13

Capitalism’s Philanthropists

During the same decade that Clyde Lott and Chaim Richman indulged their respective, and potentially cataclysmic, Christian and Jewish end-times delusions, American investors lost their collective wits in an orgy of financial speculation.

One evening in early 2000, after a long day’s work at Money magazine’s midtown Manhattan office, journalist Jason Zweig caught a taxi home. As the driver pulled into traffic, the vehicle was obstructed by four young men in expensive suits, one of whom rat-a-tatted the driver’s window to demand a ride to a destination just a few blocks away. When informed by the cabbie he already had a fare, the gentleman thrust a $100 bill in the driver’s face and said, “Throw him out and we’ll give you a hundred bucks.”

The cabbie shut the window, and, as recorded by Mr. Zweig, “We sped away from the scene like two maidens escaping the tent of Attila the Hun.” What flabbergasted Zweig, an experienced New Yorker, was not so much that the whiz kids offered a Ben Franklin for his ejection, but that the four could have gotten to their destination faster on foot.728

Like Blunt, Hudson, and Insull, these brash young men had drunk of the hubris of sudden wealth, and probably also from more mundane spirits. They were rich, and, according to the logic of our materialistic society, thus smart and important, never mind that their lucre more likely flowed from dumb luck, sharp practices, or both.

The financial mania that so intoxicated Zweig’s assailants lasted, roughly speaking, from the mid-1990s until mid-2000, and then collapsed in slow motion over the ensuing two and a half years, a deflation nearly identical in length to that following 1929’s Black Thursday. The devastation was widespread: in the aggregate, 100 million investors lost $5 trillion, roughly a third of their stock market wealth. The most aggressive of them, still many millions of Americans, having been deluded into believing that they had found the financial fountain of youth in dot-com stocks and mutual funds, had, like Edgar Brown in 1929, lost most of their life savings in the deluge.729

As with previous manias, the bubble’s underlying pathophysiology of Hyman Minsky’s four necessary conditions applies: technological and financial displacement, credit loosening, amnesia, and the abandonment of time-honored valuation principles.

To paraphrase the bubble’s mantra, the era’s great displacement, the internet, really did change everything.730 It came into existence in 1969, when the Defense Department’s Advanced Projects Research Agency linked together its first four “nodes” at UCLA, UC Santa Barbara, the University of Utah, and the Stanford Research Institute. The new “information superhighway” titillated investors, but its initial slowness and difficulty of use, combined with the expense and clumsiness of the first personal computers, meant that for its first twenty years it impinged little on everyday life. The first commonly used networks, such as AOL and Compuserve, were initially not even connected to the wider internet, and even later, when they were, functioned as walled gardens that did not allow direct navigation to web pages outside their domain.

That would change in 1990, when Tim Berners-Lee, a computer scientist working at CERN, the European high-energy physics center that straddles the Swiss-French border, invented the first primitive browser, which he prophetically named WorldWideWeb. At the time, he merely sought to connect the facility’s myriad different computers; almost by accident, he wired up the planet and created a sensation that roiled the financial markets and transformed the very way we live.731

Berners-Lee’s first browser required too much technical expertise for general purposes, but other programmers soon improved on its user-friendliness. In 1993, the National Center for Supercomputing Applications (NCSA) at the University of Illinois released Mosaic, a relatively easy to install and deploy Microsoft Windows–based application. Marc Andreessen, a University of Illinois student, headed the NCSA team; after he graduated, he moved to California, where he joined forces with a computer science Ph.D. named Jim Clark.

A decade earlier, Clark had founded Silicon Graphics, which made high-end computers. In tech argot, these devices were “workstations,” custom-made devices designed for a specific task that usually ran their own proprietary operating systems and software. In the 1980s, the manufacturers of workstations made billions, but for most companies, this profitability proved a golden trap, since increasingly capable personal computers would shortly displace them, an eventuality that the visionary Clark foresaw. Frustrated at his inability to convince the firm’s management of this, he left Silicon Graphics, angry not only that the company he had founded had veered off course, but also that his share was worth only $20 million—in his words, “relatively little to show for a dozen years of creativity, leadership, risk, and hard work in an industry that has produced vast personal wealth.”732 He vowed that next time he’d have more control and be better rewarded.

In 1994, Clark and Andreessen incorporated the Mosaic Communications Corporation. The University of Illinois, miffed at their use of the Mosaic moniker, asked them to find a new company name; they settled on Netscape Communications. Like Mosaic, the company made the browser freely available, and it spread like wildfire. By mid-1995, millions of users thrilled to the meteor shower and the N-monogrammed planet in the upper-right corner of the screen that announced that they were online and able to access web pages from anywhere on the globe.

Easy credit, the second of Minsky’s pathophysiolgical factors, provides the raw fuel for bubbles. In a modern fractional reserve system, a nation’s central bank—in the United States, the Federal Reserve—plays the money supply’s guard dog. The Fed’s job is to keep the economy humming with an adequate money supply, but also, in the immortal words of former chairman William McChesney Martin, to “take away the punch bowl just when the party gets going.”733

Under most circumstances, the Federal Reserve Board cares about two things: the overall state of the economy, as measured by GDP growth and the unemployment rate, and keeping inflation under control. Stock prices are of lesser concern, and often wind up an “innocent bystander” to these twin concerns.

