Wall Street Meltdown: Unlearned Lessons From Enron

aig.JPGBoard members of various financial behemoths are being whipsawed these days through sleepless nights and days as the Wall Street meltdown continues.

One wonders, though, why boards and their executives did not have a much better grasp on what their debt and obligations actually were and what was really going on in their companies. If they did, they might have taken actions to avoid this week's debacle.

The answer could be that boards have not learned from Enron, the last major corporate disaster that has striking similarities to today's.

Enron created innovative and reckless financial schemes to handle what then appeared to be the deregulation of energy.

These days, the culprits are securities, including credit default swaps, science fiction-style derivatives and others. Instead of natural gas or electricity, these are based on shaky mortgages.

Consider an interview published on July 7 with former Harvard Business School Professor Malcolm S. Salter, entitled "Innovation Corrupted: How Managers Can Avoid Another Enron."

Enron's seemingly innovative financing, of course, involved numerous off-the-balance-sheet entities "to avoid having to report any declines in their value."

As Salter says: "The problem was that many of these hedges were not real, because Enron was essentially hedging itself."

Investment banks and accountants played along. "To help disguise the company's deteriorating financial position, many outside advisors and bankers either colluded in or acquiesced to these questionable transactions. Enron's sophisticated risk analysis and control system also experienced serious breakdowns. These breakdowns, along with management's increasing aversion to truth telling, isolated the board from many evolving realities. In addition, Enron's supernormal growth and skyrocketing stock price made it difficult for most directors to challenge management's strategy and tactics."

Asked if Enron could happen again, Salter replied:

"Perverse incentives are legion throughout our system today. For example, perverse incentives for both mortgage brokers and investment bankers helped create the subprime crisis that we are now living through. Many boards are also still struggling to improve their oversight. Preventing future Enron-type disasters will require the kind of attention to board oversight, financial incentives and ethical discipline ..."

Salter made his comments only two months ago. Unfortunately, he seems remarkably prescient about the unlearned lessons from Enron.

The old saw that says those who do not read history are doomed to repeat it rings true, again.

(Image by Mike Licht, NotionsCapital.com, via Flickr, CC 2.0.)