A Discussion with Elizabeth Warren
Harvard Law Professor Elizabeth Warren discusses the downfall of Enron, her latest research, and recent attempts at bankruptcy reform.
First, the question on everyone’s mind: What went wrong with Enron?
I think it’s a pretty straightforward problem with Enron. The company had a core business that worked. It decided to move beyond that business, thinking that somehow the complexity itself would create profit. There were a handful of investment analysts who were deeply suspicious of Enron on the basic principle that if a transaction cannot be explained, then it probably isn’t profitable. But Enron managed to sell most of the world on the idea that if no one could understand their business transactions, then the transactions must be new, exciting and profitable. Enron’s house of cards eventually tumbled down. The real problem was not so much overall business activity that had gone sour; it was a complex, inner-related business structure that hid risks and collapsed when one piece started to go bad.
What are the implications of the Enron downfall?
The fallout from Enron will be measured over decades, not weeks. Enron has already changed the regulatory environment. The deregulation juggernaut could not be stopped until we finally witnessed the complete collapse of a company that aggressively stood for the proposition that deregulation was unquestionably good. The impact on deregulation will not be limited to the energy industry. Enron was also a product of reduced regulation of accounting and reduced regulation by the Securities and Exchange Commission. Enron could not have grown the way it did if the watchers had been watching. Part of the reason they weren’t watching was that watching had itself become a suspect activity, rather than an essential function to support a market in which all investors could have confidence. Anyone who tried to regulate, anyone who tried to watch, anyone who tried to impose curbs on business activities, was derided as merely a defender of the status quo—or insufficiently hip to understand the New Economics.
Too many people got caught up in the idea that the business must be successful—surely if it were fictitious, one of the other watchers would have caught it. Enron is the Emperor’s New Clothes story told again, 21st century style. One big fallout from Enron is that now the watchers will be back on duty and will start watching other companies. I’m not sure we’ve seen the end of Enron-style collapses. How many other emperors are out there in their undies?
Do you think the shareholders can get anything back from this?
It’s possible. It will depend on two things. One is how many valuable operating units can be sold off to generate some payback for creditors. The other will be how aggressive the new management of Enron will be in pursuing assets that were distributed pre-bankruptcy. For example, there may be assets lurking in many of those off-book partnerships that at this moment do not appear on Enron’s books. But fraudulent conveyance law and voidable preference provisions could be used to draw those assets back into the bankruptcy estate. That would make them available for distribution to the creditors and ultimately create value for the shareholders. It is also possible that Congress will change the bankruptcy laws to improve the distribution of assets to employees and retirees, putting them ahead of commercial lenders.
Do you think that’s a good idea?
There are ways the bankruptcy code can and should be amended to improve the ability of employees and retirees to collect what is owed to them when a company collapses. The worst part of Enron is that the sophisticated players got out with tens of millions of dollars while they left the employees, the retirees, and the trade creditors holding an empty bag. They used fancy accounting and special purpose vehicles to shift the risks of failure from themselves to the people who least understood it. That’s the sin of Enron.
To the layperson, it seems that when wealthy people declare bankruptcy, they emerge wealthy and when middle-income people declare bankruptcy, they emerge poor. Is this a fair perception?
They not only emerge poor, they emerge still owing money. The great shock of bankruptcy is that most middle-income people who come out of bankruptcy still owe substantial amounts of money on their home mortgages, their taxes, their alimony and child support, their appliance loans, their car loans and some of their credit card debt. People get some relief from bankruptcy, but very few of them leave bankruptcy with a balance sheet as good as flat zero. The story for the wealthy is completely different. Bankruptcy has a sufficient number of carefully crafted loopholes that anyone who has a lot of money and plenty of good legal advice can glide through bankruptcy, carefully scraping off liabilities and emerging with substantial intact assets.
What makes me so deeply angry about the pending bankruptcy legislation is that it is deliberately designed to squeeze ordinary families harder while carefully preserving every loophole in the system for the rich. In fact, the pending legislation exacerbates the distinction between big and little because it opens new loopholes for big corporations like Enron while it imposes substantial new restrictions on little businesses, making successful bankruptcy reorganization a more remote possibility for them.
Listen to the irony in this: the proposed bankruptcy legislation would make it more difficult and more expensive for any business with less than $3 million in debt to reorganize, but for any business with more than $3 million in debt, it’s business as usual. How can that be? How can Congress consider passing a law that flatly states that small businesses will have fewer opportunities to reorganize than big businesses? People of very modest means will have less opportunity to get back on their feet than rich people. The existing law already has too much of that; the pending bankruptcy legislation would go miles further in that direction.
Your research was cited frequently in last year’s debate over bankruptcy reform. What were the principal findings of your research?
My latest study on consumer bankruptcy focuses on who are the families in bankruptcy. I’ll give you three quick findings that have just knocked me over. One of the big questions is whether the rise in consumer bankruptcy filings is the result of more chronically poor people getting credit and filing, more middle-class people abusing the system, or, as I hypothesize, more families who are trying hard, but who get hit by some economic calamity they just don’t have the resources to handle? The data show that the families filing for bankruptcy last year were a cross section of middle-class America. Their educations were slightly better than average in the U.S. More than half were homeowners. Their occupational prestige mirrors the range of occupations in the U.S. job market. By virtually any definition, about 90 percent of the debtors in bankruptcy would be classified as solidly middle class. But two out of three lost a job at some point shortly before filing. Nearly half had medical problems and about a fifth had recently been through a divorce. In fact, jobs, medical problems, and divorce account for about 80 percent of all filings. These families are ordinary middle-class families who look like their neighbors, but who could not weather an economic storm. These are families trying to put together a life of reduced circumstances, but nonetheless a life where the kids get up and go to school, mom and dad go to work, they have a car, and they have a moderately safe place to live. And for some, bankruptcy means they will have a chance over the next few years to recreate a future for themselves. At its best, for corporations and families, bankruptcy is not about financial death, it is about financial rebirth.
Do you feel the bankruptcy system as it is now is failing many of these families?
It’s not as good as it ought to be. These families are not stabilizing themselves sufficiently, in part because the bankruptcy rules are not giving them enough protection. There are aggressive creditors who continue to prey on these people even after they file for bankruptcy. The current bankruptcy rules are inadequately enforced, and there should be some changes to make them more self-enforcing. We have to remember that most of the families that go through bankruptcy do not have the money to hire a lot of legal help. They get a lawyer to get them through the basics of the process, but they don’t have the money to buy active counsel—someone to fight to enforce all of their rights when they’re in financial trouble.