By the middle of the twentieth century, the Fed’s primary tool was the federal funds rate, the interest rate at which member banks lend to each other overnight—effectively, the short-term rate on government securities. When the interest rate on these safe securities is high, they attract investors. This draws money away from risky assets such as stocks and lowers their prices; contrariwise, when the Fed lowers rates, investors seeking a higher return purchase stocks, and thus raise prices.734

The early 1990s saw a moderately severe recession that precipitated two major events. First, it cost George H. W. Bush a second term; as put by the de facto campaign slogan of the victor, Bill Clinton, “It’s the economy, stupid.” Second, the recession triggered a dramatic loosening of credit by the Federal Reserve, which nourished the stock market bubble.

Under the chairmanship of Alan Greenspan, the Fed attacked the early 1990s recession by buying Treasury bills, which lowered the federal funds rate from 8.3 percent in January 1990 to around 3.0 percent in late 1992, where it remained for two full years. This fueled the initial phase of the stock market boom, and investors began to speak of the “Greenspan Put,” the impression that the chairman actively sought to keep stock prices aloft.735

By all rights, the Fed should have taken away the punch bowl around 1997, by which time the economy was clipping along nicely, with inflation falling to about 3 percent. It looked like Greenspan was about to do just that, but a sequence of events intervened that was eerily similar to the 1920s, when Chairman Strong inadvertently touched off a U.S. stock market frenzy by lowering rates to protect the English pound.

In 1997 and 1998, global events conspired to keep the punch bowl full. A series of currency and debt crises swept through world financial markets, beginning with the collapse of the Thai currency, the baht, and spread in domino-like fashion to Malaysia, Indonesia, and Hong Kong. Initially, the evolving contagion did not greatly alarm Greenspan, since those Asian economies were relatively small, but when late in 1997, the same sequence played out in Korea, a wealthier nation that hosted tens of thousands of American troops, he was forced to respond. The Fed and Treasury strong-armed America’s banks to keep lending to Korea as cheaply as possible—that is, at the lowest possible interest rate, not only in Korea but in other Asian nations as well. Lower interest rates abroad depressed these foreign currencies, which appreciated the dollar. In early 1997, the Fed had, in response to the booming economy, already begun to raise interest rates, but in order to prevent this dollar appreciation, held them steady; as in the 1920s, the persistent relatively low rates fed the by-then well-established stock market mania.

The international financial dominoes continued to fall; in late 1998, a similar shrinkage of the Russian economy precipitated a default on its debt and deflation of the ruble. This time, the contagion spread directly to the United States, where a large and prestigious hedge fund, Long Term Capital Management (LTCM), which had bet heavily on Russian debt, went under. The evaporation of the fund’s massive holdings threatened the rest of the financial system and hammered stock prices around the world.

Figure 13-1. Federal Funds Rate 1997–2000

By that point, the markets considered Greenspan the virtual author of the 1990s economic boom, and he had acquired near mythical status as “the maestro,” as Bob Woodward would later title his best-selling book about the chairman, who saw his outsized reputation threatened by the potentially catastrophic fallout of LTCM’s collapse. Not only did Green­span engineer the fund’s bailout by private banks, but he also eased credit by aggressively lowering the federal funds rate, and kept it low for a full year. This, in turn, sent stock prices into the stratosphere.736

By the end of the twentieth century, the third pathophysiological bubble factor, financial amnesia, had developed over several decades. The 1929–1932 bear market had so savaged family and institutional wealth and so seared the national psyche that for decades after stocks were not considered prudent investments; for example, as late as 1945, the first date for which there are reliable statistics, the average dollar of individual investments, which is heavily weighted toward the savings of the wealthy, hovered at around only 30 cents in stocks, and it was the rare corporate pension fund that held a significant amount.

Although only about 10 percent of Americans owned stocks and got directly burned in the 1929–1932 bear market, the subsequent Great Depression affected everyone.737 Almost all Americans of a certain age carry with them a burden of family Depression baggage (in this author’s case, his mother’s habit of carefully wrapping and saving even a single leftover restaurant asparagus). For millions of Americans, still-vivid memories of the brutal 1929–1932 period diminished the appeal of stocks for a generation or more.

A stock bubble of sorts did occur in the late 1950s to early 1960s that revolved around the invention of the semiconductor transistor a few decades previously by a Bell Labs team led by physicist William Shockley, sparking an explosion of increasingly miniaturized and capable electronic devices. By 1959, affixing “-tronics” to a company’s name served to stimulate public interest and juice the stock price in the same way that adding “dot-com” to a company would do so a generation later. One staid manufacturer of phonographs and vinyl records, American Musical Guild, went public with a sevenfold price pop simply by changing its name to Space-Tone. Some other meaningful corporate names from the era were Astron, Vulcatron, several ending in “-sonics,” and, most impressive of all, Powertron Ultrasonics. Investment banks learned to favor insiders with large share allotments and simultaneously limit the amount available for purchase by the wider public, and thereby fed the public enthusiasm, which collapsed in 1962, as almost all previous bubbles had, when the frenzy ran out of eager buyers.738

The tronics mania involved only a small corner of the equity market, and since relatively few Americans owned stocks in that era, it left little lasting impression on the public memory.739 By the 1990s, the average U.S. citizen was two generations removed from the last society-wide securities bubble. When one finally arrived, only three tiny groups had the tools to recognize it: nonagenarian investors with intact memories; economic historians; and those who had read, absorbed, and retained the lessons of the first three chapters of Extraordinary Popular Delusions.

