The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron

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Introduction

On a cool Texas night in late January, Cliff Baxter slipped out of bed. He stuffed pillows under the covers so his sleeping wife wouldnít notice he was gone. Then he stepped quietly through his large suburban Houston home, taking care not to awaken his two children. The door alarm didnít make a sound as he entered the garage; heíd disabled the security system before turning in. Then, dressed in blue jogging slacks, a blue T-shirt, and moccasin slippers, he climbed into his new black Mercedes-Benz S500 and drove out into the night.

At 43, John Clifford Baxter, the son of a Long Island policeman, had made it big in Texas. Before quitting his job eight months earlier, he had served as vice chairman of a great American corporation, capping a decade-long career as the companyís top deal maker. Baxter was rich, tooóthanks to a generous helping of stock options, a millionaire many times over. But as he cruised the empty streets of Sugar Land, Texas, Baxter was drowning in dark thoughts. Always given to mood swings, he had become deeply depressed in recent days, consumed by the spectacular scandal that had engulfed his old company.

Everyone seemed to be after him. A congressional committee had already called; the FBI and SEC would surely be next. Would he have to testify against his friends? The plaintiffsí lawyers had named him as a defendant in a huge securities-fraud suit. Baxter was convinced they were having him tailedóand rummaging through his familyís trash. Then there was the media, pestering him at home a dozen or more times a day: Did he know what had gone wrong? How could Americaís seventh-biggest company just blow up? Where had the billions gone? No one, at this early stage, viewed Baxter as a major player in the companyís crash. Yet he took it all personally. In phone calls and visits with friends, he railed for hours about the scandalís taint. Itís as if ìtheyíre calling us child molesters,î he complained. ìThat will never wash off.î

Desperate to get away, heíd spent part of the previous week sailing in the Florida Keys. Sailing was one of Baxterís passions. For years, heíd decompressed floating on Galveston Bay aboard his 72-foot yacht, Tranquility Base. But heíd sold the boat several months earlier. When Baxter returned from Florida, his doctor prescribed antidepressants and sleeping pills and told him to see a psychiatrist. Heíd called the shrinkís office that day to make an appointment. But when the receptionist explained that the schedule was booked until February, Baxter hung upóhe wasnít going to wait that long.

Less than 48 hours later, at about 2:20 a.m. on January 25, 2002, Baxter stopped his Mercedes on Palm Royale Boulevard, a mile and a half from his home. It was cloudy and a bit chilly that evening by Texas standardsóabout 48 degreesóbut the sedan was tuned to an interior temperature of precisely 79. An open package of Newport Lights sat in the center console, a bottle of Evian water in the cup holder. Baxterís black leather wallet lay on the passenger seat. Baxter parked the car in the middle of the street, with the doors locked, the engine running, and the headlights burning. Then he lifted a silver .357 Magnum revolver to his right temple and fired a bullet into his head.

Seven days later, Cliff Baxterís friends from Enron gathered to mourn. The Houston energy giantís collapse into bankruptcy had already become the biggest scandal of the new century. Baxterís death had stoked the media bonfire and tossed a fresh element of tragedy into a bubbling stewpot of intrigue. Enronís influence ranged widelyófrom Wall Street to the White House. So feared was this company, so powerful were its connections, so much was at stake that there was open speculation Baxter had actually been murderedóthe target of a carefully staged hit, aimed at silencing him from spilling Enronís darkest secrets. The rumblings had forced the Sugar Land police department to treat an open-and-shut caseóBaxter had even left a suicide note in his wifeís carólike a capital-murder investigation, requiring DNA testing, handwriting experts, ballistics studies, and blood-spatter tests.

The Texas memorial service took place after Baxter was buried in a private ceremony in his hometown on Long Island. He was laid to rest in a plot he had secretly purchased there just a few weeks earlier, in the throes of his deepening funk. An Enron corporate jetóa remaining vestige of the companyís imperial waysóflew Cliffís family and a few others east for the funeral.

Now it was Houstonís turn. The precise location of the serviceóthe ballroom of the St. Regis, the cityís swankiest hotelóremained a secret until noon that day, at the insistence of Carol Baxter. Cliffís widow was bent on avoiding the press. She blamed reportersí intrusions for pushing her husband over the edge. So the 100 hand-picked guests who pulled up to the valet-parking station on this Friday afternoon had been summoned by furtive phone calls just two hours earlier.

For 90 minutes, those who knew Baxterófamily members, fellow ìboat peopleî from his beloved yacht club, and Enron friendsóheard warm stories about his gentler side. There were images of Cliff with his family, Cliff sailing, Cliff fronting his rock band. Baxter was a gifted musician. When police found his body, there were two guitar picks in his wallet. Everyone left the service with a compact disc of his favorite songs, prepared with the help of J. C. Baxter, Cliffís 16-year-old son. The opening track was perhaps Cliffís favorite: a bouncy pop tune called ìPerfect Day.î

On this perfect day Nothingís standing in my way On this perfect day Nothing can go wrong Itís a perfect day Tomorrowís gonna come too soon I could stay Forever as I am On this perfect day

It was a tragedy layered on tragedy, but there wasnít much talk about the companyís Icarus-like fall among the former Enron executives thrust together again that afternoon. This wasnít the time for such grim shoptalk; whatís more, their lawyers had pointedly instructed them to avoid such conversations. Ken Lay, Enronís founding father, was conspicuously absent. At the insistence of the companyís creditors, he had finally yielded his job as CEO and chairman just two days before Baxterís death; Lay sent his wife, Linda, to attend the service instead. Enronís deposed chief financial officer, a onetime whiz kid named Andrew Fastow, was missing, too; he and Baxter had fought bitterly.

