More "Enron math"

Following the recent spectacular collapse of Enron (in which it went from being the seventh-largest corporation in the US worth $77 billion, to bankruptcy) investigations have sprung up like weeds - press investigations, Congressional inquiries, regulatory agency inquiries, criminal inquiries, etc. Details of Enron's creative math and book-keeping have been leaking out. A good example is Enron's treatment of a subsidiary's broadband venture with Blockbuster. Originally set up in July 2000 as a 20-year partnership intended to transmit movies-on-demand to consumers over Internet connections owned or leased by Enron, the Enron subsidiary booked revenues of millions of dollars even though it never progressed beyond a limited trial in a few selected cities (and the venture was shelved in March 2001).

Another, less noticed, example of Enron-related 'math excess' is in relation to the 401(k)s and retirement plans of Enron employees. With the collapse of Enron's stock price from over $90 to under$1 Enron employees who had their retirement savings mostly in Enron stock have seen their savings evaporate. In congressional testimony, in the press, and in motions related to a class-action suit, we have heard the stories of Enron employees who lost 70 to 90% of their retirement assets following Enron's earnings restatement and bankruptcy filing. Examples include:

Like the creative Enron accounting, the numbers here too do not add up. The reported loss of $1.3 million is based on the value of Enron stock at its highest valuation. A person can put up to 15% of their pre-tax salary into their 401(k), up to a limit of $10,500 (in 2001). Assuming that he contributed the maximum allowable, CP would have contributed $9,750 a year. Enron also matched up to half the employee contribution, up to 6% of base pay. So Enron would have kicked in $3,900 of Enron stock (subject to the condition that the matched stock be held until age 50.) Thus the maximum possible combined contribution at his highest salary level would have been $13,650 a year. Even liberally assuming this level of contribution sustained over several years and allowing for compounded interest or average stock market gains, the total value of his retirement would not approach a fraction of the claimed loss. Additionally, if Enron had not purposely complicated and obfuscated its books, it is very likely that their stock would not have attained a fraction of the valuation that it actually did. Thus, claiming a real loss of $1.3 million is also engaging in some creative valuations.

A year ago I purchased 200 shares of Conseco at $5.75 a share. In the months following my purchase the stock value went up to $17.50 a share before beginning a slow slide down to $3.95. Clearly (ignoring commissions)I have lost (5.75-3.95)*200 = $360. And unlike Enron, the $17.50 price was 'correct' in that it was the value allocated by the market based on complete information and not clouded by "off-the-books" accounting gimmickry. So, should I be feeling bad because I "lost" (17.50-3.95)*200 = $2,710 (a sum greater than my initial investment)?? Certainly not, the gain was never realized.

While the sums in this example are trivial and not comparable in scale, the analogy is correct. I may have felt better off while the stock was at its height, but the fact that its price fell since that point doesn't mean that I have "lost" those dollars. Similarly, though the entire Enron situation is very unfortunate (and no doubt extremely distressing to those who have been adversely impacted), the numbers being reported are fictitious, based as they are on the valuation of the stock at its (artificial) height and not on actual retirement contributions, even compounded at an appropriate interest rate! Congress and the appropriate agencies should investigate fully, and if any illegalities are discovered they should be prosecuted to the fullest extent of the law. However, Enron employees also need to examine their part in the debacle - a retired person (3 of the 5 above examples culled from the press) having the totality of his investments in the stock market (let alone in a single stock!) is a violation of the most fundamental and elementary rules of investing.

© SNi 01/26/2002