The 1990s tech mania prominently featured the fourth pathophysiological bubble factor, the abandonment of traditional valuation criteria for stocks. Even the highest-flying stock darlings of the late 1920s produced a solid stream of profits, and all but a few “high tech” companies (most notably, RCA and Remington Rand) sported healthy dividends as well.740 By contrast, in the 1990s, only a handful of the new tech companies produced enough revenue to pay for their lavish spending on personnel and equipment. As to dividends, tech investors thought them a quaint echo from a remote horsewhip-and-buggy era; what few turned up lay more than a decade away. Microsoft, which issued its first shares to the public in 1986, did not declare its initial dividend until 2003; as of this writing, the two biggest winners of the dot-com sweepstakes, Amazon and Google, have yet to do so. As the 1990s progressed, investors somehow convinced themselves that earnings and dividends didn’t matter at all; the true value of a company’s stock lay in fuzzier metrics, measured in millions of eyeballs or billions of clicks.

As supposedly put by a great twentieth-century investor, John Templeton, “The four most expensive words in the English language are ‘This time it’s different.’” During the 1990s, the emerging digital world really did look different, and many of the era’s wildest-sounding promises came true: near universal broadband coverage, ubiquitous and nearly free voice and video telephony, and an efficient online shopping environment that would swallow many traditional brick-and-mortar outlets whole.

Regrettably, the average investor in these technologies didn’t profit. Of the hundreds of companies that went public during the late 1990s, just a small handful survived. Only one of them, Amazon, became a dominant economic force, and even it has yet to show the earnings an investor might expect from its commanding position in the retail industry.741

Just as during the English railroad and 1920s bubbles, the 1990s tech boom, while mauling investors, left society with valuable infrastructure. Bubble companies are best understood as a three-level pyramid structured according to the relationship between the profitability and societal benefit of those companies, as depicted above.

At the apex of the pyramid sit companies that not only benefited society but also made their investors wealthy, like the East India Company or the Bank of England, and, at least as of this writing, Amazon and Google. The second and perhaps most important level consists of companies that benefit society but lose their investors money, such as George Hudson’s railway empire and Samuel Insull’s utilities trusts.

Global Crossing Ltd. was the tech bubble era’s poster child for this seemingly counterintuitive outcome. Between 1998 and 2002, during the blowing and collapse of the dot-com mania, telecommunications firms strung most of today’s current half-million miles of global submarine fiber-optic cable. One man, Gary Winnick, was responsible for nearly a third of that frenzied effort.

Winnick, a former bond salesman and protégé of junk-bond king and convicted felon Michael Milken, possessed in spades the same talent as his business ancestors, Blunt, Hudson, and Insull: a genius for raising billions in stock and bond offerings from credulous investors.

Unfortunately, Winnick possessed none of Hudson’s and Insull’s business acumen; before he founded Global Crossing in 1997, his knowledge of telecommunications did not extend greatly beyond, as one journalist put it, “an ability to make a cold call,” a deficiency compounded by his never having run a large enterprise.742 Whether the company’s failure was due to incompetence, malfeasance, or merely bad luck is still a matter of dispute. While Winnick tended to absent himself from the company’s day-to-day affairs, he, along with other top executives, did have the presence of mind to sell hundreds of millions of dollars of stock just before the firm went belly-up. Civil and regulatory actions stripped him of most of that ill-gotten gain, but in the end prosecutors declined to indict.

Winnick’s culpability is beside the point. However badly Global Crossing battered its investors’ fortunes, the company contributed in no small part to the making of today’s interconnected world. At the height of the market frenzy surrounding it and other internet-era stocks, the company was valued in excess of $40 billion, $6 billion of which Winnick owned. (“Getting Rich at the Speed of Light,” gushed the 1999 Forbes cover.)743

His scheme was neither fraudulent nor lacking in vision, as his appraisal of the importance of global bandwidth proved correct. Rather, as have many business visionaries throughout commercial history, he underestimated the two things that everywhere and always diminish profits. First, as sure as death and taxes, profits attract competition, increase supply, and depress prices and subsequent profits. Winnick’s 1997 completion of two high-capacity transatlantic links, for example, was followed within six years by ten more competing cables. Second, technological improvement also increases the supply of the goods produced, further depressing prices. In the case of submarine cables, over the subsequent decades, improvements in “dry plant,” the optical transmitters and receivers at either end of the cables, have resulted in a seven- to tenfold increase in the carrying capacity of the originally laid strands. Global data traffic is now roughly a thousand times greater than it was in 2002, despite the fact that companies laid no new transatlantic cables between 2003 and 2014; on average, less than a quarter of the world’s submarine cable capacity is currently “lit” with signal.744

As is almost always the case during bubbles, the enthusiasm of Global Crossing’s investors led them to pay far too much for their piece of the action. On January 28, 2002, the company filed for bankruptcy, following which two Asian firms scooped up a controlling interest in Winnick’s network for $250 million, literally a penny on the dollar. While the company eventually emerged from its reorganization and still operates a large slice of the internet’s backbone, the original shareholders were left with nothing beyond a few crumbs from resulting legal settlements.

The carnage was widespread: Besides individual investors, pension and mutual fund pools lost billions. Commenting on Mr. Winnick’s well-timed stock sales, Linda Lorch, an elementary school teacher who lost $120,000 in the stock, said, “I don’t know how the management of this company did so well while small shareholders did so poorly.”745 Many of Global Crossing’s employees owned the company’s shares in their 401(k) plans and fared even worse than Lorch, losing their savings as well as their jobs.746

Global Crossing’s executives weren’t the only ones who profited from well-timed sales of its stock. In March 1999, former president George H. W. Bush gave a speech to its executives; in lieu of his $80,000 speaking fee, he took company shares that he sold several months later for approximately $4.5 million, which the Wall Street Journal speculated may have gone to pay for upkeep at the family’s Kennebunkport retreat.747

While Global Crossing crippled the financial futures of unfortunates like Lorch and the company’s employees, it benefited the rest of the world by blessing it with a surfeit of bandwidth. The same cannot be said for the third level down the pyramid, the hundreds of dot-coms that disappeared without a trace, not only trampling their investors but also leaving behind nothing of societal or economic value. Perhaps the most spectacular story in the futile dot-com pursuit of eyeballs and mindshare was the Webvan episode, a fiasco on a scale unimaginable before 1995.

