“I have always tried to do the right thing, but where there was once great pride now it’s gone”

Nine years ago today a somewhat forgotten tragedy in the Enron fiasco unfolded. J. Cliff Baxter, who had retired as the vice chairman of Enron in May of the previous year, was found dead in his vehicle from a self-inflicted gunshot wound. Enron had just filed for bankruptcy the month prior, and Baxter was one of 29 former Enron employees named in a shareholder lawsuit alleging insider trading.

How did it get to this? Enron wasn’t founded as an energy company with the purpose of defrauding investors. But somewhere along the way, things got very, very off track. I’ve read a lot on this over the years and even wrote a few papers detailing the many problems Enron faced. In the end, the failure comes down to two core problems: mark-to-market accounting and the hiding of debt.

I absolutely agree with the concept of mark-to-market accounting. If I’m an investor, I prefer that any company I’m looking to invest in marks their assets to current market values. This isn’t too difficult when an asset has a market value that can be easily determined, such as a stock or bond. However, this gets a lot more complicated when the asset is an energy contract over a fixed amount of time. There is much debate over what exactly is correct here, but there isn’t any debate over what isn’t correct. Clearly, it would not be correct to account for all future expected revenues the day the contract is signed. This is what Enron did, and in some cases these contracts had up to ten years of future expected revenues. It’s not hard to see how this got so easily out of control.

Secondly was the hiding of debt. As if the insanely inflated profits caused by marking up future energy contracts didn’t make things spiral out of control enough, Enron was actually hiding a good amount of their debt that would have offset some of this profit. Andy Fastow created quite a few companies whose sole purpose was only to do business with Enron. And the only business they did was take on Enron’s debt so that it wouldn’t show up on Enron’s books. It’s estimated that almost $30 billion in debt was hidden this way.

So where are we now? Ken Lay passed away in 2006, shortly before sentencing, and subsequently all charges against him were dropped. Fastow will be released from prison later this year. Jeff Skilling is set to spend the next 17 years in prison, but with the Supreme Court vacating part of his conviction earlier last year, it is believed he will get out before then. But more importantly, a wife and two kids lost a father 9 years ago today, which is something no court can change or overturn.

Who exactly was Baxter? Strangely, not all that much is known about his role at Enron compared to the others. Most articles say he clashed with Skilling over questionable business practices and had agreed to testify against him prior to his death. Still, you have to think Cliff had some type of involvement in the activities that led Enron to its demise. To what extent, we will likely never know.

Had Baxter not taken his life, I guess he would have met a fate similar to Lou Pai, who also left Enron earlier in 2001. Pai ultimately settled out of court for a small fraction of what he made of dumping the stock in mid-2001.

Really I can’t fault Baxter for dumping his stock in mid-2001. If you are given stock options in your company as compensation and you know for a fact that the stock is overvalued, you would sell the stock. You wouldn’t sit idle and watch your money go down the drain. Of course, many issues come up if you are in a position to drive the overvalued stock’s value even higher through accounting tricks. I haven’t seen anything showing Baxter did this.

I hear a lot about the poor employees of Enron who lost their life savings when the stock tanked. Personally I have a hard time feeling sorry for someone who lost his/her life savings because he/she had it invested all in one stock. One of the very first things I learned in my money management class in high school was to not put all your eggs in one basket. I also recall learning that as you near retirement, it is wise to pull your money out of the market because of fluctuations and the fact that you no longer have time on your side to overcome these fluctuations.

What really struck me, though, was the suicide note Baxter left for his wife. Specifically the line, “I have always tried to do the right thing but where there was once great pride now it’s gone.” To me, this says Cliff was a hard-worker who really believed in his work. While he may have questioned those around him, he knew he was doing business the proper way and was proud of it. Seeing it all fall down just crushed him to the point that he saw no future.