But former chief executive officer Jeffrey Skillingóonce touted as a brilliant visionary and the man who shaped Enron in his own imageówas very much in evidence. Baxter had been his closest confidant at Enron, the nearest thing Skilling, who kept his own counsel, had to a sounding board. Widely feared during his reign at Enron, known for his unflinchingly Darwinist view of the world, Skilling spent the service in tears.

In the months after Cliff Baxterís memorial service, Jeff Skilling could often be found in an otherwise empty hole-in-the-wall Houston bar called Muldoonís, downing glasses of white wine. A short, fit man of 48 with slicked-back hair and cool blue eyes, Skilling typically appeared in faded jeans, a white T-shirt, and a two-day growth of beard. This is where he came to brood over what had happened at Enronóoften for hours at a time.

More than anyone else, Skilling had come to personify the Enron scandal. Part of it was his audacious refusal, in the face of a dozen separate investigations, to run for cover. Alone among Enronís top executives summoned before a circuslike series of congressional hearings, Skilling had ignored his lawyersí advice to take the Fifth and defiantly spoken his piece. The legislators were convinced that Skilling had abruptly resigned as CEO of the companyójust four months before Enron went belly upó because he knew the game was over. But Skilling wouldnít have any of it. At the time he quit, he insisted, he believed Enron was ìin great shapeî; he had left for ìpersonal reasons.î The nationally televised testimony was vintage Skilling: articulate, unapologetic, and prickly. He didnít hesitate to lecture, even scold, U.S. senators.

ìEnron was a great company,î Skilling repeatedly declared. And indeed thatís how it seemed almost until the moment it filed the largest bankruptcy claim in U.S. history. Fortune magazine named it ìAmericaís most innovative companyî six years running. Washington luminaries like Henry Kissinger and James Baker were on its lobbying payroll. Nobel laureate Nelson Mandela came to Houston to receive the Enron Prize. The president of the United States called Enron chairman Lay ìKenny Boy.î Enron had transformed the way gas and electricity flowed across the United States. And it had bankrolled audacious proj- ects around the globe: state-of-the-art power plants in third world countries, a pipeline slicing through an endangered Brazilian forest, a steel mill on the coast of Thailand.

As Skilling saw it, Enron had fallen victim to a cabal of short sellers and scoop-hungry reporters that triggered a classic run on the bank. Privately, he would grudgingly acknowledge occasional business mistakesóincluding one, the failure of Enronís broadband venture, that cost the company more than $1 billion. Yet Skilling remained remarkably unwilling to accept any personal responsibility for the companyís demise. ìYouíre not going to find one memo where Skilling said, ëFuck with the numbers,íî he told a friend. ìIt isnít there.î He was reluctant even to pronounce judgment on Fastow, his handpicked finance chief, whoóthe U.S. Justice Department allegedóhad not just done a lousy job as CFO but stolen millions and collected kickbacks right under Skillingís nose. What happened to Enron, Skilling insisted, was part of the brutal cycle of business life. ìShit happens,î he liked to say. Enron was a victim.

Unfortunately for Skilling, no one else believed that. Enron, which once aspired to be known as ìthe worldís greatest company,î became a different kind of symbolóshorthand for all that was wrong with corporate America. Its bankruptcy marked not merely the death of a company but the end of an era. Enronís failure resonated powerfully because the entire company stood revealed as a sort of wonderland, where little was as it seemed. Rarely has there ever been such a chasm between corporate illusion and reality. The public scrutiny Enron triggered exposed more epic business scandalsótales of cooked books and excess at companies like Tyco, WorldCom, and Adelphia. Enronís wash swamped the entire U.S. energy industry, wiping out hundreds of billions in stock value. It destroyed the nationís most venerable accounting firm, Arthur Andersen. And it exposed holes in our patchwork system of business oversightó shocking lapses by government regulators, auditors, banks, lawyers, Wall Street analysts, and credit agenciesóshaking faith in U.S. financial markets.

Yet Skilling continued to plead his case with a compelling arrogance. At different times, before different audiences, he could be self-righteous, self-pitying, sarcastic, profane, even naive. Sometimes, he was all of these things at once.

Periodically, heíd launch into an extended rant: about the media, about politicians, about the aggressive tactics of government prosecutors (ìWelcome to North Koreaî). The investigation was ìa travesty,î Skilling declared. ìIt makes me ashamed to be an American.î

Even after the bankruptcy filing, he continued to exult over the innovative ways in which Enron went about its business. In an industry built on brawn, Enron prided itself on being a company that ran on brains. And Enron was smartóin many ways, too smart as it turned out. Just as he had when Enron was riding high, Skilling labeled ExxonMobil a ìdinosaurîóas though it didnít matter that the oil giant was thriving while Enron was nearly extinct. ìWe were doing something special. Magical.î The money wasnít what really mattered to him, insisted Skilling, who had banked $70 million from Enron stock. ìIt wasnít a jobóit was a mission,î he liked to say. ìWe were changing the world. We were doing Godís work.î

In the public eye, Enronís mission was nothing more than the cover story for a massive fraud. But what brought Enron down was something more complexóand more tragicóthan simple thievery. The tale of Enron is a story of human weakness, of hubris and greed and rampant self-delusion; of ambition run amok; of a grand experiment in the deregulated world; of a business model that didnít work; and of smart people who believed their next gamble would cover their last disasteróand who couldnít admit they were wrong. In less combative moods, Skilling reflected on his plight. ìMy life is fucked,î he said. He would tear up as he spoke about what building Enron had cost him: he had destroyed his marriage, ignored his kids. ìPeople didnít just go to work for Enron,î Skilling would tell acquaintances. ìIt became a part of your life, just as important as your family. More important than your family. But at least I knew we had this company.î Skilling was seeing a psychiatrist and taking antidepressants. ìI view my life as over,î he said during an extended dark spell. Before his funk eased, in the months after Baxter took his own life, Skilling openly mulled over whether his friend had done the right thing. ìDepending on how it plays out, it may reach a point where itís not worth sticking around,î he said. ìCliff figured out how it was going to play out.î

CHAPTER 1

Lunch on a Silver Platter

It is no accident that Ken Layís career in the energy business beganóand, most likely, endedóin the city of Houston, Texas.

