I ran into a little historical tidbit that’s worth sharing. It puts a relatively obscure Hawaii business deal into quite a fascinating context.
The deal was the 1989 sale of Aloha Petroleum, then owned by Harken Energy.
If Harken rings a bell, it’s because of its ties to former president, George W. Bush.
Here’s the deal in a nutshell from a column by Paul Krugman which originally appeared in the New York Times in July 2002.
In 1986, one would have had to consider Mr. Bush a failed businessman. He had run through millions of dollars of other people’s money, with nothing to show for it but a company losing money and heavily burdened with debt. But he was rescued from failure when Harken Energy bought his company at an astonishingly high price. There is no question that Harken was basically paying for Mr. Bush’s connections.
Despite these connections, Harken did badly. But for a time it concealed its failure — sustaining its stock price, as it turned out, just long enough for Mr. Bush to sell most of his stake at a large profit — with an accounting trick identical to one of the main ploys used by Enron a decade later. (Yes, Arthur Andersen was the accountant.) As I explained in my previous column, the ploy works as follows: corporate insiders create a front organization that seems independent but is really under their control. This front buys some of the firm’s assets at unrealistically high prices, creating a phantom profit that inflates the stock price, allowing the executives to cash in their stock.
That’s exactly what happened at Harken. A group of insiders, using money borrowed from Harken itself, paid an exorbitant price for a Harken subsidiary, Aloha Petroleum. That created a $10 million phantom profit, which hid three-quarters of the company’s losses in 1989. White House aides have played down the significance of this maneuver, saying $10 million isn’t much, compared with recent scandals. Indeed, it’s a small fraction of the apparent profits Halliburton created through a sudden change in accounting procedures during Dick Cheney’s tenure as chief executive. But for Harken’s stock price — and hence for Mr. Bush’s personal wealth — this accounting trickery made all the difference.
Oh, and Harken’s fake profits were several dozen times as large as the Whitewater land deal — though only about one-seventh the cost of the Whitewater investigation.
Harken’s accounting of the deal was subsequently challenged by the Securities and Exchange Commission, which determined the sale was essentially a sham. The company was ordered to restate its earnings for the period.
It’s the same kind use of “off the books” companies set up by insiders to create illusory transactions to boost profits that later made Enron a household name, and a financial disaster.
I notice that Aloha Petroleum’s corporate history omits this period and its brief bit of national notoriety, although it was flagged by Hawaii Stories back when Krugman’s column was published. And more details were collected in a 2002 blog post by Brad DeLong.
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And lest we forget, Paul Krugman was a paid adviser to Enron before it ruined 1,000’s of lives. Very interesting web indeed.
Yes, but…Krugman was briefly part of a panel which included several other academic economists.
He has responded at length to the way this accusation is made. Here’s his short version.
Here is a link to a longer version:
http://www.pkarchive.org/personal/EnronFAQ.html
Our legal system seems to be failing. GWB and DC should have been prosecuted and imprisoned loong ago. Good citizens are asking for indictment of the pair for war crimes for Iraq/Afghanistans citizens murders.
Something that puzzles me about this accounting sham: So a company uses its own money to pay back to itself in the form of an bogus profit. How does it mask its loss of the funds in the process? It’s a zero-sum system, where it loses the money that it then receives back from itself. So wouldn’t it be a wasted effort? How does it overcome this obstacle?
It makes a loan to the insider group, which then sits on the company books as an asset, money it is owed. And it also books income from the sale as a profit. I guess that’s win-win, accountants style.
And the so-called auditors look the other way. why? because it’s all about one thing: M. O. N. E. Y. ethics only take over when tragedy finally strikes and hurts people, but the changes are always a temporary fix. that’s the way we will live, and for a very long time. there is no fix.
When it comes to Enron, remember that it was not about corporate profits, but rather was about personal stock options.
Creating a shell company by secretly using the parent company’s (overvalued) stock in order to have the shell company buy the parent company’s stock (again, using parent company’s stock to do so) doesn’t generate corporate profits. From a corporate point of view, it is an empty exercise, generating neither desired goods and services nor profit. But what it does do is further inflate the value of the stock. If executive compensation were restricted to profit sharing rather than stock options, it might cut back on abuses like this.