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Living in a House of Cards

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That strategy may have received a boost with the recent indictment of Arthur Andersen, as well as revelations that Fastow allegedly pressured banks and pension funds to invest in the off-balance-sheet partnerships in exchange for other Enron business. Watkins and chief operating officer Jeff McMahon told V&E attorneys and the Powers committee that favored lenders were known within the company as "Friends of Enron."

"That was actually a pretty widely used term -- FOE," confirms a former vice president with Enron Global Markets, who pronounced it "pho," like the Vietnamese noodle soup. "And for a while it worked. For a while everyone was happy."

Before Enron collapsed, its transformation from a stuck-in-the-mud pipeline company to New Economy "market-maker" was much celebrated, as was its principal architect, Jeff Skilling. Even today, many employees, while no longer worshiping at Skilling's altar, still marvel at his extraordinary intellect.

Lay particularly admired Skilling. In January, some weeks before he declined to testify before Congress, Lay was interviewed by attorneys representing the Powers committee. According to the notes of that session, Lay trusted Skilling, never felt manipulated by him and considered him a man of integrity and good judgment. He pointed out that Skilling had graduated from Harvard.

Skilling joined Enron in 1990 to run its embryonic natural gas trading business, Enfolio GasBank. The GasBank guaranteed its customers delivery of a certain amount of natural gas, at a certain time, for a predetermined price. At the end of each quarter, each contract was "marked to market" -- that is, its value was recorded depending on the price of gas that day. Enron then booked each contract as earnings or loss.

In 1993, Enron partnered up with the California Public Employees Retirement System, or CALPERS, to invest in independent producers of natural gas, crude oil and electricity. When CALPERS cashed out in 1997, Fastow engineered the infamous Chewco partnership. Chewco's financial statement should have been consolidated on Enron's balance sheet, but Skilling and Fastow apparently convinced the board that the partnership was an independent company, like CALPERS.

The "error" was discovered in November, and when the arithmetic was complete, Chewco accounted for a large part of the $1.01 billion write-down in asset value that preceded Enron's bankruptcy. The details of the Chewco transaction are extraordinarily complex. Less complicated is why Enron did the deal in the first place: It couldn't find a partner to invest in its assets. Michael L. Miller remembers when, a few years back, Enron tried to package its South American and Caribbean energy assets and sell them as a way of generating capital. For no apparent reason, the marketing effort was called Project California; one package was dubbed SoCal, the other NoCal.

"The SoCal package went out to ten to 12 potential buyers," Miller recalls. "Meetings were held, but they couldn't get anyone to submit even a preliminary bid. My boss pulled the NoCal book before it even went out to market. That was proof in the pudding that there wasn't a huge level of demand out there for the assets we had."

Janice Holloway, who used to work for what was once known as Enron International, remembers that the group's assets were "always on the block. But from what I could tell, they never sold more than a few." Holloway also recalls the prescient comments made by a co-worker as he left the company a few years ago. "He said to me, 'I don't know how they can keep this business going. I don't know how they are booking profits.' "

Holloway, who asserts she had a relatively low-level position working with the group's attorneys, says she responded by going downstairs to get a cup of coffee. "Yeah, I did wonder a little bit about it at the time," she says now. "But it wasn't something that people were talking about, like around the water cooler or anything. I wasn't a manager or a director. I didn't see any need to question. I really wasn't privy enough."

Enron began employing off-balance-sheet partnerships, which are widely used by U.S. corporations, in the early 1990s to hedge its investments in emerging markets. Often they proved to be good business decisions. Miller recalls that in August 2000, Enron Wholesale Services did a deal with one of several partnerships Enron named after a garbage-eating creature from Jurassic Park called a raptor. The year before, Enron had put $5 million in Active Power, an alternative energy company in Austin. The day the company went public, Enron's investment was worth $60 million. Miller's group hedged the gain by transferring the shares to Raptor during the 180-day "lockdown period," when they can't be sold on the market.

"It was a good deal," Miller recalls. "We were able to sell the shares and make a cash profit of $25 million on a $5 million investment."

That explains why Miller, who was instrumental in organizing the Severed Enron Employees Coalition and eventually wrote the group's charter, says the depiction of the horrendous Raptor losses in the Powers committee report "surprised me a little."

As detailed by the committee report, the Raptor partnerships were spun off from Enron's dealings with perhaps the best-known of its off-balance-sheet schemes, LJM -- so named for the initials of Fastow's wife and two children. Raptors I through IV had the greatest impact on Enron's financial statements, the committee report said, allowing the company to conceal $1 billion in losses on poorly performing assets it couldn't dump. The Raptors' fatal flaw was that they were capitalized not with outside equity but with Enron stock.

For example, LJM1 and its related Raptors received Enron stock to hedge investments in an Internet service provider, Rhythms NetConnections, and the expansion of a fiber-optic cable network. As long as the tech companies did well, the phony hedge was harmless. As long as Enron's share price held its own, the hedge served a useful purpose. While the details are infinitely more complex, the upshot is that both Enron's tech investments and its share price tanked. The company's management complicated matters by restructuring the deals in early 2001 without seeking approval from the board of directors. Nonetheless, the tech companies continued to decline in value, as did Enron's stock.

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