Houston was the epicenter of that world, home to giants like Exxon, Conoco, and Pennzoil. Spindletop, the legendary field that triggered the first Texas oil boom, back in 1901, is just up the road. To the south and east, sprawled over thousands of acres, lie refineries, petrochemical plants, gas-processing facilities, and tank farmsóthe grimy monstrosities that feed the nationís hunger for plastics, fertilizer, heat, electricity, and gasoline.

For most of the twentieth century, Houstonís economy rose and fell with the price of crude. In the 1970s, when an Arab oil embargo was strangling the rest of America, Houston boomed. By 1987, when lower energy prices were pumping fresh life into the country, the city was flat on its back.

Houston also perfectly reflected the culture of the energy business. It was sprawling and rough, lusty and bold, wide open to opportunity and worshipful of new money. A city built on a swamp, Houston was a place where a man with a wildcatting spirit could transform himself virtually overnight; a like-minded company could remake itself, too.

The romance and myth in the energy business, of course, had always been about oil. It was crude that built empires, inspired legends, and launched wars. It was oil that the Mideast sheiks used to hold America hostage. It was oil that created the towering fortunes of Rockefellers and Hunts.

But Ken Layís destiny lay in a humbler hydrocarbon: natural gas. Transparent, odorless, lighter than air, natural gas, composed mostly of methane, lies trapped in underground pockets, often beside oil deposits. America has long had vast reserves of gas, and it burns far more cleanly than either coal or oil. Yet for the first half of the last century, America had little use for the stuff. It was a mere by-product in the quest for oil, priced so cheaply it wasnít worth laying new pipelines to move it across the country. Instead, natural gas was usually just burned off as waste or was pumped back into the ground to maintain pressure to extract more oil.

By the 1950s, however, the perception of natural gas had begun to change. Gas was never going to attain the mythic status of oilónot even after Enron

arrived on the sceneóbut it gradually became useful and even important. A flurry of pipeline construction had linked gas supplies in Texas and Louisiana with the rest of the country. Dozens of new petrochemical plantsómany along the gulf coast of Texasórelied on natural gas as their basic fuel. By the time Richard Nixon took office in 1969, gas heated a large percentage of the nationís homes and powered thousands of industrial sites year-round. Still, except for the occasional pipeline explosion, natural gas remained largely an afterthought, literally beneath notice, crawling silently about the country at ten miles per hour through a network of buried steel.

Back in those less complicated times, there were lots of industries that operated more or less by rote: the old bankerís motto, for instance, was ì3-6-3î: take money in at 3 percent, lend it out at 6 percent, and be on the golf course by 3 p.m. But few industries were as downright sleepy as the gas-pipeline business. Yes, there was the occasional pipeline company that explored for gas, too; exploration has always been the most romantic part of the energy business. But mostly the pipeliners bought gas from oil giants and smaller independent exploration companies, then moved it across the country through their networks of underground pipes. Most of the gas went directly to industrial customers, while the rest was sold to regional gas utilities, which piped it to smaller businesses and consumers.

It was all very simple and straightforwardóespecially since every step of the process was under government control. The federal government regulated interstate pipelines, dictating the price they paid for gas and what they could charge their customers. (State agencies regulated intrastate pipelines in much the same fashion.) However much executives spent on operations, whether for moving gas or redecorating their offices, Washington let them recover their costs and tack on a tidy profit. ìIn the pipeline business, youíd have to make one or two decisions a year,î says one former Enron executive. ìEveryone who operated in it was pretty much brain dead.î

It wasnít until the 1970s that things began to changeóor at least to change enough to attract the interest of a bright, shrewd, and intensely ambitious young man like Ken Lay. Far from being afraid of the coming changes, Lay wanted to push things along, to accelerate the pace of change. In later years, colleagues joked about his penchant for taking rapid actionóany actionódescribing Layís management style as ìReady, fire, aim.î

A Baptist preacherís son, Lay believed powerfully in the dogma of deregulation. He sermonized about the virtues of unshackling the gas industry, propelling it into a new, deregulated world, where the free market set prices. In this new world, surely, there would be winners and losers: those who had the skills to thrive in a deregulated universe and those who didnít. From the start, he saw himself as one of the winners. He could envision taking control of a lowly pipeline company and transforming it into the first ìgas major,î a company with the power, brains, resources, and global reach of the oil giants.

Lay usually expressed his preference for deregulation in ideological terms; his training as an economist had taught him that free markets simply worked better than markets controlled by the government, he liked to say. But he also believed that deregulation would create opportunities to make moneyólots of money. And making money was terribly important to Ken Lay.

In later years, when Enron was at the peak of its powers, Lay was viewed as heíd always wanted the world to see himóas a Great Man. He was acclaimed as a business sage, a man of transcendent ideas who had harnessed change in an industry instinctively opposed to it. In the public face he presented, Lay seemed to care deeply about bettering the world. He spent much of his time on philanthropy: in Houston, he was the go-to man for charitable works, raising and giving away millions. He spoke often about corporate values. And he was openly religious. ìEveryone knows that I personally have a very strict code of personal conduct that I live by,î he once told an interviewer for a religious magazine called The Door. ìThis code is based on Christian values.î

Lay was a hard man not to like. His deliberately modest midwestern manneróLay made a point of personally serving drinks to subordinates along for the ride on Enronís flagship jetóbuilt a deep reservoir of goodwill among those who worked for him. A short, balding man with an endearing resemblance to Elmer Fudd, he remembered names, listened earnestly, and seemed to care about what you thought. He had a gift for calming tempers and defusing conflict.