Louis Borders, who had founded the eponymous bookstore chain, was hardly a wild-eyed twentysomething techie with an outlandish idea. In 1997, five years after he had retired from bookselling to found an investment firm, a package containing some rare spices he had ordered online, a novelty at the time, arrived on his doorstep. A lightbulb fired off: could he convince Americans to order their groceries that way?

Borders dreamed big. In order to deliver perishable goods to millions of consumers, he needed to build out a novel, massive logistical system. His first facility in Oakland was twenty times the size of a standard supermarket, housed four and a half miles of conveyor belts, and carried a vast variety of food, including more than seven hundred kinds of meat and fish.748 He then engaged Bechtel, the nation’s largest construction concern, to erect a national network of twenty-six similar complexes at a total cost of more than $1 billion—impressive for a firm that didn’t exist the year before.

Borders, who had studied mathematics at MIT, projected that each facility would assemble eight thousand twenty-five-item orders daily and each bring in a third of a billion dollars in annual revenue; human “pickers,” strategically placed among a ballet of food-bearing rotating carousels, would put together customers’ purchases and then feed them down the miles of conveyor belts to idling refrigerated trucks for delivery to homes within an hour of order. Because of its scale, Webvan’s operations were projected to spend less than 1 percent of revenues on its physical plant, versus 6 percent for soon-to-be-obsolete conventional supermarkets. Borders mused that after conquering retail food, he would move on to videos, consumer electronics, and dry cleaning.749

Webvan attracted A-list financial backing from the likes of Goldman Sachs, Oracle, Hewlett-Packard, and Knight Ridder, as well as a tsunami of popular enthusiasm. To stoke the frenzy, the initial stock offering sold off only a small percentage of the company; when applied to all of Webvan’s shares, this implied a market valuation of $8.4 billion, half that of Safeway’s, not bad for what at that point amounted to an operation centered on the twenty-six eventually constructed oversized supermarkets.750

Two problems doomed the venture. First, Webvan was hardly the first internet food seller; it had several competitors, among which was a larger and more established company, HomeGrocer.com, backed by, among others, Amazon’s Jeff Bezos. Second, the model didn’t work; the untested technology proved balky, and even had it functioned smoothly, consumers didn’t yet trust someone else to pick out perishable produce and deliver it on time. Both Webvan and HomeGrocer.com posted month after month of losses.751

HomeGrocer.com was better managed, but Webvan generated more enthusiasm and thus began with more cash, which meant that HomeGrocer.com ran dry first. In the dot-com opéra bouffe style of the late 1990s, the less competent but better-funded Webvan absorbed HomeGrocer.com, which only served to accelerate the newly merged company’s cash consumption; in July 2001, it declared bankruptcy, vaporizing billions in wealth and leaving 3,500 employees out of work.752

The three-level bubble pyramid of the 1990s sat on a slimy pool of malfeasance and deceit, as occurred at Enron, one of the biggest corporate frauds in United States history, costing investors upwards of $70 billion. The episode speaks volumes about the get-rich-quick atmosphere of the era. Unlike the likable, philanthropic, and visionary Winnick, Enron’s management consciously conjured up the mass of criminal behavior that regularly accompanies financial bubbles, and its dramatis personae came straight out of central casting’s villain folder: the sanctimonious and socially ambitious Kenneth Lay; the hyperkinetic Jeffrey Skilling; and the dark, larcenous Andrew Fastow.

Unlike Global Crossing and the dot-coms, Enron began life in one of the economy’s most unglamorous commodities: natural gas, which, until the mid-twentieth century, was most often burned off as waste. The company’s principals, in contrast, shone with dazzling brilliance, and in the memorable and pithy words of journalists Peter Elkind and Bethany McLean, were “the smartest guys in the room.”753

Born in 1942 into grinding poverty in rural Arkansas, Kenneth Lee Lay did not live in a house with an indoor toilet until he was eleven. From that point forward, though, fortune repeatedly smiled upon him, as when his father moved to Columbia, Missouri, the home of the state’s public university. All three Lay children attended at little cost, and there Kenneth encountered great good fortune in the person of an economist named Pinkney Walker.

After graduation, Lay began work at Humble Oil, Exxon’s predecessor, earning a night-school economics doctorate along the way. Next, he enlisted in the Navy, where in 1969, Walker’s connections landed him a procurement job at the Pentagon. Shortly thereafter, President Nixon appointed Walker to the Federal Power Commission, and he took his young protégé with him. The commissioner’s young aide so impressed Nixon that he tapped him for undersecretary of energy at the Interior Department.

