Much of what Enron stood for involves important policy issues and initiatives which should not necessarily be buried with its name.
As well, its legacy should be more than a knee jerk cremation. Leadership will be required to avoid having some of the important policy initiatives and novel business approaches for which Enron was carrying water thrown out because of the water boy.
Enron's promise lay (not capitalized) in its aggressive development of a wide variety of forward market tools to maximize the amount of arbitrage in gas and electric markets. Arbitrage which would facilitate market participants who place a different future value on the use of gas, or electricity, or the time value of a revenue stream, to bid on and acquire very unique ownership slices of such commodities. This arbitrage function, embodied in derivatives, hedges and swaps, plays a crucial role in moderating the volatility of, say, commodity markets (like electricity). And unchecked volatility is the enemy of smooth economic performance – as well as smooth and reliable electric service. So new SEC and accounting policy initiatives should not make it impossible to carry out complex business, or hog tie derivatives into obsolescence.
Similarly, Enron carried the promise, and apparently the portfolio, for rapidly expanded electric industry deregulation. Should electric industry deregulation die as the result of Enron's demise? The two issues are largely unrelated in fact, although unfortunately related in the public's, the body politic's mind. California. Now that's probably a good reason to rethink whether and how electric deregulation should occur. But turning our back on deregulation simply because of Enron would be the proverbial throwing the baby out with the bath water.
Enron's legacy, in some small respect like that of September 11, will be positive. A wakeup call to American business and its service providers. We must all re‑engage in the pursuit of our fiduciary responsibilities to our stakeholders and clients – to our employees, our clients, our shareholders, the investing public, the people who rely upon our investment advice. American business, the American capital markets, are not a virtual reality, with SimFinance, Sega, Gameboy-like rules. We cannot rely on slavishly literal interpretations of rules that ignore realities. It is an altogether probable fact that, apart from one or two instances of inadvertently missing technical GAAP requirements for off balance sheet treatment of Special Purpose Entities, everyone involved with Enron was coloring inside the lines. But, remember the number paintings we did as kids. Your nose against the canvas, one blotch of color carefully applied next to another – and you couldn't tell what it looked like until you stepped far enough away. So, too, with Enron, except it turned out to be an obscene painting. If painting by number, inside the lines, produces Enron, the policymakers will need to assure that the (revised) rules include or require a realistic look, a sufficient step back, so the picture represents the material, business reality.
So Enron's legacies will include the wakeup call to fiduciary responsibilities. A renewed realization that, apart from too-smart-by-one-half Wall Street convoluted deals, business realities like cash flow and risk analysis are fundamental. The American public has relearned the age old lesson – be careful whom you trust with your money. And make sure your advisors are careful as well. These legacies on top of those learned in the bursting of the E‑Commerce bubble should insert more caution into Wall Street. And caution moderates booms, decreases capital market liquidity, and makes it harder for small startup businesses to raise capital. An over reaction, caution raised to unfounded fear, could fuel a liquidity crisis based recession – one of the worst kinds.
The entrenched, salaried executives of the 1960's and 1970's, evolved into the takeover era of the 80's precipitated by that stodginess, which morphed into the hyper-aggressive executive conduct spawned by the get-rich-quick option arrangements of the 90's designed to align the interests of executives with those of shareholders – not put the interests of executives ahead of shareholders. But in some instances with very rich option arrangements, that's what happened. So another legacy will be a careful look at stock options, their tax and financial statement impacts, hopefully with an outcome that does not remove this important tool, but moderates the ability of executives to get rich out of brief upticks in long term business disasters. That has been a repeating and achievable scenario based on beating near term analyst forecasts which probably has increased the number of booms to busts which have occurred in our economy over the past 10 years.
And what will Enron's legacy be for the electric industry? Which is a different question than what should its impact be. However, with leadership (and not demagoguery) of the type we normally find in Congress, "will" and "should" scenarios could line up very well. Deregulation did not just happen in California, where it failed. It also happened in Illinois, Pennsylvania, Maine, Massachusetts and the rest of New England, and yes, Texas. And it is in various stages of happening in five or six other states. The genie is out of the bottle. Pat Wood (the FERC Chairman) and FERC Commissioner Nora Brownell (both Bush appointees), along with federal Energy Secretary Spencer Abraham, have – with speeches, articles and decisions – made it clear they intend to push for more generation market deregulation through divestitures of generating plants by the bundled, incumbent electric utilities which remain vertically integrated.
The promise of deregulation of generation is reduced costs through competition (tighter operations and technological breakthroughs). The characteristic of competition that produces lean operations and technological breakthrough is the actual risk of business failure – failures like Enron, and the risk of failure (causing significant construction plan changes) for market players like AES or Calpine.
The legacy from California's experience is that ill-conceived deregulation does not deliver lower costs – but rather shortage and higher costs. The ill-conceived deregulation did not solve the financial risk of stranded costs for California utilities that lured them into building and backing that plan – it produced bankruptcy. And, that ill-conceived deregulation was accompanied by unreliable electric supplies – blackouts. Above all, above costs, the political reality of electricity is that it must be reliably provided to the customers/voters.
Also, in California there was a lot of dysfunctional regulation of the buyers and sellers in the "competitive" market in an effort to jump start a robust spot market. Those regulations failed.
What does America need? As always, reasonably priced, reliable electric supplies. The implementation of an effective system of RTOs should help to assure that the transmission grid, our electric circuit infrastructure, is reliable and built up to first class status. What about the supply of electric capacity –at least until distributive power solutions create alternative supply solutions?
The longer-term issue is should, and if so, how should, we lay the groundwork for a truly competitive electric generation market? That groundwork needs to include absolute assurance that the political preconditions – physical system reliability, capped prices, and constantly adequate capacity – will be met. In order to offer the full promise of competition, the competitive market needs to operate (as far as possible) in an unfettered manner. And, with such physical capacity insurance in place, it would be possible to create a very unfettered competitive generation market – if the electric transmission circuit is robust enough to permit a generation market without undue market power in the hands of its participants.
Whether states have the luxury to consider generation market deregulation at their leisure, or whether federal policy under the Bush administration will essentially mandate divestiture to simplify the national patchwork which currently exits, is yet to be seen. Whichever, the legacies of our learning curve suggest our absolute need to assure adequate electric generation capacity reserves. And having an FERC-regulated physical capacity reserve system supported by transmission ratepayers who benefit from that reliability, needs to be considered. Otherwise, dysfunctional resort to partial regulation of the competitive generation system is likely.