature beyond his years, he became Enron's CFO at age 36. In October, 1999, he earned CFO Magazine's CFO Excellence Award for Capital Structure Management. An effusive Skilling crowed to the magazine: ``We didn't want someone stuck in the past, since the industry of yesterday is no longer. Andy has the intelligence and the youthful exuberance to think in new ways.'' 
But Skilling's fondness for the buttoned-down Fastow was not widely shared. Many colleagues considered him a prickly, even vindictive man, prone to attacking those he didn't like in Enron's group performance reviews. Fastow, through his attorney, declined to comment for this story. When he formed and took a personal stake in the LJM partnerships that blew up in October, the conflict of interest inherent in those deals only added to his colleagues' distaste for him. Enron admits Fastow earned more than $30 million from the partnerships. The Enron CFO wasn't any more popular on Wall Street, where investment bankers bristled at the finance group's ``we're smarter than you guys'' attitude. Indeed, that came back to haunt Enron when it needed capital commitments to stem the liquidity crisis. ``It's the sort of organization about which people said, `Screw them. We don't really owe them anything,''' says one investment banker. 
While LJM--and Fastow's direct personal involvement and enrichment--shocked many, the deal was just the latest version of a financing strategy that Skilling and Fastow had used to good effect many times since the mid-'90s to fund investments with private equity while keeping assets and debt off the balance sheet. Keeping the debt off Enron's books depended on a steady or rising stock price and an investment- grade credit rating. ``They were put together with good intentions to offset some risk,'' says S&P analyst Ron M. Barone. ``It's conceivable that it got away from them.`` 
Did it ever. The off-balance-sheet structures grew increasingly complex and risky, according to insiders and others who have studied the deals. Some, with names like Osprey, Whitewing, and Marlin, were revealed in Enron's financial filings and even rated by the big credit-rating agencies. But almost no one seemed to have a clear picture of Enron's total debt, what triggers might hasten repayment, or how some of the deals could dilute shareholder equity. ``No one ever sat down and added up how many liabilities would come due if this company got downgraded,'' says one lender involved with Enron. Many investors were unaware of provisions in some deals that could essentially dump the debts back on Enron. In some cases, if Enron's stock fell below a certain price and the credit rating dropped below investment grade--once unimaginable--nearly $4 billion in partnership debt would have to be covered by Enron. At the same time, the value of the assets in many of these partnerships was dropping, making it even harder for Enron to cover the debt. HIGH HOPES. Skilling tried to accelerate the sale of international assets after becoming chief operating officer in 1997, but the efforts were arduous and time-consuming. Even as tech stocks melted down, Skilling was determined not to scale back his grandiose broadband trading dreams or the resulting price-to-earnings multiple of almost 60 that they helped create for Enron's stock. At its peak in August, 2000, about a third of the stock's $90 price was attributable to expectations for growth of broadband trading, executives estimate. 
That rapidly rising stock price--up 55% in '99 and 87% in 2000--gave Skilling and Fastow a hot currency for luring investors into their off-balance-sheet deals. They quickly became dependent on such deals to finance their expansion efforts. ``It was like crack,'' says a company insider. Trouble is, Enron's stock came tumbling back to earth when market valuations fell this year. By April, its price had fallen to about 55. And its far-flung operational troubles were taking their own toll. In its much-hyped broadband business, for instance, a capacity glut and financial meltdown made it hard to find creditworthy counterparties for trading. And after spending some $1.2 billion to build and operate a fiber-optic network, Enron found itself with an asset whose value was rapidly deteriorating. Even last year, company executives could see the need to cut back an operation that had 1,700 employees and a cash burn rate of $700 million a year. ``SOMETHING TO PROVE.'' And the international problems weren't going away. Enron's 65% stake in the $3 billion Dabhol power plant in India was mired in a dispute with its largest customer, which refused to pay for electricity. Some Indian politicians have despised the deal for years, claiming that cunning and even corrupt Enron executives cut a deal that charged India too much for its power. 