Public utilities run through public rights of way, and ever since their birth in the late nineteenth century, the states and federal governments had heavily regulated the industry. But by the early 1970s, deregulation was in the air, and Lay found himself in the middle of the action. His Washington connections found him positions in Texas and Florida energy companies, eventually winding up in 1984 as CEO of Houston Natural Gas, where he engineered a merger with Omaha’s venerable pipeline company, Inter­North. Lay hired a consulting firm to name the merged entity, which came up with Enteron; embarrassingly, The Wall Street Journal noted that the new moniker was a synonym for the gastrointestinal tract. It was shortened to Enron.754

Lay envisioned vast profits from deregulation. Tragically, he possessed qualities that would in due time turn the name Enron into a synonym for corporate malfeasance: a love of luxury and prestige, a weakness that prevented him from reining in the accomplished and arrogant young men he hired to execute his vision; and a moral blindness that equated his own self-interest with that of both his company and of society at large. He compounded this unfortunate combination of traits by gradually absenting himself from the company’s day-to-day operations, as he spent ever more time hobnobbing in Washington, D.C., and Manhattan, and ever less time at the company’s Houston headquarters. Despite Lay’s stratospheric compensation (over $100 million in 2001, including stock options and “loans”), his social and material ambitions drove him deep into debt, more than $100 million worth when Enron failed.755

Corporate jets provide a useful window into corporate behavior. While their purchase does not by itself indicate poor management, let alone malfeasance, excessive use, and particularly personal use, does.756 Enron owned six, which Lay’s wife and children viewed as their private property, the “family taxi,” as the fleet became known within the company. Among the ultrarich, the size, range, and speed of an aircraft mark the owner’s place in the pecking order, and at the turn of the last century, private aviation’s ne plus ultra was the three-engine Falcon 900. Enron had two, over which the Lay family held priority. On one occasion in 1999, for example, when daughter Robin wanted to return from France, the company sent an empty Falcon over to pick her up. In 2001, as the company was beginning to implode, Lay enthusiastically buttonholed Jeffrey Skilling, by then about to become CEO, for his opinion regarding the choice of upholstery for yet one more newly ordered aircraft.757

The Lay family taxi informed the consumption choices of other executives, many of whom owned fleets of luxury cars, multiple luxury vacation homes, and Manhattan apartments. One exception to the Enron culture of excess stood out: a sober and competent executive named Richard Kinder, who was in line to be Enron’s CEO. Lay forced him out over personal issues, and when Kinder went through the door in 1996, the last brake on Enron’s downhill slide departed with him. (Kinder then helped found another energy company, Kinder-Morgan. It owned no private jets, and when Kinder, a billionaire, needed one, he rented it out of his own pocket.)758

Lay’s corporate vision went well beyond the everyday world of domestic pipelines; he wanted to extend the company’s ambit in both space and scope, with ambitious overseas infrastructure projects and forays into the enticing new world of energy futures trading and, once established there, to create from scratch a futures market in internet bandwidth. Once Enron had conquered these, it would move into massive industries such as steel and paper, as well as services such as freight hauling.759 In order to do so, the company needed to borrow vast amounts of money, which in turn required demonstrating the ability to earn profits early on; since the firm’s new ventures were in fact sustaining significant losses, the appearance of profits would have to suffice.

Enter Jeffrey Skilling. Raised in the suburbs of both New Jersey and Chicago, in the early 1970s, he attended Southern Methodist University, where he studied electrical engineering. He soon found that money thrilled him in a way that circuitry did not. In one class he came across a Ph.D. thesis that described how to “securitize” futures contracts into marketable financial products, in the same way that mortgages would later be disastrously bundled together and sold to credulous investors. Skilling saw a way to extract money from mathematical abstraction, in which he had excelled at SMU, and soon thereafter, at Harvard Business School, where he graduated with top honors in 1979.

The logical next step for top-flight business school graduates was McKinsey & Company, before its recent scandals the planet’s most prestigious consulting firm, where cool abstract reasoning was valued above all other skills. He made director at its Houston office within a decade, often consulting for Enron, and in 1990, it lured him away from McKinsey.

Enron, like most other companies, reported the income from gas sales as it arrived. To practitioners in the world of high-level consulting like Skilling, several things stood out about this seemingly antiquated notion of making profits from the sales of a mere commodity. He envisioned, for example, that the long-term contracts between the pipeline companies and their customers could be bought and sold in the financial markets like any other security. Even more critically, reporting income as it arrived offended Skilling’s rarified intellect. If the customer signed a contract to purchase gas over the next decade, he thought that it could be reported up front.

This technique, known as “mark-to-market” accounting, stood just on the edge of legality, so before deploying it, he asked for the SEC’s blessing. Incredibly, in 1992, the commission gave it. At Enron headquarters, the accounting change effected the pouring of champagne, for Skilling had just acquired the nearest thing to a license to print money: sign long-term contracts, book all the revenue at once and thus immediately report spectacular earnings, borrow capital based on those fictitious earnings to build out natural gas capacity, on the strength of which yet more contracts could be signed, more future earnings booked immediately, and more money borrowed for yet more expansion.760 It was as if Lockheed Martin, which expects to sell twenty-five hundred F-35 fighters to the U.S. armed forces for a total of more than a trillion dollars during the next decade, booked that revenue immediately upon signing the deal, then went out to borrow money on the strength of those projected earnings to begin the manufacture of automobiles, then booked the projected income from those future sales to build out a nationwide hospital chain.

Enron had already borrowed massively to expand the company beyond pedestrian gas delivery. Among other ventures, over the next decade the company built an enormous gas-fired power plant at Dabhol, south of Mumbai; established Azurix, a conglomeration of water companies around the globe as far-flung as Romania, Peru, and Morocco; and set up trading platforms for natural gas, for electricity, and, most seductively of all for credulous tech investors, for internet capacity (the last of which meant doing business with Winnick’s Global Crossing).

