Bethany McLean — Enron, FTX, 2008, Musk, frauds, & visionaries

Bethany McLean is the journalist who first broke the Enron story with her 2003 Fortune article “Is Enron Overvalued?” and co-authored the definitive book The Smartest Guys in the Room; she has since written major works on the financial crisis (All the Devils Are Here), Fannie and Freddie (Shaky Ground), and fracking (Saudi America). In this conversation, she draws on decades of covering corporate fraud to explore the recurring patterns that connect Enron, the 2008 financial crisis, Theranos, and FTX—arguing that the line between visionary and fraudster is far thinner than people think, that self-delusion is the common thread in nearly every major business collapse, and that the financial system has grown too large relative to the real economy.

The visionary-fraudster spectrum

• McLean argues that visionaries and fraudsters share many of the same traits—grand ambition, charisma, the ability to inspire belief—and that the only thing separating them is often just access to continued funding; if a company can keep raising money, the fraudster’s lies are papered over and they go down as a visionary, but if funding dries up, the fraud is exposed.
• Enron’s Jeff Skilling genuinely believed in his vision for energy trading and broadband; Enron Broadband could have been Netflix ahead of its time, but the company lost access to capital markets after the dot-com bust, and all the fraud came to light.
• Elizabeth Holmes, Sam Bankman-Fried, and Skilling all convinced themselves they were doing the right thing, at least initially; self-delusion is so powerful that studying past frauds may not deter future ones because perpetrators never identify themselves with the villains of history.
• Elon Musk sits on this spectrum—McLean’s 2018 Vanity Fair piece on the Buffalo solar factory showed how Musk relies on government subsidies while presenting himself as a free-market libertarian, and how the Tesla-SolarCity acquisition was largely a bailout of Musk and his relatives who had loaned money to SolarCity; she notes that the solar roof business has largely collapsed and the promised employment never fully materialized.

Enron and FTX: parallels and differences

• The similarities between Enron and FTX are striking: both used related-party transactions and conflicts of interest, both had politically connected CEOs, both used their own stock or tokens as collateral, both had implausible valuations, and both attempted short-lived buyouts by competitors.
• But McLean cautions that FTX deliberately operated outside the U.S. regulatory perimeter (based in the Bahamas), which suggests that post-Enron reforms like Sarbanes-Oxley did work in a narrow sense—they pushed fraud offshore or into less regulated spaces.
• Enron’s collapse was not purely fraud; McLean coined the term “legal fraud” to describe how Enron abused accounting rules (especially mark-to-market accounting and special purpose entities) to create an appearance of economic reality that had no basis in actual cash flows, with only some elements (Andy Fastow’s theft, the alleged “Global Galactic” agreement) constituting outright illegal fraud.
• The prosecution of Skilling and Fastow was aggressive partly because Enron’s collapse was a watershed moment that shook public confidence in retirement savings and corporate America; McLean notes the relative unfairness that Skilling served over a decade in prison while almost no major figures in the 2008 crisis faced criminal penalties.

Why frauds recur and why we fail to learn

• McLean is skeptical that documenting frauds has a strong deterrent effect because self-delusion prevents perpetrators from identifying with past villains; she does believe, however, that understanding how things go wrong has intrinsic value for society—humans need narrative to make sense of the world.
• She is skeptical that white-collar criminal sentences deter future crime; the 2006 Enron convictions did not prevent the financial crisis, and Holmes’s conviction did not prevent FTX.
• The order in which information is presented affects perception: if a trusted, respected person presents an opportunity first, it is much harder to see red flags than if a skeptic raises concerns first—this is a fundamental cognitive bias, not a failure of intelligence.

Short sellers and market efficiency

• McLean argues that the efficient market hypothesis is obviously wrong in the short term; Keynes’s dictum that “the market can remain irrational longer than you can remain solvent” is more accurate.
• There is a persistent cultural stigma against short selling in America—it is seen as un-American or rooting for failure—which reduces the number of market participants willing to bet against overvalued companies.
• The four-decade bull market driven by falling interest rates made shorting extremely difficult and unprofitable, further reducing the short seller population.
• Jim Chanos noted that finding technically skilled short sellers is easy, but finding people with the psychological fortitude to hold a conviction while losing money and being told they are wrong by everyone is extremely rare.
• The shortage of short selling is especially dangerous in private markets (venture capital, private equity), where there is no mechanism for betting against overvaluation; McLean argues this contributed to bubbles in Theranos and FTX, both private companies with opaque financials.

