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Much closer to the present was the spectacular collapse of Michael Milken and his investment banking firm Drexel Burnham. Milken pioneered the use of junk bonds—bonds that have a high risk of default and do not qualify as "investment grade," usually because the company that issues them has a great deal of debt. Although investors traditionally had steered clear of junk bonds, Milken realized that their high yield, together with investors' ability to reduce much of the risk through diversification, made junk bonds a promising new source of financing. Milken's discovery quickly transformed the world of investment banking, and junk bonds were used to finance nearly all of the high-profile takeovers of the 1980s. Drexel threw an annual party, the "Predator's Ball," at which the leaders of Wall Street hobnobbed with Washington politicians. Yet, in less than a decade, Milken found himself in jail, and Drexel Burnham filed for bankruptcy shortly thereafter.
Why is it that, throughout American history, today's brilliant innovator so often becomes tomorrow's disgraced failure? One explanation is simple hubris. "Pride goes before a fall," we are reminded in Proverbs. Very frequently, the same qualities that make entrepreneurs special—brilliance, self-confidence, visionary insight—also bring them crashing down. Brilliant innovators often underestimate their own limitations, and think that everything they do is destined to succeed. Enron's "Darth Vader," former chief executive Jeffrey Skilling, is a vivid example of the type. Shortly before Enron's bubble burst, Skilling sneered at any analyst who dared to question Enron's business plan.
The second crucial ingredient is competition. Although entrepreneurs make enormous profits when they create or discover a new market, their success is sure to attract competitors—and the more spectacular the success, the fiercer the efforts to get a piece of the pie. As competitors enter their market, innovators often see their lavish profits begin to slip away. Spurred by a dangerous combination of pride and desperation, they may take misguided and even illegal risks as they attempt to replicate their early success.
If anything, the remarkable market innovations of the past two decades have magnified the risk of future Enrons, both by enabling competitors to respond ever more quickly to new advances and by creating new financial devices that desperate innovators can use to place enormous bets on the future direction of the markets. Drexel Burnham's collapse was precipitated, in part, by competition from lenders who could provide quicker and more complete financing for takeovers. Only a few years later, Long Term Capital, a hedge fund masterminded by several Nobel laureates, created a worldwide liquidity crisis when its massive bets on esoteric securities turned sour.
Enron has all of the attributes of these previous scandals and more. Enron's energy trading business was a brilliant innovation, but its managers took more and more gambles as competitors emerged. They then tried to obscure Enron's true condition through their now infamous off-balance-sheet partnerships.
What should Christians make of the Enron mess? The most important point is to recognize the limitations of legal solutions to the problems that made Enron possible. There is a tendency, among Christians and non-Christians alike, to assume that we can use legislation to force people to act morally. This impulse has inspired many of the reforms that have been proposed in the wake of the Enron debacle. The problem, as legal scholar William Stuntz has pointed out, is that these kinds of reforms often have effects precisely the opposite of what they intend. Prohibition is the most obvious example, and there are many others.
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