Like Winnick, Enron’s crew excelled at accounting legerdemain and dazzled inattentive stock analysts and small investors, and just like Winnick, few at Enron knew how to run a real-world business. Almost all of their operations lost boatloads of money, most spectacularly the Dabhol power plant, whose output cost so much that the local electricity board refused to pay for it, following which the plant sat mothballed for five years. Enron’s international adventure in water companies, run by a charismatic and glamorous executive named Rebecca Mark, who had little prior experience with water utilities, imploded even more rapidly. Most incredibly of all, Enron contracted to deliver electrical power to twenty-eight thousand sites around the world, what the cerebral types at the Houston headquarters derisively called “butt-crack businesses,” and because they had little experience with electrical utilities, they then had to hire the technical and administrative expertise to do so. Skilling, who envisioned a high-tech globe-circling broadband trading platform, tellingly had to have his secretary print out his emails and turn on his computer terminal for him.761

Rather than come clean to their shareholders about the company’s losses and debt load, Skilling ordered twenty-eight-year-old new hire Andrew Fastow to conceal them. In order to borrow, companies need to demonstrate not only an ability to earn profits, but also that they are not already burdened with preexisting debt. Skilling had previously “solved” the earnings problem with his aggressive mark-to-market booking of future earnings; Fastow would surmount the borrowing problem by hiding the company’s massive existing debt.

Fastow had acquired expertise in securitization of loans at his previous employer, the Continental Bank. Securitization involves the assembly of packages of loans and other debt that could next be marketed to buyers and traders. These highly complex and shadowy structures, so-called special purpose entities (SPEs), assumed the burgeoning debt and so theoretically took it off Enron’s accounts; analysts, institutional investors, small investors, and even Enron’s own board no longer saw them on its balance sheet and this deception made it appear as if the company was not heavily indebted.

Fastow constructed more than thirty-five hundred of these SPEs, featuring names like Marlin, Rawhide, Braveheart, Raptor, JEDI, Chewco (named after Chewbacca, a furry Star War’s character), and LJM1, LJM2, and LJM3 (named after Fastow’s wife and children, Lea, Jeffrey, and Matthew). Many of them were specifically designed to transfer money to the personal accounts of Fastow and other executives from shareholders, lenders, and even its own lower-level employees.762

Each of Skilling’s and Fastow’s accounting shenanigans kicked the cans of Enron’s debt down the road, and all those cans accumulated into a massive garbage heap that eventually could no longer be hidden. What’s remarkable is why shareholders and analysts took so long to recognize what should have become plainly visible far sooner.

The man who finally did so was James Chanos, who runs a hedge fund that specializes in so-called short sales. In the normal course of events, share buyers hope that they can buy low, then sell high, and thereby profit. Counterintuitively, a trader can do the opposite: sell first at a high price, then reap a profit by purchasing the shares back later at a lower price. In order to do so, he must first borrow the shares from someone else; the share lender receives a fee for lending the shares, while the share borrower alone reaps the return—and the risk—of the short sale operation.763

Mr. Chanos was not the first analyst to realize that Enron’s financial reports didn’t make sense; rather, his edge lay in better handling the cognitive dissonance between the socially acceptable, happy narrative of Enron’s genius and the contrary financial data, and in acting on it by shorting the stock.764 The loans made to Enron depended on its credit rating, which in turn depended upon Fastow’s ability to hide Enron’s debt with the SPEs. Those loans also hinged on the value of Enron’s stock, which was offered as collateral for their loans; when word of the shenanigans finally seeped out, the stock price fell, the banks called in the loans, and the house of cards came tumbling down. On October 16, 2001, Enron finally came clean about its losses; Ken Lay remained optimistic about the company’s prospects right up to the moment it declared bankruptcy six weeks later. When he and his lieutenants went to New York to file the Chapter 11 papers, they flew there on an Enron jet and stayed at the Four Seasons.765

As with Charlie Mitchell’s National City Bank, the collapse pummeled Enron’s rank and file, who had been encouraged to lard their 401(k) plans with Enron stock; in 2005, for example, twenty thousand former Enron employees received a class-action award of $85 million, pennies on the dollar of their actual losses, which were estimated to be in the billions. (The money was recovered from insurance and banking firms, not from defunct Enron.)766

Adding insult to injury, employees were unable to sell the shares held in their retirement plans for a month, ostensibly because of ongoing changes made to the accounts, during the steepest stock price decline. On the other hand, Enron’s top brass could unload their shares en masse ahead of the collapse, Skilling doing so to the tune of $71 million. When Dynergy, another utility company, offered to rescue Enron, the latter’s executives demanded bonuses and payouts totaling more than $100 million, most for Lay, which Dynergy refused.767

Unlike in the cases of Blunt, Hudson, and Mitchell, justice was served: Multiple executives, including Skilling and Fastow, did jail time (eleven and six years, respectively), and Lay died of a heart attack just before his sentencing.

The Enron episode, along with other similar scandals of that era, such as Dennis Kozlowski’s Tyco International and Bernard Ebbers’s WorldCom, were merely one end of a continuum of accounting manipulation that emanated from an obscure regulatory tweak.

In 1993, in a well-meaning effort to rein in excessive executive compensation, the IRS limited corporate tax deductibility for direct executive salaries to $1 million; this shifted executive payment toward stock options, which become more valuable as the stock price increases. Theoretically, payment in options aligns the incentives of both the executives and the shareholders, but in a classic example of the law of unintended consequences, options payment also incentivizes executives to fudge quarterly earnings numbers to show consistent, reliable earnings increases.

All other things equal, at a given average level of earnings, a small quarter-to-quarter variation in them makes the shares more valuable. Since real-world corporate fortunes fluctuate a lot, this questionable “management” of earnings reports proved too tempting for many CEOs, who made “adjustments” in accounting technique.