Enron's ill-fated 1998 investment in the water-services business was another drag on earnings. Many saw the purchase of Wessex Water in England as a ``consolation prize'' for Rebecca P. Mark, the hard-charging Enron executive who had negotiated the Dabhol deal and other investments around the world. With Skilling having won out as Lay's clear heir apparent, top executives wanted to move her out of the way, say former insiders. A narrowly split board approved the Wessex deal, which formed the core of Azurix Corp., to be run by Mark. But Enron was blindsided by British regulators who slashed the rates the utility could charge. Meanwhile, Mark piled on more high-priced water assets. ``Once [Skilling] put her there, he let her go wild,'' says a former executive. ``And she's going to go wild because she has something to prove.'' Mark spent too much on a water concession in Brazil and ran into political obstacles. She declined to comment for this story. 
But if Azurix was a prime example of Enron's sketchy investment strategy, it also demonstrated how the company tried to disguise its problems with financial alchemy. To set up the company, Enron formed a partnership called the Atlantic Water Trust, in which it held a 50% stake. That kept Wessex off Enron's balance sheet. Enron's partner in the joint venture was Marlin Water Trust, which consisted of institutional investors. To help attract them, Enron promised to back up the debt with its own stock if necessary. But if Enron's credit rating fell below investment grade and the stock fell below a certain point, Enron could be on the hook for the partnership's $915 million in debt. 
The end for Enron came when its murky finances and less-than-forthright disclosures spooked investors and Dynegy. The clincher came when Dynegy's bankers spent hours sifting through a supposedly final draft of Enron's about-to-be-released 10Q--only to discover two pages of damning new numbers when the quarterly statement was made publicly available. Debt coming due in the fourth quarter had leapt from under $1 billion to $2.8 billion. Even worse, cash on hand--to which Dynegy had recently contributed $1.5 billion--shrunk from $3 billion to $1.2 billion. Dynegy ``had a two-hour meeting with the new treasurer of Enron, who had been in that seat for two weeks,'' said a source close to the deal. ``He had no clue where the numbers came from.'' RESPECT FOR ASSETS. Skilling and Fastow face most of the wrath of reeling employees. ``Someone told me yesterday if they see Jeff Skilling on the street, they would scratch out his eyes,'' says a former executive. One of Fastow's lawyers, David B. Gerger, says his client has been the subject of death threats and anti-Semitic tirades in Internet chat rooms. ``Naturally people look for scapegoats, but it would be wrong to scapegoat Mr. Fastow,'' says Gerger. 
He confirms that Fastow has hired a big gun to handle his civil litigation: David Boies's firm, which represented the Justice Dept. in its suit against Microsoft Corp. On Dec. 5, Milberg Weiss Bershad Hynes & Lerach filed a suit against Fastow, Skilling, and 27 other Enron executives, saying they illegally made more than $1 billion off stock sales before Enron tanked. And a source at the Securities & Exchange Commission says four U.S. Attorney Offices are considering whether to pursue criminal charges against Enron and its officers. 
Would the cash squeeze have caught up to Enron, even without Skilling's and Fastow's fancy financing? Credit analysts still argue that the debt would have been manageable, absent the crisis of confidence that dried up Enron's trading business and access to the capital markets. But even they have a new respect for old-fashioned, high-quality assets. ``When things get really tough, hard assets are the kind you can depend upon,'' says S&P's Shipman. That's something Enron's whiz-kid financiers failed to appreciate.

Enron's Stock Price
DEC. 31 1996
$21.50
AUG. 17 2000
$90
DEC.5 2001
$1.01
Data: Bloomberg Financial Markets
Skilling's Strategy: What Went Wrong?
         THE BIG IDEA                              THE PROBLEM
Create an ``asset light'' company.      Some partnerships required Enron to
Skilling applied Enron's trading        kick in stock if its rating and
and risk-management skills to           stock price fell below a certain
power plants and other facilities       point. Enron could be left holding
owned by outsiders. To maintain         the bag on about $4 billion in
a high credit rating and raise          debt. With its stock and asset
capital, Enron moved many of its        values falling, Enron was vulner-
own assets off the balance sheet        able. And when things started to
into complex partnerships.              unravel, its murky finances spooked
                                        investors and lenders.
Expand Enron's energy trading           Enron tried to do too much, too
expertise into a vast array of          fast, with little or no return.
new commodities to sustain              It invested $1.2 billion in fiber-
earnings growth. Skilling en-           optic capacity and trading facili-
visioned taking on markets              ties, but the broadband market
ranging from paper goods to             crashed. And it was never able to
metals to broadband capacity.           show that it could generate the
                                        profits it got from energy trading
                                        in markets such as metals.
