WSJ - Enron's Rise and Fall Mirrors Collapse of Middle West Utilities 70 Years Ago 2002 02.04

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Enron's Rise and Fall Mirrors Collapse Of Middle West Utilities 70 YearsAgo

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Updated Feb. 4, 2002 4:58 a.m. ET

Flash Forward: Step back into the present

and see full coverage of the Enron saga.

As Congress investigated the collapse of a high-profile energy company, it faced a

daunting challenge.

One senator said that to understand the huge company's shocking failure, lawmakers

must consider the regulatory and legal missteps that led to its downfall. How, he

wondered, could Congress restore investors' confidence in the financial system? By

repealing old laws? Enacting new ones?

One of his colleagues answered by recounting an old joke: A man gets a message that

his mother-in-law has died. "Shall we embalm, cremate or bury?" it asks. Replies the

man, "Embalm, cremate and bury. Take no chances."

Was this a moment of levity during last

week's hearings into the Enron Corp.

debacle?

Actually, it was a scene that played out nearly seven decades ago between Fred

Herbert Brown, a New Hampshire Democrat and George Norris, a Nebraska

Republican, as they took to the Senate floor to discuss the demise of Middle West

Utilities Co. The holding company -- the hub of a vast empire built by energy magnate

Samuel L. Insull -- had sunk abruptly into bankruptcy amid allegations of stock fraud

and crooked accounting, wiping out thousands of investors.

Today, many students of corporate history get a sense of dj vu as they

watch the Enron saga unfold. "In the 1930s, investors lost confidence in the basic

institutions of capitalism -- banks, corporations and accountants," says Richard Hirsh,

professor of economics at Virginia Polytechnic Institute and State University in

Blacksburg, Va. "To see this happening again with Enron certainly gives one pause."

Middle West was made up of a host of interconnected companies with interlocking

boards -- an arrangement mirrored, in some ways, by the web of off-balance-sheet

partnerships that concealed Enron's heavy debt burden. So complicated was Middle

West's structure that it took seven years for a team from the newly formed Federal

Trade Commission to fully unravel its financial structure.

Other similarities between Middle West and Enron go straight to the top. Like Kenneth

Lay, who resigned last month as Enron's chairman and chief executive, Middle West's

Mr. Insull was a big campaign contributor, with powerful friends in Washington. Both

men were successful in keeping the government out of their business dealings. Mr.

Insull, for one, "was careful to regulate the regulator," Sen. Norris declared in June

1934.

In its era, Middle West's operations were every bit as groundbreaking as Enron's would

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be with EnronOnline, its Internet-based energy-trading system. Mr. Insull, for example,

pioneered the idea that central power plants should operate 24 hours a day to help

defray their high fixed costs.

To generate enough demand to fulfill this vision, Mr. Insull, who sported a broom

mustache, wooed electric streetcar companies, promoted electric elevators and touted

the labor-saving advantages of the "all-electric home." He even coined the term

"massing production," later shortened by his publicists to "mass production," to describe

the benefits of huge power plants supplying electricity to large regions of the country.

Some economists credit Mr. Insull with single-handedly driving down power costs,

helping American factories to flourish.

But, also like Enron, Middle West pushed its financial engineering too far. By the early

1930s, it was emblematic of the octopus-like "power trusts" that were suspected of

manipulating the nation's energy markets in unseen ways.

Middle West was born in Chicago in 1912, about 31 years after the London-born Mr.

Insull immigrated to the U.S., where he became private secretary to Thomas Alva

Edison. While Mr. Edison invented the technology that harnessed electricity, Mr. Insull

invented the business model that turned it into a money maker. He rose to manage Mr.

Edison's Schenectady, N.Y., operations, later to become General Electric Co.

Then, he moved on to Chicago, where he broke free of Mr. Edison in 1892

and formed Commonwealth Edison Co. by merging smaller companies.

Building Pyramids

Middle West was the first and most prominent of Mr. Insull's half-dozen or so holding

companies. Its myriad affiliates, which included utilities, construction outfits and

electrical-equipment makers, hawked stocks tied to other Insull enterprises. "There was

tremendous pyramiding and preferential treatment of affiliated companies," says Alfred

Kahn, an economics professor at Cornell University in Ithaca, N.Y.

Middle West withstood the stock-market crash of 1929, and it looked at first like Mr.

Insull might emerge relatively unscathed. At one point, he even extended $50 million in

credit to the city of Chicago to pay its schoolteachers and police.

But Middle West had an Achilles' heel. Its companies had taken on an enormous

amount of debt during the go-go years of the 1920s, and the company accelerated its

borrowings after the crash. By the middle of 1931, creditors and rivals, including

financier J.P. Morgan, were circling. In 1932, with presidential hopeful Franklin

Roosevelt blasting the "Insull monstrosity" for allegedly inflating the value of its holdings

and selling worthless bonds, Middle West and many of its 284 affiliates were placed in

receivership.

Washington quickly got into the act. In rapid order in 1934 and 1935, Congress passed

the Securities and Exchange Act, the Public Utility Holding Company Act and the

Federal Power Act. Those laws sought to break up the power trusts and guarantee

investors the information they needed to make informed decisions. More than a half

century later, Enron would figure out ways around parts of those same laws.

After Middle West went bust, an exhausted Mr. Insull left the country, landing in Greece.

Later, at the behest of the U.S., Turkish authorities arrested him on his yacht and

shipped him home to stand trial for fraud and embezzlement.

Shades of Horatio Alger

In a packed Chicago courtroom, the 75-year-old Mr. Insull took the stand, mesmerizing

jurors with his Horatio Alger-like tale of how an English dairyman's son rose to become

secretary to the Wizard of Menlo Park, as Mr. Edison was known, and head of a vast

conglomerate. In all, he stood trial three times; all three trials ended in his acquittal.

Still, he was far from home free. The politicians whom he had liberally supported now

took pains to distance themselves from him. He also lost his personal fortune, estimated

in 1930 at $150 million, which remained significantly tied up with Middle West -- a

notable difference, it seems, from Mr. Lay and other Enron executives who cashed out

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hundreds of millions of dollars in stock before the company went under.

"It looks to me like Enron management made beaucoup boatloads of money and

jumped ship," says University of Alabama historian Forrest McDonald, an Insull

biographer who sees his subject as a tragic figure whose contributions have been

largely overlooked. By contrast, Mr. McDonald says, Mr. Insull "went down with the ship.

"

In 1936, Mr. Insull left the U.S. to live in France, trusting his son to defend his interests

in lingering lawsuits. Two years later, at age 78, he suffered a massive heart attack

while waiting for a Paris subway train. When police arrived, his wallet was missing. The

next day, newspapers gloated over his rags-to-riches-to-rags saga, noting that the

onetime millionaire had died alone, and with a mere 85 cents in his pocket.

Write to Rebecca Smith at [email protected]

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WSJ - Enron's Rise and Fall Mirrors Collapse of Middle West Utilities 70 Years Ago 2002 02.04

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