I think at some point or another, we can all say we’ve felt the same way. Maybe not even necessarily in a business or work setting. You tried your best, thought you were doing the right thing, and put all of your effort into it. Only to one day see it all crumble around you for reasons that were really out of your control. It breaks my heart to think of how much pain Cliff must have felt over everything that unfolded where he just felt as if he could not go on anymore in life. Today, I remember Cliff Baxter.

Rising Debt

I touched on this last week, but I’m finally seeing headlines today on the national debt. Why? We have once again hit the debt limit that was set by Congress.

Although it was fairly easy for most analysts to predict this would happen, what isn’t easy is how to turn this around. Accumulating more debt is simply the American way. The treasury records debt by comparing the current debt load at the end of Q3 in the current year to the debt load at the end of Q3 in the prior year. The last time debt actually was lower versus the prior year was 1957. That’s right, it’s been over 50 years since we’ve saved more than we borrowed. Some point out surpluses during some of the Clinton years, however those only happened when looking at fiscal year data. By looking at the Q3 treasury data, they aren’t there.

It’s almost certain that Congress will just raise the debt ceiling again, like they have done several times in the past decade. Not doing so would contradict the American way of life. But we’ve finally reached the point where taking on much more debt would finally brand us as insolvent. The Wall Street Journal points out that by the year 2020, we will be spending as much on interest as we are on national defense. This is assuming that no more debt is taken on, which is an assumption being made against over 50 years of data.

I think the main point here is that we’ve finally reached a critical moment in our future. There are really only two options here: borrow more to bring on insolvency, or stand up and finally change the way we’ve been living for over 50 years. There is still hope for the latter, but I’m not sure Congress will ultimately see the need for it.

Market values

I’ve always been a firm believer in market price.  Given the amount of available data as well as the volume that stocks trade at, it’s been an easy assumption that the current price of a stock is its true market value.  However, taking a step back and looking at the bigger picture of where we’ve been and where we are now, I’m not so sure stocks are really trading at their true market values today.

I see a lot of headlines as of late that the DOW could easily hit its all-time high in 2011.  I’m not sure where this thought is even being drawn from, but it probably is the same train of thought that somehow led to the DOW getting to its current spot.  Yet, if we step back and take a look at the facts, they look to be pointing to a different market value.

The DOW should reflect the performance of the US economy.  We can easily track the DOW’s performance.  The performance of the US economy is ultimately tracked by growth in GDP.  I’m going to take a look at where both have gone in the last two years.

The economy grew at a rate of 5.5% in the first quarter of 2009.  Since then, it has grown at a total rate of about 17% (versus where it was prior to 2009).  These numbers are as of the end of Q3 2010 since Q4 data won’t be out for a bit yet.  The DOW came into 2009 valued at 8,776.  The DOW ended Q3 2010 at 10,788, which is almost a 23% increase over that time.  Furthermore, as of today the DOW is valued at 11,755, which is a 34% increase in the last 2 years.  Surely I’m not the only one who realizes the economy didn’t grow by 15% in Q4 to keep up with current market prices!

I know, we need to take more into consideration before drawing any conclusions.  If you don’t want to measure the market by the DOW, I’ll point out that the S&P has outperformed the DOW over this time period.  Another figure that really blows my mind on this is the amount of national debt we’ve accrued over this same time period.  We’ve taken on over $3 trillion in debt from Q1 2009 through Q3 2010, which is almost a 30% increase.  Also, estimates are that we incurred another 500 billion in debt in Q4 2010, the same time the market was really taking off.

Furthermore, it took us roughly 5 years prior to accumulate the amount of debt we’ve accumulated in the last two years.  And it took us 12 years prior to that to accumulate the same debt we’ve accumulated in the last two years.

Clearly, these numbers don’t add up.  Many factors have pushed the market to where it is now.  If you want to be able to see the future just look up a graph of an overpriced stock that was overpriced because of the lack of understanding its debt load.  I think we are at the peak right now.  And if you think government debt is much different than corporate debt, ask yourself where a lot of the cash on these major corporations balance sheets is coming from?