But this style, soothing though it may have been, was not necessarily well suited to running a big corporation. Lay had the traits of a politician: he cared deeply about appearances, he wanted people to like him, and he avoided the sort of tough decisions that were certain to make others mad. His top executivesó people like Jeff Skillingóunderstood this about him and viewed him with something akin to contempt. They knew that as long as they steered clear of a few sacred cows, they could do whatever they wanted and Lay would never say no. On the rare occasion when circumstances forced his hand, heíd let someone else take the heat or would throw money at a problem. For years, Lay seemed to float, statesmanlike, above the fray, removed from the tough day-to-day business of cracking heads in corporate America. Somehow, until Enron fell, Ken Lay never seemed to get his hands dirty.

A man of humble origins, Lay also became addicted to the trappings of corporate royalty. For years, he spent most of his time playing power broker. He traded personal notes with presidents, pulled strings in Washington, and hobnobbed with world leaders. Back in Houston, he was known as someone whose ring any aspiring politician needed to kiss. Indeed, there was talk he would someday run for mayoróif he didnít accept a presidentís call to serve in the cabinet instead. Some of that, unquestionably, came with the territory; some of it even benefited Enron. But it came at a big cost: over time, he lost touch with his companyís business.

Though few people complained about it before Enron fell, Layís behavior also betrayed a powerful sense of personal entitlement. Long after his annual compensation at Enron had climbed into the millions, Lay arranged to take out large personal loans from the company. He gave Enron jobs and contracts to his relatives. And Lay and his family used Enronís fleet of corporate jets as if they owned them. On one occasion, a secretary sought to arrange a flight for an executive on Enron business only to be told that members of the Lay family had reserved three of the companyís planes.

At lunchtime, top Enron executives, who worked on the richly paneled fiftieth floor of the companyís headquarters tower in downtown Houston, routinely dispatched their assistants to fetch lunch so they could eat at their desks. Most ate their sandwiches on deli paper. Not Ken Lay. When his meal arrived, his staff carefully unwrapped it, placed the food on fine china, and served him lunch on a covered silver platter.

There was no fine china in Kenneth Lee Layís early life. He grew up dirt-poor. Indeed, the Enron chairmanís history is a classic Horatio Alger story. He was born in 1942 in Tyrone, Missouri, an agricultural dot on the map in the Ozarks. Before Lay became a business celebrity, the regionís most famous former resident was Emmett Kelly, the circus clown known as Weary Willie.

Lay portrays his childhood, spent largely in tiny farm towns with outhouses and dirt roads, in Norman Rockwellesque terms. But the Lays were always strugglingóuntil he was 11 years old, Ken Lay had never lived in a house with indoor plumbingóand at a young age, he set his mind on finding his fortune. His parents, Omer and Ruth Lay, had three children; he was the middle child, after Bonnie and before Sharon. For a time, the Lays owned a feed store. Then disaster wiped them out: the Laysí deliveryman crashed a truck, slaughtering a load of chickens. Omer had to take to the road as a traveling stove salesman; the family followed from town to town, until they were finally forced to move in with in-laws on a farm in central Missouri. Omer, a Baptist lay preacher who held a succession of day jobs to feed the family, started selling farm equipment. Acutely conscious of the family circumstances, young Ken always worked: running paper routes, raising chickens, baling hay. ìItís hard for me not to think Ken was an adult when he was a child,î his sister Sharon said years later. The hardship honed Layís ambition. He later spoke of spending hours on a tractor, daydreaming about the world of commerce, ìso different from the world in which I was living.î

Layís parents never made it past high school, but college transformed his life. The family eventually resettled in Columbia, Missouri, where all three children attended the University of Missouri. Omer worked as parts manager in a Buick dealership then as a security guard at the university library while preaching at a small Baptist church. Ken painted houses, earned scholarships, and took out loans to pay his way through school.

Lay was a devoted and stellar student, serious beyond his years, with a natural intellectual bent. Heíd entered college planning to become a lawyer but became enraptured by the study of economics during an introductory class taught by a popular professor named Pinkney Walker. He discovered that theory and fresh ideas fascinated him. But his passion always had a pragmatic side. He cared about politics and public policy, how government could shape markets. ìKen was one of these 4.0 guys who had some street sense,î says Phil Prather, a Missouri classmate and lifelong friend. ìMost 4.0 guys I know are a bunch of savants.î

Although Lay stood out for his brains, he was never the stereotypical egghead who spent every waking moment in the library. Though slight, low-key, and quietóhe struggled for years to overcome a mild stammeróhe was popular as well. At Missouri he won election as president of Beta Theta Pi, the universityís largest and most successful fraternity. (Among Layís predecessors in the Missouri frat house: Wal-Mart founder Sam Walton.) Lay became an inveterate collector of relationships. At each major stop in his early life, he forged bonds that lasted for decades. These werenít only personal acquaintances. Time and again, he would tap his growing network: for a job, for a favor, or to surround himself with those he trusted. This skill propelled his climb.

The first key relationship, in fact, was with Pinkney Walker. Walker was drawn by Layís brains and ambition and quickly became his mentor. ìWe just hit it off with each other from the first,î remembers Walker. ìIt was always inevitable that he would be a man of wealth.î After a lifetime of pinching pennies, Lay was eager to start making money. But after graduating Phi Beta Kappa in economics, he remained in school to get his masterís degree after Walker convinced him that he would be better off in the long run with a masterís on his rÈsumÈ. Lay finished school in 1965.

