Editorial Comment

	Vol. 228 No. 2
PERRY A. FISCHER, EDITOR

Complexity. In the year 2525, if Man is still alive, if television can survive—there’ll be some late-night comedian telling Bill Clinton jokes. And some editor staring at a blank screen, up against deadline, without a clue.

Well, World Oil has a new publisher, Ron Higgins. Ron is a 35-year veteran of this industry, has earned the promotion, and I look forward to working with him in making a good magazine even better. The occasion did prompt me to create a new joke:

How many publishers does it take to change a light bulb?

Apparently five, but the light bulb never gets changed, because they spend all their time holding down the editor, who just doesn’t want to change anything.

A long editorial in the Jan. 8 issue of The New Yorker was sent to me by our new contributing editor, Arthur Berman, who will be writing the Exploration Column beginning next month (and who’s eminently qualified to write it). It’s a good read and available online. The editorial, called Open secrets by Malcolm Gladwell, used the semantics of “puzzles vs. mysteries” as a literary vehicle to discuss the Enron debacle. But it was really about complexity.

As Gladwell explains, Enron used a complicated accounting technique called mark-to-market. To illustrate, suppose you’re an energy company that enters into a $50 million contract with the state of California, to deliver a zillion kilowatt-hours of electricity 10 years from now. You can estimate the worth of that contract even though you won’t get paid for 10 years. At that time, you could have a profit or a loss, depending on the cost of producing and delivering electricity, and the prevailing prices at that time. With mark-to-market accounting, you estimate the future worth of the deal when you sign the contract, and adjust it accordingly over time. If you say you made $5 million when you signed, this might be little more than a guess, since no money actually changed hands. Gladwell writes, “In the second quarter of 2000, $747 million of the money Enron said it had made was ‘unrealized’ money.”

As if that weren’t enough, Enron had about 3,000 Special Purpose Entities, or SPEs. These entities allow a company to borrow money at a favorable interest rate, among other things. This type of transaction did not have to be reported (at the time) in the company’s balance sheet, allowing a company to raise capital without increasing its debt. SPEs have become common in corporate America. But Enron added the twist of using them to sell parts of itself, to itself.

Without real money coming in, this combination meant, as one expert put it, “They were basically liquidating themselves. ... It was as if you had borrowed money from the bank at 9% and invested it in a savings bond that paid you 7% interest.”

Gladwell writes, “The paperwork for each one probably ran in excess of 1,000 pages. It scarcely would have helped investors if Enron had made all three million pages public. ... a summary of Enron’s SPEs would have come to 120,000 single-spaced pages.”

Gladwell continues, “In Conspiracy of Fools, Kurt Eichenwald convincingly argues that Enron’s CFO, Andrew Fastow, didn’t understand the full economic implications of the deals, either, and he was the one who put them together.”

Anthony Catanach, who teaches accounting at the Villanova University School of Business, said “These were very, very sophisticated, complex transactions ... I’m not even sure any of Arthur Andersen’s field staff at Enron would have been able to understand them, even if it was all in front of them.”

In fact, much of the data was disclosed in unplain sight, tucked away in footnotes, in 10-K and 10-Q financial statements and SEC filings. But there were some people who took the hours and days to read it: reporters at The Wall Street Journal who published articles expressing skepticism about the company’s methods; a famous short seller, who then went about “blowing the whistle” for his own benefit; and six graduate students from Cornell University’s business school enrolled in an advanced financial analysis class in 1998. The students concluded that “Enron may be manipulating its earnings.” They recommended “Sell.” Their analysis is still on the Internet. Enron didn’t hide things, they complicated them.

The Financial Accounting Standards Board (FASB) regulations are several zillion pages long. And there is no chance that the FASB rules are going to become simpler.

Back in my university days, the College of Business was embroiled in a huge cheating scandal. It seems that someone had systematically broken into various professors’ offices and had stolen the tests and answers for most of the college’s coursework. We at the physics department just shook our heads and wondered: What would be the point of having a degree yet being ignorant? Is achieving success so important that, some distant day, we will have a generation of engineers, scientists, accountants and lawyers, all believing that understanding the complexity of a nuclear power plant, an atom, the FASBs or the law is secondary to the success that these professions bring? The challenges to prevent cheating are growing. In decades to come, cheating devices will be the size of a pencil eraser—maybe they’ll have to sweep the room for bugs before giving a test.

If any system is set up to work best by appealing to the basest elements, as epitomized by the famous line “Greed is good,” in Michael Douglas’ impassioned speech in the movie Wall Street, it is doomed to fail. Greed should never be used as a “goodness” to justify unethical behavior. But complexity can be the obfuscating factor that allows exactly that behavior to happen. And preventing wrongdoing through police work will only get more difficult.

The reason is much less than logical or scientific. The reason that a school system, financial system, justice system, indeed, a society works is not because of mastery of the rules of how they work. Complex human systems work because of culture, integrity and behaving honorably. We will never be able to hire enough testing monitors to proctor the proctors, enough internal police to police the police, or enough judges to judge the judges.

Writing this on a laptop 38,000 ft above the Atlantic, cruising at 650 mi per hour, I have this rather certain feeling that, in an uncertain future, one thing we can count on is increasing complexity. How will we handle it? Will we use it for good, or for evil?

I would not be surprised if there were Bill Clinton jokes in 2525, but there won’t be any “light bulb” jokes. No one will remember how to screw one in.