Malcolm Gladwell, author of The Tipping Point and Blink, has produced another fascinating contribution to understanding our thought processes. The January 8th issue of The New Yorker presents his article entitled “Open Secrets” in which Gladwell examines the difference between puzzles and mysteries. He posits that puzzles become easier to solve with more information while mysteries already have all the information needed. Understanding the difference helps one understand the ongoing political shenanigans here in Illinois.
Gladwell uses Osama bin Laden’s location to illustrate puzzles. If we were to discover the world’s most wanted man is holed up in Pakistan, finding him becomes easier than if we only know he’s somewhere in the Eastern Hemisphere. If we develop more information, learning he’s in Rawalpindi, finding him becomes easier. If we divine his street address, the puzzle is solved. Developing this sort of information usually requires someone close to bin Laden to tell us.
Mysteries, in contrast, are conundrums for which sufficient information exists to understand them if experience, judgment and intuition are properly applied. Gladwell uses the experience in Iraq to illustrate mysteries, positing that all developments could have been anticipated before Saddam fell. The distinction is important because the resources required to deal with either a puzzle or a mystery are different; puzzles require spies while mysteries require analysis.
The most interesting of Gladwell’s examples comes from the Enron case. Using Jeffrey Skilling’s sentencing hearing as the touch point, he develops the reasons why Skilling protested his innocence in the face of overwhelming public opinion that he was one of the business world’s great villains. While the public (and apparently the federal judge) concentrated on the effects of Enron’s business strategy, there is reason to believe that Enron actually disclosed enough information for investors to understand what the company was doing long before it collapsed. Gladwell reviews the work of several investors and even a student group that solved the mystery of Enron’s internal business arrangements.
One can almost believe that Enron did comply with the letter of the law by disclosing all their bent deals. The problem is that Enron provided too much information and in that, actually obfuscated their financial position. The company created “special purpose entities” which were essentially side deals designed to allow the company to recognize future, actually uncertain, profits on its current financial statements. One supposes that there is sometimes justification for these sorts of deals but Enron raised them to an art form that actually covered the fact that the company wasn’t as successful as the stock market thought.
In disclosing the existence—if not the import--of these special purpose entities, Skilling apparently thought that he had complied with the securities laws and was “not guilty” of the charges against him. Indeed, for those willing to read these disclosures, the astonishing risk the company was assuming became clear. Gladwell shows how very sophisticated analysis, using tools that are not generally available to the average investor, revealed the company’s problems.
One, not-so-slick analytical trick, available to any investor, is to examine the tax payments the company reported. Essentially, Enron did not pay taxes on the earnings of these side deals. We can assume that the IRS honors its 16th Amendment charge to “collect taxes, from whatever source derived”, so, when Enron disclosed its reported earnings were not taxable income under the Internal Revenue Code, we can believe they really did not exist. This simple fact, clearly reported all along, unlocks the Enron mystery.
This all sounds a lot like the situation in Illinois. For most of us, state finances are also a mystery and, at a $50 billion annual cost, it’s in a similar league as Enron. The state—like Enron—does disclose its financial position in an 800+ page document. Like Enron’s disclosures, the state’s financial statements are a self-contained mystery that defies expert’s understanding. Weird bond deals, suspicious fund transfers and pension payment deferrals are disclosed but so were Enron’s special purpose entities. The information the state provides is so dense that it take great skill to understand the accounting, let alone the meaning of the statements.
But, like Enron, there is one telling fact that anyone can understand. Just like the tax payments Enron did not make exposed its earnings to be imaginary, the state’s accumulated deficit shows the scale of the state’s financial misconduct. Estimates of the deficit range from $44 to $108 Billion or as much as $9,000 for each and every citizen in Illinois. One wonders how such a huge financial hole can even exist because Illinois has a constitutional and statutory requirement to balance its budget. The governor and the General Assembly certify they are in compliance every year. A year later, long after the next budget has been passed, the state releases last year's financial statements disclosing all the reasons that the budget became unbalanced and how they have overspent.
Jeffrey Skilling will probably spend the rest of his life in prison puzzling why he’s there. From his point-of-view, Enron told investors everything they needed to know to make an informed decision. Eventually, the markets rejected Enron. In Illinois, we also fully disclose the same sort of risky financial behavior but here, there’s a different reward—it’s re-inauguration and the near certainty of higher taxes. Why we treat such similar misbehavior so differently is a mystery to me.
