I Get Mail: Why Did Enron Need So Much Credit?

Cara,

You keep defending Enron but I think you are just making excuses because they ran into trouble with credit.   If Enron had lived within its means it would not have failed.  Even the banks recognized at the end that they were not able to pay their credit and downgraded them.

(Name and email address withheld by request)

 
Despite the awkward phrasing, this is actually a good jumping-off point for a discussion on credit and debt. I think the first thing to understand is that companies, particularly large public corporations like Enron, are not run like households. They are not cash-in, cash-out operations. They rely on massive amounts of credit every day to complete their transactions. Commercial paper is considered synonymous with paying daily expenses – it’s the small number of basis points paid to delay operating costs until quarterly numbers are out. There is nothing untoward or unusual about this at all. Companies pay these loans back usually at the end of every day or week. When something goes wrong, i.e., Fastow was fired as his crimes came to light, banks and creditors were less willing to give Enron the credit they needed to stay alive. When one bank stops, other banks stop as well, sensing that something is very wrong. They start demanding to be repaid right now. Once the banks start, the counterparties start trying to get their money out too. This increases the pressure on the organization as they bleed cash trying to keep creditors and counterparties mollified. This is the run-on-the-bank that we hear so much about.

You’re confusing credit with commercial debt. Public companies can issue stock, which is equity, and bonds, which is debt. [It is perhaps interesting to note that in the case of bankruptcy (not just Enron’s) that debt holders will be compensated before equity holders (ie, shareholders).] This debt essentially makes you a lender to the organization where owning stock makes you an owner. This outstanding debt is rated by several organizations, but the two you are probably familiar with are Moody’s and Standard and Poor’s. Investment grade ratings are required to keep credit flowing (ie, who would lend you more money if your old debt has defaulted?) Enron maintained a pretty good rating with both Moody’s and S&P until both companies began to downgrade in increments as they saw the company floundering; it was apparent that Enron was not able to pay the outstanding loans and it was increasingly unlikely that Enron could honor its bonds/debt. It became a credit crisis when Enron, a trust-based business, experienced a run on their liquidity while their rating agencies put them under review.