The Enronization Of The Banking Industry by J. Edward Ketz, Associate Professor of Accounting (SMEAL College of Business)

"Those who cannot learn from history are doomed to repeat it." We frequently utter those words of Santayana, yet we commit the same mistakes.

The ashes of Enron are not a decade old, but we have forgotten the sources of this debris. Instead of sweeping out the rubbish, we cover it up and are surprised to encounter a growing trash pile. Yesterday it was Enron and WorldCom; today it is the banking sector. Who will it be tomorrow—the federal government?

The Bush administration has proposed a $700 billion bailout of Wall Street, which would be the largest wealth transfer from the middle class to the rich. Before we accept this or any other proposal, let's recall the lessons from Enron and WorldCom.
Enron was a bright star in the energy industry. Unfortunately, the firm disintegrated in 2001, leaving many investors empty handed. We learned that the company was a house of cards with jokers for managers.

Four factors sum up the problems surrounding Enron. With few constraints, top managers engaged in self-dealing, including high salaries, huge stock options, and lots of perquisites to themselves. Managers employed aggressive accounting methods to hide their problems and inflate profits. Regulators and watchdogs didn't do their jobs. And Congress stifled real reform by enabling corporate managers to abuse the system and incur few penalties. Let's review these problems and compare them with today.

Enron managers had salaries much higher than the average worker. They had stock options that were supposed to reward them for good performance, but were written so that they enjoyed their millions whatever the performance. They acted as if they were the sole proprietors of the organization. When CEO Jeff Skilling left Enron, his severance package was worth millions.
Ditto for the banking industry. Top managers are consistently overpaid. If they actually delivered value, then maybe they would earn their salaries and stock options. As bank executives have failed us in this subprime mess, why are they receiving these huge salaries and outrageous stock options? And when they screw up, they leave with severance packages in the tens of millions of dollars. If only we had corporate directors who would rein in these undeserved remunerations.

Enron engaged in aggressive accounting behavior, including inappropriate applications of fair-value accounting and incorrect accounting for special purpose entities. Enron misapplied fair-value accounting when it overstated the value of its assets and concomitantly its net income. Enron also used special purpose entities with which to transfer resources, but accounted for these transactions as if the special purpose entities were independent entities.