A Star Is Born, Then Burns Out
JANUARY, 1997
Jeffrey Skilling is named president and COO. In six years, he had put Enron on
the map as a natural-gas and electricity trading powerhouse.
JULY
Enron pays $3.2 billion for Portland General Electric to combine the utility's
wholesale and retail electricity expertise with Enron's natural-gas and
electricity marketing and risk-management skills.
AUGUST
Enron branches out beyond energy, introducing commodity trading of weather
derivatives.
MAY, 1998
Rebecca Mark, a rising star who helped cinch Enron's $3 billion power plant in
Dabhol, India, in the early '90s, is named vice-chair. She had been a rival to
Skilling as a successor to Chairman and CEO Ken Lay.
JULY
Enron pushes into foreign markets, paying $1.3 billion for the main power
distributor to Sao Paulo and $2.4 billion for Britain's Wessex Water. Wessex
becomes a building block for Mark's new global water business, Azurix Corp.
APRIL, 1999
Enron agrees to pay $100 million to name Houston's new baseball stadium Enron
Field.
JUNE
Enron sells a third of Azurix to the public, raising $695 million.
NOVEMBER
Skilling launches EnronOnline, a Net-based commodity trading platform. A few
days later, proclaiming ``this is Day One of a potentially enormous market,''
he introduces trading of broadband capacity.
JULY, 2000
Enron launches online metals trading.
AUGUST
A power shortage darkens California, and state politicians blame Enron and
other energy outfits. Problems at Azurix drive its stock to $5, down from $19
at the IPO. Mark resigns as Azurix' chief and an Enron director.
SEPTEMBER
Enron launches online trading of wood products.
DECEMBER
Skilling is promoted to CEO, effective Feb. 2001. Enron's stock has soared 87%
in 2000. Enron offers to take Azurix private.
MARCH, 2001
California officials investigate alleged price gouging by Enron and other
power marketers.
JUNE
Enron execs sold shares in the first half as the stock slid 39%. Skilling's
total: $17.5 million.
AUGUST
Skilling stuns investors by quitting, for ``personal reasons.'' Lay reclaims
the CEO title.
OCT. 16
Enron reports a third-quarter loss of $618 million and shrinks shareholder
equity by $1.2 billion, citing losses due partly to partnerships run by
then-CFO Andrew Fastow.
OCT. 22
Enron says the SEC has started an inquiry into Fastow's partnerships. Two days
later, he's out.
OCT. 31
Enron sets up a committee to conduct an investigation of its accounting.
NOV. 8
Net income is revised back through 1997, trimming it by $586 million.
NOV. 9
Dynegy Corp. agrees to buy Enron for $10 billion.
NOV. 15
Lay says Enron made billions of dollars of ``very bad investments.''
NOV. 19
Enron says it may have to repay a $690 million note and take a $700 million
pretax charge.
NOV. 28
Dynegy bails out of the merger after seeing unanticipated debt and cash flow
problems in Enron's 10Q filing. Enron's credit is downgraded to junk status.
DEC. 2
Enron files for the largest Chapter 11 reorganization in history.
Data: Company reports, BusinessWeek
Everyone Loved Enron
Here's what some management gurus said about Enron's rise, and what they think
now
JAMES J. O'TOOLE, Professor, Univ. of Southern Calif.
BEFORE
``Leadership is not a solo act...it is a shared responsibility, a chorus of
diverse and complimentary voices. To an unusual degree, [Enron] is chock-full
o' leaders''
AFTER
``Egg all over the face is an understatement. As embarrassing as it is, we
basically took the word of Lay and his people. Was there a way to spot that
the emperor was wearing no clothes? I don't think so.''
CHRISTOPHER A. BARTLETT, Professor, Harvard Business School
BEFORE
``Skilling and Lay created `a hotbed of entrepreneurial activity and an engine
of growth.'''
AFTER
``There are absolutely some strong, helpful lessons to learn by what they did
right. Unfortunately, all those are trumped by the mistakes they made.''
GARY HAMEL Chairman of consultant Strategos
BEFORE
``Enron isn't in the business of eking the last penny out of a dying business
but of continuously creating radical new business concepts with huge upside.''
AFTER
``Do I feel like an idiot? No. If I misread the company in some way, I was one
of a hell of a lot of people who did that.''