For the next six years, Lay paid his dues: first in Houston, at Humble Oil (a forerunner to Exxon), where he worked as an economist and speechwriter while taking night classes toward his Ph.D., then in the navy, in which he enlisted in 1968, ahead of the Vietnam draft. Originally intended to become a shipboard supply officer, perhaps in the South China Sea, Lay was abruptly reassigned to the Pentagon. This assignment introduced him to Washington. Lay later attributed such critical turns in his life to divine intervention, but in this instance, there was no miracle involved: Pinkney Walker had pulled some strings for his protÈgÈ. Instead of putting in his tour of duty at sea, Lay spent it conducting studies on the military-procurement process. The work provided the basis for his doctoral thesis on how defense spending affects the economy. At night he taught graduate students in economics at George Washington University.

At each of these early stops, Lay received a taste of life at the top. At Humble, he wrote speeches for CEO Mike Wright; at the Pentagon, he recruited a high-level officer to provide support for his work as a lowly ensign.

By then Lay was a father of two. He was married to his college sweetheart, Judith Diane Ayers, the daughter of an FBI agent from Jefferson City, Missouri. They met in French class, and like so many others, Judie recalls being drawn by Kenís ìmaturity and dependability.î Ken and Judie wed in the summer of 1966, after she completed her journalism degree. Ken was 24, Judie 22. Their children, Mark and Elizabeth, arrived in 1968 and 1971.

Before joining the navy, Lay had promised Exxon (the name had been changed from Humble) that he would return to the company. But once again, Pinkney Walker had other ideas. President Richard Nixon had just named Walker to the Federal Power Commissionóthen the agency regulating the energy businessóand Walker wanted Lay as his top aide. The new commissioner placed a call to Exxonís CEO, urging him to let Lay off the hook. ìI made it clear to him he was making a friend,î says Walker.

Though Walker wound up staying only 18 months in Washington, it was long enough for his young deputy to make an impression. In October 1972, the Nixon White House tapped Lay for a new post as deputy undersecretary of energy in the Interior Department. He became one of the administrationís point men on energy policy. Layís new government position paid him a higher salary than was typical for such rank, thus requiring a special exemption from the U.S. Civil Service Commission. Interior Secretary Rogers Morton made the request. ìThe potential of an energy crisis is of immense proportion,î wrote Morton. Without the exemption, ìthe Department of the Interior cannot hope to attract a man of Dr. Layís stature and unique talents.î Lay was 30 years old.

What a time it was to be making energy policy for the United States! Or rather, what a time it should have been. In early 1973, shortly after Lay began his new job, the country suffered electrical brownouts and natural-gas shortages. Then came the Arab oil embargo. Pump prices soared, and people had to line up for blocks to get gasoline for their cars. Government officials warned Americans to curtail long vacation trips. After decades of consuming ever more energy, the country was in the midst of a full-fledged energy crisis. The president capped the year by announcing that because of the crisis, he wouldnít light the national Christmas tree.

But the Interior Departmentís new deputy undersecretary of energy wasnít around long enough to effect policy. Concluding that the energy crisis was bound to mean big changes for the staid old pipeline industry, Lay decided the time was ripe to exit the government and head into the world of business. In September 1973, less than a year after he arrived at the Interior Department, Lay put out a feeler to W. J. (Jack) Bowen, CEO of a midsize pipeline company called Florida Gas, whom heíd met at a public hearing in his capacity as deputy undersecretary. ìAs you know, I have been involved in energy policy making in Washington for the past two and one-half years,î Lay wrote, using Interior Department stationery. ìI feel it is now time I begin thinking about returning to the private sector and resuming my career in business. I would be most interested in being considered for possible job opportunities with Florida Gas Company. The natural-gas industry, obviously, faces some very difficult challenges in the months and years ahead, and I would like to be in a position in industry to help meet these challenges.î

Bowen, a West Point graduate, met with Lay in Washington then brought him and Judie down for a visit to the companyís headquarters in the Orlando suburb of Winter Park. Bowen also personally called his references: Layís old boss at Exxon, a rear admiral in the Pentagon, and, of course, Pinkney Walker. Bowen took notes on their comments. ìNever had a better man technically. Would like to haveótops!î declared the admiral. ìHeadís screwed on straight,î said Walker. ìThink a great deal of him.... Good worker. Very smart,î added the Exxon man, who went on to offer the only cautionary note: ìMaybe too ambitious.î By yearís end, Lay was in Winter Park as vice president for corporate planning, with a starting salary of $38,000 a year plus 2,500 stock options.

Bowen left the next year for Transco Energy, a much bigger pipeline company in Houston. That only accelerated Layís rapid ascent. By 1976 he was president of the pipeline division at Florida Gas; by 1979, president of the entire company. For the first time in his life, Ken Lay was flush. He owned a $300,000 house, joined the Winter Park Racquet Club, and bought a beach condo on the Florida coast and a ski condo in Utah. In 1980 Lay made $268,000.

His marriage, however, was falling apart. The preacherís son was carrying on an affair with his secretary, a divorced mother of three named Linda Phillips Herrold, who would become his second wife. Newspaper profiles later described Layís divorce as ìamicable.î And indeed, in the years after his split, Lay established a remarkably cordial relationship with his first wife. Over the years, Lay even paid for Judie and their two kids to accompany him, Linda, and Lindaís children on family ski trips and cruises. When friends showed up for the Laysí Christmas parties in Aspen, they were startled to discover both of his wives there, mixing amiably. Says one friend: ìI was expecting to see Judie in Kenís Christmas card.î

But if the aftermath was friendlyóa testament to Layís ability to smooth over any conflictóthe split itself was anything but. Lay began talking to Judie about separating in late 1980. About that time he called up his old boss, Transco chairman Jack Bowen, told him he had ìdomestic problems,î and asked if Bowen had a job for him in Houston. Once again, a key relationship Lay had forged paid off. Bowen, then 57, hired the 39-year-old Lay as Transcoís presidentóand his heir apparent. In late April 1981 Lay filed for divorce, requesting custody of his two children, just days before officially beginning his new job in Houston. About this time, Linda Herrold was also transferred to Florida Gasís Houston office.