General Electric epitomized this legal but sleazy practice, rearranging the inevitable occasional losses seen in a normally operating far-flung empire from quarter to quarter to generate the appearance of smooth, dependable earnings growth.768 The engineer of that prestidigitation, Jack Welch, had done nothing out of the ordinary, let alone fraudulent. Quite the contrary; the financial and popular press hailed him as the second coming of Thomas Edison.

Still, the point cannot be overemphasized: The stock bubbles that emanated from previous revolutionary technologies—the railroad in the nineteenth century and radio and automobiles in the early twentieth century—provided the free-flowing capital that powered economies and advanced societal well-being.

The same was true of the 1990s internet bubble. Even after taking into consideration the nonproductive companies at the bottom of the pyramid like Webvan and the frankly fraudulent companies in the muck under it like Enron, incalculable online intellectual, entertainment, shopping, and banking benefits flowed from investments, most of them money-losers, made in those technologies during that heady period. It’s not too much of a stretch, then, to label bubble investors as capitalism’s unwitting philanthropists, who unconsciously and tragically sacrifice their wealth in the service of the greater public good.

By the late twentieth century, large investment banks, the folks who manufactured the stocks and bonds of new and existing companies, had become the prime bubble promoters. Financier Jay Gould pioneered this industry during the Civil War by selling the government bonds necessary to finance the Union army. In the wake of the 1929 crash, the Pecora Commission blew the lid off Charlie Mitchell’s seamy investment banking practices at National City and brought about the Glass-Steagall Act of 1933, which separated commercial and investment banking by forbidding Main Street banks from issuing stocks and bonds and investment banks from taking deposits from and loaning to ordinary citizens.

Over the succeeding decades, lobbying by investment banks brought about a gradual weakening of Glass-Steagall’s enforcement. This eventually culminated, under the direction of free-market ideologue Republican lawmakers such as Phil Gramm and with the acquiescence of the triangulating Democratic president Bill Clinton, in the act’s repeal at the bubble’s height in 1999.

During the tech bubble, the investment banks revved up their issuance of stock shares in the new companies, and the public, ecstatically connected by the Netscape browser to the internet for the first time at speeds ten thousand times slower than today’s broadband connections, needed no convincing to buy them. Netscape founders Marc Andreessen and Jim Clark, aware that giant Microsoft was developing its own browser, moved quickly to cash in with an initial public offering (IPO).

The Glass-Steagall Act had forced the Morgan company, which had kept its nose clean during the 1920s, to split off from the investment banking half and become Morgan Stanley, Inc. In the 1990s, Morgan Stanley, now the nation’s largest issuer of new stock shares, would float Netscape’s IPO, the most spectacular of the dot-com bubble.

Morgan Stanley, heretofore the great bastion of establishment wealth and privilege, had changed; one of its executives, Frank Quattrone, who hailed from Italian immigrant roots and still spoke with a strong accent, had already taken public Cisco, a major producer of the internet’s backbone hardware. With Netscape’s initial offering on August 9, 1995, he proved himself the worthy successor to Sunshine Charlie Mitchell (and like Mitchell, Quattrone narrowly avoided serving jail time in a series of trials that included a conviction—later reversed on appeal—on obstruction and witness tampering charges).

A major question vexed Quattrone, Clark, Andreesen, and Jim Barksdale, who had just been hired as Netscape’s CEO: How much should investors pay for the company’s shares? Properly pricing an IPO is a fine art. Ideally, in order to sustain enthusiasm, a stock should experience a significant “pop” up from the offering price on its first day of trading; if that offering price is too high, it may discourage retail investors by falling on the first trading day; if set too low, the company and its founders get shortchanged. The four decided on $28 per share, which valued the company at about a billion dollars. When the market opened that morning, the four held their collective breath.

Demand for the stock was so heavy that at the 9:30 a.m. opening bell in New York, Morgan Stanley’s traders couldn’t arrive at a sensible price; one brokerage firm quickly added a new phone prompt: “Press one if you’re calling about Netscape.” Unaware of the frenzy, a bewildered Clark looked at his monitor at 9 a.m. Pacific time, two and a half hours into the east coast trading day, and saw the stock flatlined at $28. He called a broker at Morgan Stanley, who told him there was a “trade imbalance.” Not fully comprehending what that meant, Clark wondered if the IPO had bombed.

“Trade imbalance” did not even begin to describe the deafening scene at Morgan Stanley’s New York IPO desk. At its heart sat approximately two hundred workstations, each manned by a trader desperately trying to answer several simultaneously ringing extensions, each of which, in turn, conveyed a demand for Netscape shares.

Shortly after Clark’s initial call, the broker rang back to inform Clark that it had opened at $71, which meant that his net worth had abruptly shot past a half billion dollars, and that the company had raised much more than that. As put by one of the chapter titles in Clark’s memoir, “One Billion Is the Best Revenge.”769

The Grateful Dead’s Jerry Garcia died later that day of a massive heart attack. His last words supposedly were, “Netscape opened at what?”770

728. Jason Zweig, Introduction to Schwed, xiii; and Zweig, personal communication.

729. Maggie Mahar, Bull! (New York: HarperBusiness, 2003), 333–334. A Vanguard Group study demonstrated that by 2002, 70 percent of their 401(k)s had lost at least 20 percent of their value; Vanguard investors were, in general, more conservative than usual, and the firm offered no internet fund; for a better sense of how the dot-com bubble devastated small investors, see the “Bill’s Barber Shop” section of Chapter 14.