SAMUEL E. BODILY, Professor, University of Virginia
BEFORE
``Skilling and others have led a transformation in Enron that is as
significant as any in business today. This is brand new thinking, and there
are broad implications for other companies.''
AFTER
``History can't be very kind to it. It's sad: The innovation and ideas and
what was good about what they did may be lost in the demise of the company.''
Photograph: LAID-OFF WORKERS WITH THEIR BELONGINGS JAMES NIELSEN/GETTY IMAGES 
Photograph: SITTING PRETTY: SKILLING AT NEW HEADQUARTERS IN MAY, 2000 PHOTOGRAPH BY WYATT MCSPADDEN 
Photograph: SKILLING AND LAY FOSTERED A DEALMAKING CULTURE PHOTOGRAPH BY ROCKY KNETEN 
Photograph: REBECCA MARK PHOTOGRAPH BY DAN FORD CONNOLLY 
Photograph: DABHOL: MARK MADE A NAME FOR HERSELF WITH THE POWER PLANT PHOTOGRAPH BY PABLO BARTHOLOMEW/GETTY IMAGES 
Photograph: ENRON'S INTELLECTUAL CAPITAL: TRADERS PHOTOGRAPH BY PAUL HOWELL/GETTY IMAGES 
Photograph: ANDREW FASTOW PHOTOGRAPH BY RICHARD LOPER 
Photograph: CHUCK WATSON PHOTOGRAPH BY CHRISTOBAL PEREZ/HOUSTON CHRONICLE Illustration: Chart: NOW YOU SEE IT, NOW YOU DON'T 
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Editorials
ENRON: LET US COUNT THE CULPRITS

12/17/2001
BusinessWeek 
154
(Copyright 2001 McGraw-Hill, Inc.) 

Enron Corp.'s bankruptcy is a disaster of epic proportions by any measure--the height from which it fell, the speed with which it has unraveled, and the pain it has inflicted on investors, employees, and creditors. Virtually all the checks and balances designed to prevent this kind of financial meltdown failed. Unless remedied, this could undermine public trust, the capital markets, and the nation's entire equity culture. Even now, no one really knows what liabilities are buried inside dozens of partnerships or the role ex-CEO Jeffrey Skilling played in creating a byzantine system of off-balance-sheet operations. A culture of secrecy and a remarkable lack of transparency prevented any realistic assessment of the company's financial risk. Nothing less than an overhaul of the auditing profession is now required to police accounting standards. Wall Street, mutual funds, and the business press would also do well to rethink why each, in its own way, celebrated what is now revealed to be an arrogant, duplicitous company managed in a dangerous manner (page 30). 
What is increasingly clear is that Skilling, a former McKinsey & Co. consultant and Harvard Business School grad, tried to craft Enron as a new kind of virtual trading giant, operating outside the scrutiny of investors and regulators. Enron's numerous partnerships were shrouded in secrecy, tucked away off the balance sheet. They were used to shift debt and assets off the books while inflating earnings. The chief financial officer ran and partly owned two partnerships, a clear conflict of interest. Enron leveraged itself without a reality check by any outsider. ASLEEP. Hardly anyone inside the company was urging caution, certainly not chairman Ken Lay. The independent auditing committee on the board of directors was clearly asleep. Given Enron's arcane financial engineering, the committee probably relied on Arthur Andersen, the auditor, for information. But Andersen didn't blow any whistles. No surprise there. It made more money selling consulting services to Enron last year than it did auditing the company. Criticizing Enron's books might have jeopardized consulting work. Similar conflicts of interest stopped Wall Street analysts from pulling the plug on Enron. Even as Enron slid toward bankruptcy, ``buy'' recommendations were being issued by analysts whose firms were doing investment-banking business with the company, or were hoping to.
Did anyone really know what was going on inside Enron? The rating agencies, Moody's Investor Service and Standard & Poor's, presumably had better access than average investors, but neither downgraded Enron's credit rating to below investment grade until the bitter end. The rating agencies argue that had they downgraded Enron sooner, they would have simply pushed the company into bankruptcy earlier. Here's a flash: So what? Moody's and S&P have one basic job--assessing risk for investors. If they couldn't penetrate Enron's complex financial engineering, the rating agencies should have said so. 
