Tuesday, January 09, 2007

Smart Bomb

Here in corporate governance geekland we’re buzzing about Malcolm Gladwell’s piece on Enron in last week’s New Yorker. The article is elegantly written and much more entertaining than it should be, given the subject. And it asks a great question: Why didn’t the financial world see that Enron’s business was a joke, leaving journalists (imagine) to figure this out using publicly available information?

Malcolm Gladwell being Malcolm Gladwell, he comes up with an intriguing answer employing the distinction between a "puzzle" and a "mystery." That’s a little too cute for me, so I'll rephrase what I take to be his working hypothesis: When there’s a whole lot of information and the information is complicated, it’s hard to understand what’s going on. And Enron’s complex financial structure made it especially difficult to sort things out.

But Gladwell doesn't entirely buy this theory. He notes that Enron made clear in SEC filings it was getting significant revenues from related partnerships run by one of its own senior executives, and he wonders why no one except The Wall Street Journal seemed to care.

We should all wonder. The moment people saw that, they should have caught the next flight to Houston and stormed the place with torches.

So why didn’t they? During my days as a lawyer on the Street, there were two players on whom everyone developed a crush. One was Long-Term Capital Management and the other was Enron. In both cases the managers were said to be geniuses. It turned out what they were geniuses at was convincing everyone they were geniuses; if the businesses of LTCM and Enron didn’t make sense, scores of Wharton grads just decided their own IQs must be a few points too low to get it. (We lawyers were mostly unaffected by the madness, having figured out that the air pumped into the trading room contained some sort of happy gas.)

I understand that no one in the corporate world wants to apply psychology except when they’re trying to get people to buy things, but I believe the answer to Gladwell’s question lies in the mystery - or puzzle - that is the human brain. This was a story of normally capable and savvy people caught up in mass financial self-delusion. It’s happened before and it will happen again. Somewhere out there, it’s happening right now.