Judie responded in court papers that Ken was unfit to have custody. A few weeks later, Judie suffered what doctors later called a ìpsychotic episodeî resulting from ìmanic-depressive illness.î She spent several months undergoing treatment at hospitals in Houston and North Carolina. At one point, at her doctorsí urging, Ken had signed legal papers to have his estranged wife involuntarily committed. The psychiatrists treating Judie concluded that the episode was triggered by the coupleís impending divorce. As one psychiatrist later testified in deposition: ìThe divorce or the thought of a divorce hit her very hard. ëIt was like dying,í as she put it.î

By the end of 1981, Judie had recovered, and the year-long courtroom sparring resumed. As a court date loomed, her lawyers deposed Lay, Jack Bowen, and Bill Morgan, a University of Missouri frat brother Lay hired to work for him as an attorney at Florida Gas. The two sides finally signed settlement papers in June 1982, with the trial just a week away. Under the agreement, Judie would get primary custody of the children. Lay would make a lump-sum payment of $30,000 plus $500 a month in child support, alimony of $72,000 a year for four years, and $36,000 a year thereafter. (Lay later voluntarily increased his payments to Judie on five occasionsómost recently in 1999, to $120,000 a year.)

A Florida Gas executive named John Wingówho later played a big role at Enronóserved as the legal witness for Lay at the three-minute hearing in which the divorce was finalized. When it was over, Lay headed straight to the Orlando airport, where a Transco jet was waiting to fly him to Texas. Lay and Linda Herrold were married one month later in Houston.

Judie Lay, who still lives in Winter Park, credits her ex-husband for extending an olive branch. About three years after the divorce, she says, their children told her that Ken and Linda had invited them all to go skiing together for Christmasóand that he would pay for her hotel room. ìWe didnít all sit down under the Christmas tree the first year,î she says. ìIt kind of gradually became more togetherness. The bad times sort of flowed away. Weíre all good friends now. Heís treated me very nicely.î

It was at Transco that Ken Lay came to be widely regarded as a rising star. Unlike Florida Gas, Transco was a big-time company. It controlled a 10,000-mile pipeline system that provided almost all of New York Cityís natural gas and served large portions of New Jersey and much of the Southeast. But it wasnít just the size of the company that allowed Lay to shine; it was the condition of the pipeline industry. The business was in terrible shape.

One part of the nationís energy crisis was a persistent shortage of natural gas; in some regions, schools and factories had been forced to close because the gas needed to heat them was in such short supply. Gas producers, not surprisingly, argued that the problem was that the government-mandated price was simply too low to encourage new exploration efforts. So in 1978 Congress hiked the regulated price that would be paid to producers (as exploration companies are called) for some types of natural gas. At the same time, though, Congress passed legislation barring the use of natural gas for any new industrial boilers. Thus the first law was intended to increase supply, while the second was intended to depress demand. Although this was hardly full-scale deregulation, it was the governmentís first tentative step in that direction.

Unfortunately for the pipeline industryóand here was the great irony of the situationóthe new rules worked far too well. Sure enough, the higher prices jump-started gas exploration and increased the nationís supply of natural gas. But at the same time, demand for gas began dropping precipitously, not only because of government action but because as natural gas prices rose, many industrial customers switched to coal or fuel oil, which were suddenly cheaper. Over time, this put the pipeline companies in an impossible position.

Why? Because the pipelines, eager to protect themselves against future shortages, had started cutting long- term deals with individual producers to take virtually all the gas they could provide at the very moment when demand was dropping. The contracts theyíd signed were called ìtake or pay,î meaning they were obliged to pay for the gas at the new higher rates even if they didnít need it. Then, in the mid-1980s, the government made a bad situation even worse when it took its next small step toward deregulation: it freed utilities and industrial customers from their contracts to buy from the pipelines, allowing them to shop for better prices on the open market or turn to cheaper fuels.

But the government refused to let the pipelines out of their expensive take-or-pay commitments. This put pipeline companies between a rock and a hard place: stuck with huge volumes of gas at prices they could no longer pass on to customers. As a result, many of the companies became technically insolvent, and a few went bankrupt. Some form of relief was obviously neededófrom Washington, the gas producers, or the courts. Over time, the companies pursued all three avenues: lobbying, negotiating, and litigating. Orchestrating it all took years and proved expensive. It wasnít until the late 1980s and early 1990s that the crisis finally ended and the natural-gas business, including the pipeline industry, was largely deregulated. But though the beginning of this crisis was bad for the industry, it was certainly good for Ken Lay. With his Ph.D. in economics, his Washington experience, and his long advocacy of deregulation, Lay seemed like just the right man for the new age. With the industry in paralysis, he began helping Transco work through its take-or-pay problem by setting up a fledgling spot market for natural gas, where producers who let Transco out of its take-or-pay obligation could sell directly to their customers, paying Transco just to move the gas. Thoughtful and articulate, Lay was in demand at industry conferences and Capitol Hill hearings. ìKen isnít bound by tradition,î declared John Sawhill, head of the global energy practice for the consulting firm, McKinsey & Company. Even Wall Street viewed him as a major asset. The Houston Chronicle wrote in 1983, ìSome analysts attribute the strength of Transcoís stock price to Layís credibility and his bold and unique accomplishments.î