The business press, including BusinessWeek, did no better. It celebrated Skilling's vision of Enron as a virtual company that could securitize anything and trade it anywhere. The press blithely accepted Enron as the epitome of a new, post-deregulation corporate model when it should have been much more aggressive in probing the company's opaque partnerships, off balance sheet maneuvers, and soaring leverage. TRAGIC. Enron's fall is made all the more tragic because of the pain inflicted on its thousands of employees. Not only are many losing their jobs, but some 12,000 are also losing most of their retirement savings. In perhaps its most egregious risk-management error, employees mostly held Enron stock in their 401(k)s, yet the company prevented them from selling until they reached the age of 54. People could only watch as the stock plummeted from $89 to a dollar. Diversification, particularly in retirement accounts, is the cardinal rule in managing risk. Enron broke that rule, as have other companies. 
Enron's tale is a clarifying event. It reveals key weaknesses in the financial system that must be corrected as the U.S. moves forward in the 21st century. If America is to have an equity culture in which individuals invest in stocks and provide the capital for fast economic growth, the market must be able to correctly value companies. This requires making financial data readily available and easily comprehensible. 
To restore public confidence, several steps should be taken. After accounting disasters at MicroStrategy, Cendant, Lucent, Cisco, and Waste Management, it is clear that self-regulation is not working. Conflicts of interest within auditing firms remain widespread. Investors can ignore analysts on TV who work for investment firms. But someone has to play the role of the honest watchdog. Unless the Big Five auditing firms clean up their act, they will wind up with a federally chartered oversight body. It is equally clear that current standard accounting rules aren't sufficient. Loopholes allowed Enron to fool everyone, making a mockery of public disclosure. 
Regulators should also insist that corporations give their employees choice in their 401(k)s. Some 30% of assets held in 1.5 million 401(k) plans are in the stock of the company sponsoring the plan. This lack of diversification puts too many people at risk. 
In the end, the Enron story is about a secretive corporate culture that failed in its primary business mission: to manage risk. Had the Federal Reserve and other central banks not flooded the global economy with liquidity in recent months, Enron's collapse could have posed a deep threat to the financial markets. It's past time to fix the system.

Illustration: Chart: STUNNING COLLAPSE CHART BY RON PLYMAN/BW 
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Business
Digging Into the Deal That Broke Enron; Behind the web of mysterious partnerships that led to the world's biggest corporate collapse. Follow the Raptors
By Allan Sloan With Debra Rosenberg in Washington and Anne Belli Gesalman in Houston. sloan is NEWSWEEK's Wall Street editor. His e-mail address is sloan@panix.com.

12/17/2001
Newsweek 
48
Copyright (C) 2001 Newsweek Inc. All Rights Reserved. 

Enron corp. used to talk about becoming the world's biggest company. Instead, it became the world's biggest corporate failure, filing for bankruptcy last week. The company, which used complexity to its advantage on the way up, became a victim of its own complex dealmaking on the way down. A NEWSWEEK examination of Enron's filings shows that the company's fatal mistake was an unintended byproduct of one such deal. The transaction first inflated Enron's reportednet worth, then deflated it. When the company cleaned up its books this fall, it triggered the $1.2 billion net-worth write-down that touched off the downward spiral that led to bankruptcy. 
Enron looked like a well-oiled machine, but a lot of it seems to have been jury-rigged. The company was housed in a spiffy 50-story building in downtown Houston, a structure whose elevators flashed Enron's latest stock price and delivered upbeat messages to get employees pumped by the time they got to their offices. In the best New Economy tradition, Enron had an on-site health club, casual dress and employees piling up paper wealth by investing in Enron stock.
But when things started going bad, Enron couldn't cope. It couldn't even fire people properly. Information-technology specialist Diana Peters says her entire department was told to clear out on half an hour's notice and to call their office voice mail to see if they should return to work the next day. Very classy. "I was crying, a lot of people were crying," says Peters, 51. "It reminded me of a mass funeral." 
The company even had trouble going broke. Normally, a company hoards cash in preparation for bankruptcy by accelerating collections from its customers and slowing down payments to vendors. Enron didn't start doing that until a few days before the filing, far too late. Enron almost became the Flying Dutchman of the bankruptcy world. It wanted to file in Wilmington, Dela., but the bankruptcy court there didn't want the case. So Enron ended up in New York City. And it was so short of cash that it had to scurry around to line up $1.5 billion of so-called debtor-in-possession financing to keep the place operating. Normally, you make DIP arrangements before you file. 
