Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enronby Bethany McLean, Peter Elkind
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Until the Spring of 2001, The Houston energy giant Enron epitomized the triumph of the new economy. Feared by rivals, worshiped by investors, Enron seemingly could do no wrong. Its profits rose every quarter; its stock price surged ever upward; its leaders were hailed as visionaries. Then a young Fortune writer named Bethany McLean wrote an article posing a simple question -- How, exactly, does Enron make its money? -- and the company's house of cards began to collapse. Though other business scandals would follow, none has had the shattering effect of Enron's bankruptcy, which caused Americans to lose faith in a system that rewarded top insiders with millions of dollars while small investors, including many Enron employees, lost everything. Despite enormous media coverage of Enron, the definitive story of its astonishing rise and fall comes alive for the first time in this gripping narrative by McLean and her Fortune colleague Peter Elkind. Drawing on a wide range of private documents and well-placed sources, many of them exclusive, McLean and Elkind lead you behind closed doors and deep into Enron's past, to pierce the veil of secrecy that has surrounded the company's inner workings and corrupt culture.
The Smartest Guys in the Room is fundamentally a human drama -- of people drunk on their own success, people so ambitious, so certain of their own brilliance, so fueled by greed and hubris that they believed they could fool the world. The book explores the motives, thoughts, and secret fears of a fascinating array of characters. No matter how much (or how little) you already know about Enron, the revelations in The Smartest Guys in the Room will shock you. You'll witness the astonishing extent to which Enron's business was an illusion. You'll meet the enigmatic Enron executive who seemed interested in only two things: money and strip clubs. You'll learn the truth about the California power crisis. You'll see how much Wall Street knew about Enron's shenanigans and why the Street chose to look the other way. You'll learn the dirty secrets that Merrill Lynch, Citigroup, and J. P. Morgan Chase have kept out of the headlines to this day. Just as Watergate was the defining political story of our time, so Enron is the biggest business story of our time. And just as All the President's Men was the one Watergate book that gave readers the full story, with all the drama and nuance, The Smartest Guys in the Room is the one book you have to read to understand this amazing business saga.
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The Smartest Guys in the RoomThe Amazing Rise and Scandalous Fall of Enron
By Bethany McLean
PortfolioCopyright © 2004 Bethany McLean
All right reserved.
Chapter OneLunch on a Silver Platter
It is no accident that Ken Lay's career in the energy business began-and, most likely, ended-in 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 farms-the grimy monstrosities that feed the nation's hunger for plastics, fertilizer, heat, electricity, and gasoline.
For most of the twentieth century, Houston's 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 Lay's 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 wasn't 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 oil-not even after Enron arrived on the scene-but 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 plants-many along the gulf coast of Texas-relied on natural gas as their basic fuel. By the time Richard Nixon took office in 1969, gas heated a large percentage of the nation's 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 banker's motto, for instance, was "3-6-3": 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 straightforward-especially 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. "In the pipeline business, you'd have to make one or two decisions a year," says one former Enron executive. "Everyone who operated in it was pretty much brain dead."
It wasn't until the 1970s that things began to change-or 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 action-any action-describing Lay's management style as "Ready, fire, aim."
A Baptist preacher's 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 didn't. 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 "gas major," 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 money-lots 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 he'd always wanted the world to see him-as 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. "Everyone knows that I personally have a very strict code of personal conduct that I live by," he once told an interviewer for a religious magazine called The Door. "This code is based on Christian values."
Lay was a hard man not to like. His deliberately modest midwestern manner-Lay made a point of personally serving drinks to subordinates along for the ride on Enron's flagship jet-built 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 executives-people like Jeff Skilling-understood 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, he'd 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 mayor-if he didn't accept a president's 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 company's business.
Though few people complained about it before Enron fell, Lay's 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 Enron's 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 company's planes.