730. In a narrow, semantic sense, though, this was untrue: the word “internet” refers to the fiber optic backbone that connects high-powered computers and servers. The ubiquitous “www” of modern discourse is the gateway to access documents or websites over that backbone with a system of digital addresses—uniform resource locators (URLs)—through browsers such as Chrome, Safari, and Internet Explorer. Technically “http” and “https” are the ways or protocols for accessing web pages. URLs are shortcuts that redirect traffic to the document at a web server computer’s location, “IP address” in web argot.

731. William J. Bernstein, Masters of the Word (New York: Grove/Atlantic, 2013), 309–310; and Tim Berners-Lee, Weaving the Web (San Francisco: Harper­SanFrancisco, 1999), 7–51.

732. Jim Clark, Netscape Time (New York: St. Martin’s Press, 1999), 20–32, quote 32.

733. The Economist, “William Martin,” August 6, 1998.

734. The federal funds rate is in reality just a target. The actual overnight rate is negotiated between the lending and borrowing banks; the Fed influences it by either buying Treasury bills on the open market, which tends to lower rates, or by selling them, which tends to raise them.

735. A “put” is an option to sell a security at a given floor price, thus insuring against a large loss.

736. Robert L. Hetzel, The Monetary Policy of the Federal Reserve (New York: Cambridge University Press, 2008), 208–224, see especially Chairman Greenspan’s remarks, 221; and Sebastian Mallaby, The Man Who Knew (New York: Penguin Press, 2016), 514–521, 536–542.

737. https://www.fdic.gov/about/history/timeline/1920s.html, accessed June 24, 2017.

738. Burton G. Malkiel, A Random Walk down Wall Street (New York: W. W. Norton & Company, Inc., 1999), 57–61.

739. Personal communication, Burton Malkiel, Richard Sylla, and John Bogle.

740. For 1929 PE ratios and dividend yields, see Wigmore, 35–85.

741. John Cassidy, dot-con (New York: Penguin Press, 2002), 348–363; and Roger Lowenstein, Origins of the Crash (New York: The Penguin Press, 2004), 101.

742. Thomas Easton and Scott Wooley, “The $20 Billion Crumb,” Forbes, April 19, 1999.

743. Ibid.

744. Personal communication, Alan Mauldin, TeleGeography, Inc.

745. Simon Romero, “In Another Big Bankruptcy, a Fiber Optic Venture Fails,” The New York Times, January 29, 2002.

746. Timothy L. O’Brien, “A New Legal Chapter for a 90’s Flameout,” The New York Times, August 15, 2004.

747. Steven Lipin et al., “Deals & Deal Makers: Bids & Offers,” The Wall Street Journal, December 10, 1999.

748. Randall E. Stross, eBoys (New York: Crown Business, 2000), 30, 36.

749. Linda Himmelstein, “Can You Sell Groceries Like Books?,” Bloomberg News, July 25, 1999, http://www.bloomberg.com/news/articles/1999-07-25/can-you-sell-groceries-like-books, accessed October 26, 2016.

750. Mary Dejevsky, “Totally Bananas,” The Independent, November 9, 1999.

751. William Aspray et al., Food in the Internet Age (New York: Springer Science & Business Media, 2013), 25–35; and Mylene Mangalindan, “Webvan Shuts Down Operations, Will Seek Chapter 11 Protection,” The Wall Street Journal, July 10, 2001.

752. Mangalindan, ibid.; and John Cook and Marni Leff, “Webvan is gone, but HomeGrocer.com may return,” Seattle Post-Intelligencer, July 9, 2001.

753. Bethany McLean and Peter Eklind, The Smartest Guys in the Room (New York: Penguin Group, 2003).

754. Ibid., 4–13.

755. Alexi Barrionuevo, “Did Ken Lay Demonstrate Credibility?” The New York Times, May 3, 2006. For Ken Lay’s salary, see Thomas S. Mulligan and Nancy Rivera Brooks, “Enron Paid Senior Execs Millions,” Los Angeles Times, June 28, 2002.

756. David Yermack, “Flights of fancy: Corporate jets, CEO perquisites, and inferior shareholder returns,” Journal of Financial Economics Vol. 80, No. 1 (April 2006): 211–242.

757. McLean and Elkind, 89–90, 97–98, 338; and Robert Bryce, “Flying High,” Boston Globe Magazine, September 29, 2002.

758. Ibid., 89–90, 97–98; and Bryce.

759. Elkind and McLean, 225.

760. Ibid., 28–33.

761. Ibid., 183, 184–185, 254.

762. John R. Emshwiller and Rebecca Smith, “Murky Waters: A Primer On the Enron Partnerships,” The Wall Street Journal, January 21, 2001.

763. In order to protect the lender of the shares, the short seller must provide her with cash collateral of greater than the value of the share loan.

764. Cassel Bryan-Low and Suzanne McGee, “Enron Short Seller Detected Red Flags in Regulatory Filings,” The Wall Street Journal, November 5, 2001.

765. Elkind and McLean, 405.

766. Chris Axtman, “How Enron awards do, or don’t, trickle down,” Christian Science Monitor, June 20, 2005.

767. Rebecca Smith, “New SEC Filing Aids Case Against Enron,” The Wall Street Journal, May 15, 2003; Ellen E. Schultz, “Enron Employees’ Massive Losses Suddenly Highlight ‘Lockdowns,’” The Wall Street Journal, January 16, 2002; and Elkind and McLean, 297–398.

768. Lowenstein, 58–60.

769. Clark, 12–15, 19; Joshua Quittner and Michelle Slatalla, Speeding the Net (New York: Atlantic Monthly Press, 1998), 242–248.

770. Richard Karlgaard, “The Ghost of Netscape,” The Wall Street Journal, August 9, 2005, A10.