If Lay had stayed at Transco, he probably would have become CEO in 1989, when Bowen planned to retire. But as it turned out, he didnít have to wait nearly that long to become a chief executive. In the summer of 1984, opportunity came knocking, and he eagerly answered the call. It came in the form of a meeting with a man named John Duncan, who had helped put together the old conglomerate Gulf & Western, and was a key board member of a midsize pipeline company called Houston Natural Gas (HNG). Lay and Duncan had gotten to know each other a few months earlier, when HNG had been trying to repel a takeover attempt by a corporate raider and Transco had offered to act as a white knightóa friendly alternative acquirer. Ultimately, Transcoís help wasnít needed, but Lay had clearly made an impression. In their meeting, which took place over breakfast on a Saturday morning, Duncan popped the question: would Lay consider becoming CEO of HNG? He didnít require a lot of convincing. ìBy Sunday morning,î Lay later recalled, ìit was sounding kind of interesting.î

Houston Natural Gas had a special place in the city. Though smaller than many local rivalsóannual revenues were $3 billionóit had for years assumed the role of the ìhometown oil company.î Part of that was its heritage: the company dated back to 1926, and it had long been the prime gas supplier to the huge industrial plants on the Texas coast. Part of it was due to Robert Herring, its longtime chairman, who was active in every important civic project and charitable event in town. Herringís wife, Joanne, was an international socialite, and the coupleís home in exclusive River Oaksóone of Americaís wealthiest neighborhoodsóbecame Houstonís preeminent salon, a place where oilmen mixed with international royalty. Herring had died of cancer in October 1981; HNG, though still profitable, hadnít been quite the same since. His successor, 60-year-old M. D. Matthews, was a nondescript caretaker type. Even after the takeover attempt was repulsed, HNGís modest debt made it a juicy target for corporate raiders. And the takeover battle had left the HNG board convinced that it needed stronger leadership.

On Monday, Lay won Jack Bowenís blessing for his departure, and in June 1984, at the age of 42, Ken Lay became chairman and chief executive officer of Houston Natural Gas. After her husband assumed his big new job, Linda Lay exulted to a friend: ìItís fun to be the king.î HNG would serve as the foundation for building Enron.

From the moment he walked in the door, Lay operated on one theory: get big fast. His core belief, as ever, was that deregulationóreal deregulationówas coming soon. And when it did, he believed, the price of the commodity would reflect true market demand and the companies with the best pipeline networks would be the ones calling the shots. In just his first six months, Lay spent $1.2 billion on two pricey acquisitions that dramatically extended HNGís pipeline system into the growth markets of California and Florida. (The Florida pipeline had been owned by Layís old company, Florida Gas.) He even talked to his old friend, Jack Bowen, about a deal with Transco. At the same time he unloaded $625 million in holdings outside the core pipeline business, including coal-mining properties and a fleet of barges.

Then came a bit of luck. In April 1985 Lay got a call out of the blue from a man named Sam Segnar, the CEO of InterNorth, a big Omaha pipeline company. Because Lay was in Europe at the time courting investors, John Wing, his old deputy from Florida Gasówho had just hired on as HNGís chief strategy officeróhandled the call. Segnar wanted to pitch the idea of InterNorthís buying HNG. But it quickly became apparent that Segnar was too eager for his own good.

InterNorth, three times the size of HNG, had long been one of the most respected operators in the pipeline business. Among its 20,000 miles of pipeline was a genuine prize: Northern Natural, the major north-south line feeding gas from Texas into Iowa, Minnesota, and much of the rest of the Midwest. For decades, InterNorth had assumed a role in Omaha much like that of HNG in Houston. It was the caretaker of civic causesóthe number one corporate citizen. Like HNG it had been run for years by a beloved figure, Bill Strauss. Under Strauss, InterNorth was a quiet, steady company with low debt and terrific cash flow that paid executives modest salaries and carefully watched expenses.

But in 1981 Strauss had turned the company over to Segnar, a charmless personality who upset many in frugal Omaha with a series of ham-handed moves. He purchased a company jet, bought a corporate ranch in Colorado, and closed the fifteenth-floor corporate dining room to all but a few top executives, who were served by white-gloved waiters. Worst of all, Segnar made a string of bad diversification investments. InterNorth was also powerfully motivated by the fact that Irwin Jacobs, a corporate raider, was buying up its shares. Jacobsís looming presence sent Segnar into a panic. He persuaded the board that the only way to make InterNorth ìsharkproofî was to make the company bigger and dramatically increase its debt. Buying HNG would accomplish both goals.

Lay and Segnar turned over negotiations to Wing and Rocco LoChiano, Segnarís top deputy. They met at the St. Regis Hotel in Houston and quickly started talking price. At the time, HNG was trading at about $45 per share. LoChiano figured HNG was worth perhaps $60, $65 tops. But Wing, a canny negotiator, took advantage of InterNorthís desperation to strike a deal, and quickly brought the price up to $70 a share. And that wasnít all. Wing demanded that the smaller companyís younger management team ultimately end up in charge. Amazingly, LoChiano and Segnar agreed: Lay would replace Segnar, then 57, as CEO and chairman of the combined company after just 18 months. ìI think I get this,î LoChiano told Wing over a cup of coffee. ìWeíre the rich old ugly guy with all the money, and youíre the good-looking blonde.î Wing laughed. ìYeah, thatís right,î he replied.

Just 11 days after the first phone call, the two CEOs won approval for the $2.3-billion deal from their respective boards. From a business standpoint, HNG InterNorth, as it was called, seemed an elegant combination: with 37,500 miles of pipeline, the new $12 billion company would have the largest gas- distribution system in the country, running from border to border, coast to coast. It would have access to the three fastest growing gas markets: California, Texas, and Florida. And it had some $5 billion in debt, surely more than enough to put it safely beyond the reach of raiders like Irwin Jacobs. As for Ken Lay, he wound up with a personal windfall: a $3 million profit from converting his stock and options in the wake of the merger.