It would be lots of fun to give you Washington's take on all this, Enron being famous for close ties to the White House and the Republican Party. But we'll leave that for another day, because the juicy stuff probably won't show up until the Democrats get in gear. Hearings in the Republican-controlled House are set for this week, and will focus on accounting and stock analysts and the Securities and Exchange Commission rather than on Enron's political relationships and what, if anything, the White House did during Enron's final days. 
Although some details are still murky, one thing is clear: Arthur Andersen, Enron's outside accountant, is in big trouble, and it (or its insurers) will have to fork over big bucks. Andersen's big problem stems from a company called JEDI--as in "Star Wars"--that Enron now says should have been on its books since 1997. Andersen allowed JEDI to remain off the books for years. The other deal, involving a company called Raptor, caused the net-worth disappearance that set Enron on the road to ruin. 
JEDI stands for Joint Energy Development Investments. It was a partnership between Enron and the California state-employees' pension fund, known as Cal-pers. The Force was with Enron, which invested the money--$250 million each from itself and Calpers--in power plants, energy stocks and such, making more than 20 percent a year. Pretty neat. In late 1997, Calpers was willing to invest $500 million in a new partnership, JEDI 2. But it wanted to first cash in its JEDI 1 chips, worth $383 million. Instead of just liquidating JEDI, Enron got cute. (I'm not sure why. Enron declined to comment.) It went looking for an outsider to fork over $383 million and take Calpers's place. Enter something called Chewco Investments--as in Chewbacca of "Star Wars" fame. Chewco was a partnership of Enron employees and some undisclosed outsiders. (Who they are and how much they made is a mystery, because Chewco is a private entity.) Chewco's investors didn't have a spare $383 million. So Enron lent Chewco $132 million and guaranteed a $240 million loan that Chewco took out elsewhere. Enron was thus at risk for its own JEDI stake and essentially all of Chewco's. That being the case, it's a mystery why Andersen let Enron keep JEDI off its books. Accounting experts who have looked at this transaction, which Enron disclosed last month, just shake their heads. Andersen has refused to comment, saying it's too early to reach conclusions. Enron has restated its earnings dating back to 1997 because it says JEDI should have been on its books since then. Guess what? The restated profits are far lower than the original ones. 
Now, to the deals that sank Enron. As in JEDI, Enron won't comment. These transactions involve four companies called Raptor. It looks like the Raptors were set up to let Enron use financial gymnastics to get gains from stocks it owned without actually selling them. The major holdings were Rhythms Net Connections, a now bankrupt start-up telecom company, and NewPower Holdings, which competes with established power companies for customers. At their height, Enron's stake in these companies totaled about $2 billion. Friday's value: about $40 million. Enron won't say why it didn't just sell the stock and take its profits. The most logical explanation is tax avoidance. 
Now, the key to Enron's undoing. The company committed to put $1.2 billion of Enron stock into the Raptors to make them more creditworthy. It didn't promise a fixed number of shares--it promised $1.2 billion worth, regardless of the share price. A seriously dumb move for a company that talks about hedging risks. In return for that commitment, the Raptors gave Enron $1.2 billion of promissory notes. Enron put them on its balance sheet as an asset. When a company adds to its assets and nothing else changes, its net worth rises. Hence, Enron marked up its net worth by $1.2 billion. 
But as the stock prices of Rhythms, NewPower and Enron all sank, Enron faced having to fork over a ruinous number of new shares. So Enron paid $35 million to the Raptors' outside investors--yet another mysterious partnership--and liquidated the Raptors. That eliminated the notes, which eliminated the aforementioned $1.2 billion from Enron's net worth. That set off the now famous October run on Enron's credit, which ultimately led to bankruptcy. Now, far too late, Enron says it shouldn't have counted the notes as assets. 
The bottom line: numbers matter. So does truth. Enron was too clever by half. And that's a good way to end up looking stupid. 
Photo: Enron built a pipeline to the GOP, as well as to natural-gas fields 


Photo: Enron built a pipeline to the GOP, as well as to natural-gas fields Photo: Kenneth Lay: Enron's CEO is a longtime friend of Bush's and was a top contributor to his campaign Graphic: (Chart) Sphere of Influence? Enron's demise has rekindled questions over Bush & Co.'s links to the company. (Graphic omitted) 
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Copyright ? 2000 Dow Jones & Company, Inc. All Rights Reserved.