Private markets and the opacity problem

• The massive shift into private assets has reduced systemic safety because private companies lack publicly available financials, short seller scrutiny, and journalist access.
• The common justification that only sophisticated institutional investors bear the risk is misleading—those institutions are largely pension funds, mutual funds, and ultimately the savings of ordinary people (teachers, firefighters).
• Private equity marks on portfolio companies appear to be significantly overstated relative to public market valuations, suggesting another bubble is forming.
• Investors have been complicit because they benefit from the ability to “smooth” returns by avoiding mark-to-market losses that would be visible in public markets.

Intelligence, rationalization, and fraud

• McLean’s title The Smartest Guys in the Room was partly ironic, but she acknowledges that corporate fraud is almost always masterminded by very intelligent people.
• Smart people may actually be more susceptible to self-delusion because their ability to rationalize is more profound—they can construct elaborate narratives under which their actions are blameless.
• The relationship between intelligence and fraud is not that smart people are more likely to commit fraud, but that when they do, the scale is gargantuan because of their ability to construct complex schemes and convince others.

Deal-making for its own sake

• Both Enron and FTX engaged in frenzied deal-making (Enron’s broadband and international projects, FTX’s $5 billion in investments and acquisitions in a single year) that destroyed value.
• McLean argues this pattern is not limited to fraudulent companies—most M&A transactions do not create shareholder value, and most promised synergies never materialize; deal-making is often driven by the desire to show Wall Street short-term earnings growth and by CEO hubris.
• The culture of valuing deal volume over deal quality is pervasive in corporate America.

Culture versus incentives

• McLean sees culture and incentives as deeply intertwined—incentives help create culture, but culture has an independent, powerful effect.
• She reflects on whether she would have been a whistleblower or a believer had she joined Enron; she suspects culture is so strong that she likely would have been a believer, illustrating how difficult it is to see outside the prevailing narrative of a compelling organization.
• The more compelling and visionary the CEO, the more susceptible employees are to mass delusion; people have a deep human desire to matter and be part of something greater, and visionary leaders tap into that desire in ways that incentives alone cannot explain.

Compensation and long-term thinking

• Stock options were supposed to align management and shareholder interests but created perverse incentives: repricing, gaming earnings targets, and pressure to inflate stock prices in the short term so executives could cash out when options vested.
• Designing compensation that rewards long-term thinking is extremely difficult; longer vesting periods are better in theory but create problems like executives who should retire staying in place, and the question of how much money is enough to motivate someone who already has millions.
• McLean concludes there is no perfect compensation system, but longer-term vesting is probably better than short-term.

The FTX aftermath and the “Enron mafia” question

• After Enron, many talented employees went on to start successful firms (Kinder Morgan, Centaurus); McLean thinks some FTX alumni will likely start successful firms too, but whether they stay in crypto depends on the long-term viability of the crypto industry itself.
• She is skeptical about crypto’s fundamental value—she never understood it despite its explosion, and now wonders if there was nothing to understand; she notes Larry Fink’s prediction that the industry will implode and the recent departure of Binance’s auditor as signs of systemic collapse.
• The energy trading business that Enron pioneered largely disappeared after its collapse, and McLean suspects something similar may happen to crypto after FTX.

Is finance too big?

• McLean believes finance is too large relative to the economy (9% of GDP); the right level is whatever enables productive business activity without becoming an end in itself.
• Signs that finance is too big: disproportionate talent flowing into finance rather than productive enterprises, and disproportionate financial rewards relative to other careers.
• A former Goldman Sachs partner told her finance should be like the substrata—the thing that enables other things to happen—not the thing itself; when finance becomes the thing itself, there is a problem.
• Hedge funds especially draw her ire because their returns have been largely enabled by 40 years of declining interest rates—a gift of timing, not unique brilliance—and yet the participants now believe they are genuinely smart.

Fannie, Freddie, and off-balance-sheet debt

• Fannie and Freddie are essentially America’s special purpose entities—their debt is off the balance sheet, much like Enron’s SPEs.
• The old Fannie and Freddie, with shareholders bearing some risk, were more honest than the current conservatorship structure; the “implicit guarantee” (the market’s belief the government would bail them out despite official denials) was a textbook example of market inefficiency.
• Reforming Fannie and Freddie is politically impossible because it is enormously complicated and any solution angers one side of the aisle or the other; they are likely to remain in conservatorship indefinitely.

