What the Dog Saw

What he found startled him. Words about some partnerships run by an unidentified “senior officer.” Arcane stuff, maybe, but the numbers were huge. Enron reported more than $240 million in revenues in the first six months of the year from its dealings with them.

Enron’s SPEs were, by any measure, evidence of extraordinary recklessness and incompetence. But you can’t blame Enron for covering up the existence of its side deals. It didn’t; it disclosed them. The argument against the company, then, is more accurately that it didn’t tell its investors enough about its SPEs. But what is enough? Enron had some three thousand SPEs, and the paperwork for each one probably ran in excess of a thousand pages. It scarcely would have helped investors if Enron had made all three million pages public. What about an edited version of each deal? Steven Schwarcz, a professor at Duke Law School, recently examined a random sample of twenty SPE disclosure statements from various corporations—that is, summaries of the deals put together for interested parties—and found that on average they ran to forty single-spaced pages. So a summary of Enron’s SPEs would have come to a hundred and twenty thousand single-spaced pages. What about a summary of all those summaries? That’s what the bankruptcy examiner in the Enron case put together, and it took up a thousand pages. Well, then, what about a summary of the summary of the summaries? That’s what the Powers Committee put together. The committee looked only at the “substance of the most significant transactions,” and its accounting still ran to two hundred numbingly complicated pages and, as Schwarcz points out, that was “with the benefit of hindsight and with the assistance of some of the finest legal talent in the nation.”

A puzzle grows simpler with the addition of each new piece of information: if I tell you that Osama bin Laden is hiding in Peshawar, I make the problem of finding him an order of magnitude easier, and if I add that he’s hiding in a neighborhood in the northwest corner of the city, the problem becomes simpler still. But here the rules seem different. According to the Powers report, many on Enron’s board of directors failed to understand “the economic rationale, the consequences, and the risks” of their company’s SPE deals—and the directors sat in meetings where those deals were discussed in detail. In Conspiracy of Fools, Eichenwald convincingly argues that Andrew Fastow, Enron’s chief financial officer, didn’t understand the full economic implications of the deals, either, and he was the one who put them together.

“These were very, very sophisticated, complex transactions,” says Anthony Catanach, who teaches accounting at the Villanova University School of Business and has written extensively on the Enron case. Referring to Enron’s accounting firm, he said, “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. This is senior-management-type stuff. I spent two months looking at the Powers report, just diagramming it. These deals were really convoluted.”

Enron’s SPEs, it should be noted, would have been this hard to understand even if they were standard issue. SPEs are by nature difficult. A company creates an SPE because it wants to reassure banks about the risks of making a loan. To provide that reassurance, the company gives its lenders and partners very detailed information about a specific portion of its business. And the more certainty a company creates for the lender—the more guarantees and safeguards and explanations it writes into the deal—the less comprehensible the transaction becomes to outsiders. Schwarcz writes that Enron’s disclosure was “necessarily imperfect.” You can try to make financial transactions understandable by simplifying them, in which case you run the risk of smoothing over some of their potential risks, or you can try to disclose every potential pitfall, in which case you’ll make the disclosure so unwieldy that no one will be able to understand it. To Schwarcz, all Enron proves is that in an age of increasing financial complexity, the “disclosure paradigm”—the idea that the more a company tells us about its business, the better off we are—has become an anachronism.

5.

During the summer of 1943, Nazi propaganda broadcasts boasted that the German military had developed a devastating “super weapon.” Immediately, the Allied intelligence services went to work. Spies confirmed that the Germans had built a secret weapons factory. Aerial photographs taken over northern France showed a strange new concrete installation pointed in the direction of England. The Allies were worried. Bombing missions were sent to try to disrupt the mysterious operation, and plans were drawn up to deal with the prospect of devastating new attacks on English cities. Nobody was sure, though, whether the weapon was real. There seemed to be weapons factories there, but it wasn’t evident what was happening inside them. And there was a launching pad in northern France, but it might have been just a decoy, designed to distract the Allies from bombing real targets. The German secret weapon was a puzzle, and the Allies didn’t have enough information to solve it. There was another way to think about the problem, though, which ultimately proved far more useful: treat the German secret weapon as a mystery.

The mystery solvers of the Second World War were small groups of analysts whose job was to listen to the overseas and domestic propaganda broadcasts of Japan and Germany. The British outfit had been around since shortly before the First World War and was run by the BBC. The American operation was known as the Screwball Division, the historian Stephen Mercado writes, and in the early 1940s had been housed in a nondescript office building on K Street, in Washington. The analysts listened to the same speeches that anyone with a shortwave radio could listen to. They simply sat at their desks with headphones on, working their way through hours and hours of Nazi broadcasts. Then they tried to figure out how what the Nazis said publicly—about, for instance, the possibility of a renewed offensive against Russia—revealed what they felt about, say, invading Russia. One journalist at the time described the propaganda analysts as “the greatest collection of individualists, international rolling stones, and slightly batty geniuses ever gathered together in one organization.” And they had very definite thoughts about the Nazis’ secret weapon.

The German leadership, first of all, was boasting about the secret weapon in domestic broadcasts. That was important. Propaganda was supposed to boost morale. If the Nazi leadership said things that turned out to be misleading, its credibility would fall. When German U-boats started running into increasingly effective Allied resistance in the spring of 1943, for example, Joseph Goebbels, the Nazi minister of propaganda, tacitly acknowledged the bad news, switching his emphasis from trumpeting recent victories to predicting long-term success, and blaming the weather for hampering U-boat operations. Up to that point, Goebbels had never lied to his own people about that sort of news. So if he said that Germany had a devastating secret weapon it meant, in all likelihood, that Germany had a devastating secret weapon.

Starting from that premise, the analysts then mined the Nazis’ public pronouncements for more insights. It was, they concluded, “beyond reasonable doubt” that as of November 1943 the weapon existed, that it was of an entirely new type, that it could not be easily countered, that it would produce striking results, and that it would shock the civilian population upon whom it would be used. It was, furthermore, “highly probable” that the Germans were past the experimental stage as of May of 1943, and that something had happened in August of that year that significantly delayed deployment. The analysts based this inference, in part, on the fact that, in August, the Nazis abruptly stopped mentioning their secret weapon for ten days, and that when they started again, their threats took on a new, less certain, tone. Finally, it could be tentatively estimated that the weapon would be ready between the middle of January and the middle of April, with a month’s margin of error on either side. That inference, in part, came from Nazi propaganda in late 1943, which suddenly became more serious and specific in tone, and it seemed unlikely that Goebbels would raise hopes in this way if he couldn’t deliver within a few months. The secret weapon was the Nazis’ fabled V-1 rocket, and virtually every one of the propaganda analysts’ predictions turned out to be true.

The political scientist Alexander George described the sequence of V-1 rocket inferences in his 1959 book Propaganda Analysis, and the striking thing about his account is how contemporary it seems. The spies were fighting a nineteenth-century war. The analysts belonged to our age, and the lesson of their triumph is that the complex, uncertain issues that the modern world throws at us require the mystery paradigm.

Diagnosing prostate cancer used to be a puzzle, for example: the doctor would do a rectal exam and feel for a lumpy tumor on the surface of the patient’s prostate. These days, though, we don’t wait for patients to develop the symptoms of prostate cancer. Doctors now regularly test middle-aged men for elevated levels of PSA, a