At lunchtime, top Enron executives, who worked on the richly paneled fiftieth floor of the company's 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 Lay's early life. He grew up dirt-poor. Indeed, the Enron chairman's 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 region's 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 struggling-until he was 11 years old, Ken Lay had never lived in a house with indoor plumbing-and 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 Lays' 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. "It's hard for me not to think Ken was an adult when he was a child" his sister Sharon said years later. The hardship honed Lay's ambition. He later spoke of spending hours on a tractor, daydreaming about the world of commerce, "so different from the world in which I was living."
Lay's 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. He'd 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. "Ken was one of these 4.0 guys who had some street sense," says Phil Prather, a Missouri classmate and lifelong friend. "Most 4.0 guys I know are a bunch of savants."
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 quiet-he struggled for years to overcome a mild stammer-he was popular as well. At Missouri he won election as president of Beta Theta Pi, the university's largest and most successful fraternity. (Among Lay's 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 weren't 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 Lay's brains and ambition and quickly became his mentor. "We just hit it off with each other from the first," remembers Walker. "It was always inevitable that he would be a man of wealth." 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 master's degree after Walker convinced him that he would be better off in the long run with a master's on his resume. 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 protege. 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.
Excerpted from The Smartest Guys in the Room by Bethany McLean Copyright © 2004 by Bethany McLean. Excerpted by permission.
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“The authors write with power and finesse. Their prose is effortless, like a sprinter floating down the track.”
“Well-reported and well-written.”
Meet the Author
Bethany McLean and Peter Elkind collaborated on this book when they both were Fortune senior writers. McLean, a former investment banking analyst for Goldman Sachs, is now a contributing editor to Vanity Fair and lives in Chicago. Elkind, an award-winning investigative reporter, is now an editor-at-large for Fortune and lives in Fort Worth, Texas.
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So I started into Bethany McLean & Peter Elkind's narration of Enron's rise & fall with high expectations. My expectations were very high having seen the movie version of the same book admittedly several times and knowing that the book is often times better then the movie. Additionally being a subscriber to Fortune magazine I've been privy to both writers work and have been impressed with their style & substance. The Smartest Guys in the Room, The Amazing Rise and Scandalous Fall of Enron does do what a lot of books that are then made into movies which is to fill in gaps and put more meat on the bones of the story. The depth of character building that the authors put into the book is very well done, enhancing and providing greater insight into each of the key players (and a few contributing characters) then what is more broadly known. Further, McLean & Elkind's ability to simplify abstract and highly technical terminologies from the off-partnership entities to the accounting rigueur that Enron utilized allows even a non-MBAer to understand what occurred. The part that undoes most of this great work is the flow of the story-telling itself. With each successive deep-dive into a character the authors start at the earliest possible point in that persons career & then makes their way forward to the eventual demise of Enron and that persons role in it. The issue is that if you take that across the multitude of characters that they bring forward you get a sense that you're on a bungee chord dropping until you get to current events only to be pulled back upwards (or back in time) to restart with another character. It isn't until close to the end when, thankfully, all the character have been developed that the reader can then continue with a sequential story-line. Also, while the story itself is told from a fairly objective point-of-view you get the sense the authors, particularly McLean, are gunning for Jeff Skilling given his treatment of her as described in one part of the book. From a historical perspective one looks at Skilling and can say, he was judged by a jury of his peers and found guilty but when you contrast his actions with the actions of senior executives at the financial institutions during the recent financial crisis you have to ask, did he really do anything different? The financial institutions were reliant on ratings to ensure they had access to liquidity, just like Enron. They needed that liquidity to fund not only their day-to-day operations but any particular growth initiatives, just like Enron. Additionally, all counterparties were aware that this was how they operated because they were on the other end of the deals/transactions that were being made.just like Enron. And then, when that perception is altered, right or wrong, then it's like a deck of cards falling down as the shorts come out of the woodwork..just as Alan Schwartz, Dick Fuld, John Mack and.you got it, Jeff Skilling proclaimed. Now, did the financial institutions use off-balance sheet transactions to move debt to look like earnings? No. But they did use a tool that was highly risky and created increased level of leverages in CDOs. Different tool, same result. I haven't gotten to Crash of the Titans (Merrill Lynch), The Last of the Imperious Rich (Lehman Brothers), but it will be interesting to see what light the senior executives in the financial industry are cast..