Mergers that sound good on paper often wind up facing a far harsher reality. Such was the case with HNG InterNorth. There were two fundamental issues. The first was that almost immediately after the transaction closed, the InterNorth directors came down with a bad case of buyerís remorse. As the implications of the deal sunk in, they began to realize that even though their company was the acquirer, they had pretty much given away the store to the Texans. Why, they now wondered, did HNG come before InterNorth in the new name when InterNorth had been the acquirer? Why was Segnar so quick to agree to give the CEO job to Lay in 18 months? Did it have anything to do with promises of a fat severance package? (Segnar ended up walking away with $2 million.) Why did HNG have almost as many seats (8) on the new board as InterNorth (12)? The more they thought about how theyíd been snookered, the madder they got, but they were far angrier at their man, Segnar, than at Ken Lay, whose company had done the snookering.

Among the old-line InterNorth directors, the biggest fear of all was that the Texans were planning to move the companyís headquarters to Houston, even though everyone concerned, including Lay, had repeatedly promised that the company would remain in Omaha ìfor the forseeable future.î This wasnít just a matter of jobs (though 2,200 were at stake); it was also a question of civic pride. It quickly became evident that the promises really werenít worth much. Houston, after all, was the center of the U.S. energy business. Once the merger went through, the issue became so heated that the board created a special committee to study the matter. The committee retained the management-consulting firm, McKinsey & Company, to make a recommendation.

The McKinsey consultants, who included Layís old friend John Sawhill and a young partner named Jeff Skilling, were scheduled to unveil their recommendation to the board on November 11, 1985, a frosty day in Omaha, at the Marriott Hotel. They were indeed going to advise the company to move to Houston. But the meeting quickly took a different turn, and the consultants were told to wait outside. Hours later, Segnar stepped out of the board meeting with tears in his eyes. He shook Sawhillís hand. ìIím leaving InterNorth,î he told the consultant.

Afterward, all parties claimed that Segnar had voluntarily resigned. In truth, the meeting had been a bloodbath, and he hadnít really had a choice. Convinced that Segnar had made a series of secret side deals with Lay to betray Omaha, the old InterNorth directors demanded his head. Of course, since the board didnít have another CEO candidate, it also meant that Ken Lay would become chief executive immediately, instead of having to wait the agreed-upon 18 months.

As a counterweight to Lay, the board brought back Bill Strauss as nonexecutive chairman and some even tried to mount a bid to reclaim the company for the River City. But the effort quickly fizzled when Strauss refused to lead the charge and quit after just four months, giving Lay the chairmanís title, too. It wouldnít have succeeded in any case, for Lay had quietly won control of the board. A father-son pair of old InterNorth directors, Arthur and Robert Belfer, had lined up behind Lay. Two new directors, appointed after the merger by agreement between both sides, also turned out to be Texas partisans.

Over the next three years, the Omaha bloc was purged, and Lay started packing the board with his own directors, including a powerful Washington lobbyist named Charls WalkeróPinkney Walkerís brotheró and an old Pentagon friend named Herbert (Pug) Winokur. John Duncan, the HNG director who had hired Lay, became head of the executive committee. And the corporate headquarters? The directors resolved to split the difference, maintaining an executive headquarters in Omaha and an operating headquarters in Houston. But that arrangement obviously couldnít last long, and it didnít. In July 1986 Lay announced that the companyís corporate headquarters would relocate to Houston, to a silver-skinned downtown skyscraper at 1400 Smith Street.

In Omaha, this decision was bitterly resented for years to come.

There was a second issue looming, of far more consequence than the question of where to put the companyís headquarters. It was this: all the good things Ken Lay assumed would happen once the HNG- InterNorth merger took place simply werenít happening. For the moment, Layís get big fast strategy was only bringing bigger problems.

Irwin Jacobs? Even though the new company was now drowning in debt, the raider and an investor group allied with him still wouldnít go away. Lay wound up having to shell out about $350 millionóa modest premium to the market priceóto buy out the groupís 16.5 percent stake. There wasnít enough cash in the corporate coffers to pay the greenmail, so Lay had to tap the companyís pension plan for the money. Deregulation? All of a sudden, there was a glut of gas on the market, prompting prices to plunge to levels no one had ever imagined. That only multiplied the companyís take-or-pay problem. Layís new business had more than $1 billion in take-or-pay liabilities.

Lay seemed unable to assemble a coherent management team amid bitter political infighting involving not just the old HNG and InterNorth executives but also the pipeline businesses heíd acquired the year before and a handful of well-paid friends that Lay had hired from outside.

Lay even ran into trouble coming up with a trendy new name for the company. After four months of research, the New York consulting firm Lay had hired had settled on Enteron in time for the merged businessís first annual meeting, in the spring of 1986. But then the Wall Street Journal reported that Enteron was a term for the alimentary canal (the digestive tract), turning the name into a laughingstock. Though it meant reprinting 75,000 covers that had already been printed for the new annual report, the board convened an emergency meeting and went with a runner-up on the list: Enron.

Oh, and just for good measure, Lay had to battle the government of Peru, which nationalized the companyís Peruvian production assets just a month after heíd become CEO. That alone produced a $218 million charge to earnings.

In early 1986 Enron reported a loss of $14 million for its first year. Lay announced a series of cost-cutting measures and job cuts. He froze pay for top executives and started selling off assets to cut debt, including 50 percent of the Florida pipeline he purchased just two years earlier.

Enronís financial situation had grown so dire that by January 1987 Moodyís had downgraded its credit rating to junk status. One former executive recalls that during this period there was even worry about meeting payroll. ìThe company was in deep shit,î Bruce Stram, then vice president of corporate planning, says.

What Ken Lay and Enron desperately needed was a fresh source of profitsówhile there was still time.