Household debt and the next crisis

• U.S. household debt has reached $16.5 trillion, rising $350 billion in a single quarter; McLean is uncertain whether this signals another crisis.
• The key difference from 2008 is that consumer debt is not embedded in the financial system’s plumbing the way mortgage-backed securities were; the 2008 crisis was caused not by mortgage losses themselves but by the way those losses were magnified through complex instruments and then by the collapse of confidence.
• Consumer debt is unsecured and more visible, which may make it less dangerous, but McLean acknowledges she hasn’t studied it enough to be certain.

The big picture problem: who synthesizes?

• A recurring theme in McLean’s work is that people become so focused on their narrow domain that they miss systemic risks—Enron employees didn’t see the total debt load, mortgage market participants didn’t see the correlation of nationwide housing delinquencies.
• She believes the role of synthesizing the big picture is critically important but has no one assigned to it; the Financial Stability Oversight Council (FSOC) was created after 2008 for this purpose but faces the near-impossible task of mapping reverberations in an increasingly complex system, especially when confidence collapse is a key risk factor that cannot be quantified.
• The decline of local journalism has dramatically reduced the chances of serendipitous big-picture discovery; national outlets depend on local reporters to surface stories, and without them, the ecosystem of accountability is degraded.
• McLean’s own training—a math major and investment banking experience—gave her the logical framework to notice when something doesn’t add up; she believes formal training in logic is essential for big-picture thinking, as is the humility to recognize that the improbable happens repeatedly.

Rating agencies and the conflict-of-interest problem

• Credit rating agencies were central to both Enron and the 2008 crisis; despite the 2006 Credit Rating Agency Reform Act passed after Enron, the agencies sat at the center of the financial crisis just a few years later.
• The fundamental problem is that rating agencies are paid by the companies they rate, creating an inherent conflict of interest.
• But the libertarian alternative—replacing private agencies with government ones—is not clearly better; government raters would still face limitations.
• Large investors actually want the cover of rating agencies so they can blame the agency rather than take responsibility for their own due diligence; this is why reform appetite disappears after each crisis.

Legal fees and the cost of bankruptcy

• In Enron’s bankruptcy, roughly a billion dollars that should have gone to victims was consumed by legal fees; McLean notes this is a systemic problem where the capital supposed to be rebuilt is instead extracted by the financial and legal system.
• She draws an analogy to the NTSB’s highly effective process of investigating plane crashes, which has dramatically improved aviation safety; a similar non-legalistic, expert-driven approach to corporate collapses might be more effective.
• However, she acknowledges that the investigative work done by the Justice Department, Congress, and bankruptcy examiners is essential—journalists depend on the documents and data these entities uncover through subpoena power, and without that work, books like hers could not be written.

John Ray and the bankruptcy administrator role

• John Ray, who oversaw both the Enron and FTX bankruptcies, is a somewhat mysterious figure; McLean downplays the significance of his role, noting that bankruptcy administrators have an incentive to portray the situation as catastrophic so that any money they recoup looks like a triumph of their management.

McLean’s writing process and intellectual honesty

• McLean tries not to work on stories that require a predetermined answer; she prefers stories that are interesting regardless of how they turn out, to avoid the bias of wanting the story to fit a thesis.
• She changed her mind significantly while reporting All the Devils Are Here: she initially believed homeowners were equally to blame for the financial crisis, but after discovering internal Washington Mutual presentations showing how lenders deliberately steered borrowers into riskier mortgages to sell to Wall Street, she concluded the responsibility was fundamentally unbalanced.
• She believes everyone has the capacity for deception; the rationalization that “I’m doing this to protect shareholders” or “I’m serving a greater good” is available to anyone, and smart people are especially good at it.
• She also notes the concept of “moral luck”—many CEOs are as disconnected from their companies as Ken Lay was, but only the unlucky ones whose companies collapse are held accountable; this is analogous to texting while driving, where many do it but only the one who crashes is punished.

Advice for big-picture thinkers

• McLean’s key advice: force yourself to write things out in full prose rather than relying on bullet points and PowerPoints; writing clearly requires thinking clearly, and it is only through writing that she discovers what she doesn’t actually understand.
• She acknowledges the journalism industry she entered no longer exists—it is now much harder to make a living as a writer without independent financial support—but the discipline of writing remains the best tool for understanding complex systems.

Next book

• McLean is writing a book with Joe Nocera (her co-author on All the Devils Are Here) about the economic consequences of the pandemic, which has broadened into an examination of how capitalism is and isn’t functioning in modern society, and how government sets the rules that determine whether markets function well; it is scheduled for publication in October 2023.