I am only through the first few chapters (I work three jobs, so it's difficult to take in more than a few pages at a time.) however, I am so amazed at the scandalous minds that corrupted Enron and still to this day find it unbelievable the length of time the deceit went undetected! The authors write in such a way that it's very easy to understand and you can almost put yourself in the midst of the lies, false records, and greed; almost as if you're there just watching the events unfold. Very well written so far. So glad my husband made this purchase for me. Enjoy!
Enron is, of course, old news by now. The company went bankrupt in 2001, and its spectacular collapse was merely the first of a series of notorious corporate scandals. Most of the story Bethany McLean and Peter Elkind tell in their book has already appeared in newspaper and magazine accounts and in other, rush-to-publish books that hit the market during or shortly after the events described. However, these authors have assembled what may be the single most comprehensive, detailed account and written it like an anecdote-rich, lively business-based novel. We do wish they had included a timeline and a list of sources, since they have had the benefit of being able to draw on all of that other work, on indictments and on testimony before courts and Congress, but their account is engrossing and complete. If you read just one book on the Enron scandal, we believe this may be the book to read.
A compelling look at Enron's demise--the top executives are repugnant, amoral and astoundingly arrogant. The web of byzantine accounting practices at Enron should make all shareholders take a closer look at dya-to-day corporate activities. A well-written, well-researched, and informative read.
This book is thoughtfully written and certainly entertaining, even if at times repetitive. It is a thorough investigation into one of the most dramatic corporate scandals of our time. You don't have to know anything about Enron to enjoy the read. Most importantly, it gives the individual investor, corporate employee or corporate 'advisor' some insight on corporate ethics gone wrong. Egos took over here. As the saying goes 'If its too good to be true it probably is.'
Trully the best book on the greatest corporate scandal ever! Loaded with more details and history on the history and the events the lead to the downfall of Enron. And for people who no nothing of Enron, this book breaks it down down to the financial transactions. It is the best investagative book of our time.
The book was very detailed in its explaination of everything, Enron, how the system works and the people. One of the best books dealing with the business world. Readers may not find all the information interesting, maybe even boring!But can learn a great deal!
I thought it was a great book. I wondered if the authors would be able to convey not only the culture in Enron but the feeling that permeated the air in the market bubble. Great job on both. It is amazing that such a collection of people could allow some strange form of group psychology to permeate that made them believe that paper profits were more important than cash in hand. Of course cash was flowing into their hands (executives) ... just not the company's. Another point of interest is how people who are viewed as powerful are at times tied to and subordinate to the groups that make them powerful. Skilling for example, could not control the very group he created. All in all a good read.
Fantastic Read. The making of history in our country.
First of all, this book is a must read for everyone, particularly politicians and all CEOs of businesses. This is a clear example of what has gone wrong in the business world (and then some). I knew Enron had engaged in fraudulent and highly unethical business practices. However, i had no idea to the extent in which the management team at Enron abused ethics, the law, morality and everything else. I am not even sure what the goal was here. Nobody seemed to be happy in the book despite the money they made and the "status" that they achieved. And it is not just the management team to blame. The SEC, the FERC, the accountants, the attorneys and wall street all created this monster. Perhaps this was a prelude to the the recent scandals, which are the most prolific we have ever seen. The unfolding of events at Enron should have been a warning sign that something was/is truly wrong. There is no doubt in my mind that Enron was no different than a Mafia style boiler room operation. In any event, this shows how dangerous it is to let business run unregulated and unchecked. The goal of business cant just be to make money. It has to be more than that i hope. There has to be some modicum of respect for the law, for ethics and for each other. The way they treated each other and conducted even their personal lives was appalling. All the money in the world is not worth that legacy. The book is very well written and incredibly engaging and riveting. The story of Enron is truly shocking and the authors did a fine job in recounting this sad tale. I think that this is a must read for everyone--no wonder Buffett recommended this. It is sad that this could have happened on our watch.